The New York Times Econmix blog features a post from Simon Johnson and Peter Boone, who point out that the path taken was not chosen due to an absence of alternatives, but was a political decision, where powerful interests shaped government policy, damning generations of Irish taxpayers to debt and austerity.

“Ireland had more prudent choices. It could have cut the budget deficit while also acknowledging insolvency and requiring creditors to share some of the burdens. But a strong lobby of real estate developers, the investors who bought banks’ bonds and politicians with links to the failed developments (and their bankers) prefer that taxpayers, rather than creditors, pay. The European Central Bank, the European Union and the International Monetary Fund share some responsibility; they advocate these unlikely programs so that European and global banks, which provided the funds to the Irish banks, do not suffer losses from such bad lending decisions.

The Irish government plan is – with good reason – highly unpopular, but the coalition of interests in its favor seems strong enough to ensure that it will proceed, at least until it either succeeds and growth recovers, or ends in failure with the default of banks or the nation itself.

Under the current program, we estimate that each Irish family of four will be liable for 200,000 euros in public debt by 2015. There are only 73,000 children born into the country each year, and these children will be paying off debts for decades to come – as well as needing to accept much greater austerity than has already been put into force. There is no doubt that social welfare systems, health care and education spending will decline sharply.”

Brian Lucey proposes in the Irish Times that the government  “seek the assistance of the EU in restructuring our fiscal position.” However, as Donagh from Irish Left Review comments, the EU’s policy will likely be determined by the needs of their own dominant interests.

The EU has accepted almost all of the governments plans so far – and as Johnson and Boone argue, do so largely to protect the interests of the larger banks within the Eurozone (mainly French and German) do not suffer unduly.

There’s no easy way to fill the gap, but an alternative to a hike in income tax rates on middle income earners would be to take the radical step of abolishing (or dramatically reducing) stamp duty on homes and introduce an annual levy based on the size of the house. Maybe large homes could pay €600 a year, medium sized home €400 and smaller home €200. How would you define this? A home over 200 sq.m might be at the larger end of things, and under 100 sq. m could be in the smaller category. It all could be done by self-assessment. If home-owners couldn’t pay, then the levy could remain as a charge on the home when it eventually changed hands.

What’s funny about this is that it takes a few recommendations from the Site Value Tax proposals, namely, a) allowing for the charge to be deferred until the property changes hands and b) using it to replace stamp duty. It does of course, go against Party policy, and Cuffe duly removed the offending musings from his blog, though it’s still available on the Green Party feed aggregator.

..But the other lesson of the Great Depression is that properly targeted fiscal policy which focuses on job creation can work. The Great Depression was indeed a disastrous human calamity but FDR’s New Deal (including the high wage policies) attenuated the disaster. There is nothing to the claims that the interventions made things worse, other than when Roosevelt himself capitulated to the tired old forces of financial conservatism and fiscal austerianism, and the economy paid the price. Thankfully, FDR was not ideologically wed to the ideas of fiscal austerity and quickly reversed course. It helped, of course, that his Cabinet was well represented by progressive figures such as Frances Perkins, Henry Wallace, Harold Ickes and Harry Hopkins, who overcame the forces of economic conservatism embodied by FDR’s Treasury Secretary, Henry Morgenthau. We need these kinds of progressive forces in current Administration, especially given the recent resignation of CEA head, Christina Romer. It’s time to let go of the old ideology, which created today’s crisis. Here’s hoping that President Obama, like FDR before him, changes course quickly. America is ready for a new New Deal. (link to full article)

The LVT, an annual tax on the market rental value of land, would allow for the abolition of stamp duty – a tax on the aspirations of young people to put down roots and get on in life.

In this way, it puts aspirational socialism into practice – a philosophy that combines the best of old Labour and the best of New Labour, where collective action helps all people be the best they can be. It captures mainstream Labour opinion in a way that old Labour or New Labour never truly did. And that is why it is right for this time.

The full article was published in the Guardian, here

Monetary policy under challenge … finally

The central bankers have been meeting in Wyoming over the weekend as part of the annual Economic Symposium organised by the Federal Reserve Bank of Kansas City. While not all of the papers and discussion are yet available for public scrutiny there were some notable presentations (that you can access in full) which suggest that key central bankers are starting to realise that the economic crisis in not over and the fiscal-led recovery is slowing and that monetary policy alone cannot provide the solution. Moreover, one leading central banker indicated that monetary policy is not a suitable tool for controlling longer term problems such as price bubbles in specific asset classes. This view challenges the basis of the mainstream macroeconomics consensus that has dominated the policy debate for 30 odd years and culminated in the worst financial and economic crisis in 80 years. It is certanly a welcome trend in a debate which is typically flooded with ideological input from the mainstream macroeconomics profession.

This afternoon (August 30, 2010), Bloomberg is reporting that – Bernanke Faces Skepticism on Policy Tools, May Need Fiscal Aid.

The news report is updating coverage of the Economic Symposium organised by the Federal Reserve Bank of Kansas City. You can access the papers for the Symposium – HERE – but at the time of writing they were not yet available for the 2010 event.

Over the weekend, the Economic Symposium at Jackson Hole, Wyoming heard two strong presentations from central bankers – Ben Bernanke and Bank of England deputy Charles Bean.

Modern Monetary Theory (MMT) posits that fiscal policy is the most effective counter-stabilisation tool available to national governments if they are sovereign (that is, run a currency-issuing monopoly and float the currency on international foreign exchange markets).

MMT downplays the effectiveness of monetary policy claiming it is a blunt instrument which cannot be targetted (by demographic cohorts, region etc) and has uncertain aggregate impacts on overall spending because it creates winners and losers each time the interest rate is changed.

At the Economic Symposium this theme has begun to emerge among the mainstream speeches of Bernanke and Bean. I guess they cannot go on ignoring the empirical evidence forever even if the mainstream academic economists seem unable to poke their heads out the window to see what actually happens in the real world and why…(link to full article)

Japan’s example. Does it apply to our current challenge?
from New Deal 2.0 by Robert Johnson

No Convincing Economic Arguments Against Further Stimulus Spending

….Rogoff cites his own work, with Carmen Reinhart, in arguing that debt-to-GDP ratios of more than 100 percent are “above the threshold where growth might be affected.” But their paper really doesn’t show much at all, especially for economies like the United States and the Eurozone that can borrow in their own currencies. Countries that end up with debt greater than 100 percent of GDP are likely to have other problems that got them there. As others have also noted, without controlling for these other factors — which this paper decidedly does not do — there is no way of establishing causality. In fact, the authors do not even control for changes in population growth, since they look only at GDP growth rather than per capita GDP.

Rogoff adds another self-defeating argument: “Importantly, governments that emphasize long-term fiscal sustainability are likely to have an easier time inducing their central banks to maintain highly supportive monetary conditions.”

In other words, he is saying that central banks might react to expansionary fiscal policy in the present situation by tightening monetary policy. But this just means that the central bank should be subordinated to national economic policy, instead of the other way around. He is taking for granted that central banks must be “independent.” But as experience has demonstrated — e.g. the U.S. Federal Reserve somehow missed the two biggest asset bubbles in world history — this doesn’t necessarily mean independent of Wall Street, it means independent of the public interest. So yes, a government that wants to use expansionary fiscal policy will need the cooperation of its central bank. And should have it.

Rogoff argues that “anemic growth with sustained high unemployment is par for the course in post-financial-crisis recoveries.” Par for whose course? If past governments made stupid mistakes and/or didn’t care about condemning a generation of low-income young people to years of unemployment, does that mean we should do the same? At the end of the day, Rogoff provides no convincing economic argument why either the United States or Europe cannot, or should not, finance the necessary stimulus until unemployment approaches more normal levels.

Smart Taxes has decided to devote itself to get the message out.  Here below is as good exposition as you will get on why the government’s deficit is not the problem – politicians and economists in thrall to defunct gold standard monetary theory is our problem.

Deficits Do Matter, But Not the Way You Think
from New Deal 2.0 by L. Randall Wray

Budget deficits and government spending are necessary to end today’s crisis.

In recent months, a form of mass hysteria has swept the country as fear of “unsustainable” budget deficits replaced the earlier concern about the financial crisis, job loss, and collapsing home prices. What is most troubling is that this shift in focus comes even as the government’s stimulus package winds down and as its temporary hires for the census are let go. Worse, the economy is still — likely — years away from a full recovery. To be sure, at least some of the hysteria has been manufactured by Pete Peterson’s well-funded public relations campaign, fronted by President Obama’s National Commission on Fiscal Responsibility and Reform — a group that supposedly draws members from across the political spectrum, yet are all committed to the belief that the current fiscal stance puts the nation on a path to ruinous indebtedness. But even deficit doves like Paul Krugman, who favor more stimulus now, are fretting about “structural deficits” in the future. They insist that even if we do not need to balance the budget today, we will have to get the “fiscal house” in order when the economy recovers.

There is an alternative view propounded by economists following what has been called “Modern Money Theory”, which emphasizes the difference between a currency-issuing sovereign government and currency users (households, firms, and nonsovereign governments) (See here and here). They insist that the notion of “fiscal sustainability” or “solvency” is not applicable to a sovereign government — which cannot be forced into involuntary default on debts denominated in its own currency. Such a government spends by crediting bank accounts or issuing paper currency. It can never run out of the “keystrokes” it uses to credit bank accounts, and so long as it can find paper and ink, it can issue paper currency. These, we believe, are simple statements that should be completely noncontroversial. And this is not a policy proposal — it is an accurate description of the spending process used by all currency-issuing sovereign governments.

And, yet, there are a number of misconceptions circulating that need to be addressed. Many (often of the Austrian persuasion) interpret this simple statement as a Leninist plot to destroy the nation’s currency by flying black helicopters dumping an infinite supply of bags of money all over the planet. This is usually accompanied by a diatribe on the evils of fiat money, with a call to return to “sound money” based on shiny yellow metal. Others suggest that we are instead proposing to ramp up the size of government, until it completes Obama’s plan to gobble up the whole economy. Almost all critiques eventually produce a lecture on the lessons to be learned from Weimar Germany and from Zimbabwe.

The strangest criticism of all is that we MMT-ers argue that “deficits do not matter”. In a recent exchange in the New York Times, Paul Krugman put it this way: “But here’s the thing: there’s a school of thought which says that deficits are never a problem, as long as a country can issue its own currency.” In that piece he took Jamie Galbraith to task for arguing that “Insolvency, bankruptcy, or even higher real interest rates are not among the actual risks” facing a sovereign government. I won’t go into the details, but Krugman produced a simple model in which ever-larger budget deficits generate ever-rising prices. You can see the rest of that back-and-forth here. But the strange thing is that Krugman never actually addressed Galbraith’s points that insolvency, bankruptcy, or higher interest rates are non-issues for a sovereign government. Nor did Krugman even try to justify his claim that MMT-ers “say that deficits are never a problem”.

In fact, MMT-ers NEVER have said any such thing. Our claim is that a sovereign government cannot be forced into involuntary default. We have never claimed that sovereign currencies are free from inflation. We have never claimed that currencies on a floating exchange rate regime are free from exchange rate fluctuations. Indeed, we have always said that if government tries to increase its spending beyond full employment, this can be inflationary; we have also discussed ways in which government can cause inflation even before full employment. We have always advocated floating exchange rates — in which exchange rates will, well, “float”. While we have rejected any simple relation between budget deficits and exchange rate depreciation, we have admitted that currency depreciation is a possible outcome of using government policy to stimulate the economy.

A favorite scenario used by the critics is the ever-rising budget deficit that causes the government debt-to-GDP ratio to rise continuously. As interest payments on the debt increase, government faces a vicious cycle of rising deficits, more debt, more interest paid, higher interest rates, and even higher deficits.

Our response is two pronged.

First, OK, let us accept your premise. Will the government be able to make all payments (including interest paid on debt) as they come due? The answer is, of course, “yes — by crediting bank accounts”. Insolvency is not possible when one spends by a simple keystroke. The critic then quickly changes the subject: Weimar! Zimbabwe! You are a destroyer of the currency! Yes, but it was your scenario, not mine. And even in your worst case scenario, the government cannot be forced to default. Instead, Krugman argues “the government would decide that default was a better option than hyperinflation”. In other words, Krugman veers off into politics — government “decides” to default — because the economics does not give him the result he wants.

Second. Your scenario is highly implausible. As budget deficits rise, this increases income (government spending exceeds tax revenue, thus adds net income to the nongovernment sector) and wealth (nongovernment savings accumulated in the form of government debt) of the nongovernment sector. Eventually, this causes private spending and production to grow. As the economy heats up, tax revenue begins to grow faster than government spending or GDP. (In the US over the past two cycles, in the expansion phase federal tax revenue grew two to three times faster than GDP and government spending.) This reduces the government deficit (remember the Clinton boom and budget surpluses?). Even if the government spending is on interest (in Krugman’s model, the deficit is due to interest payments) that generates nongovernment income and spending. In other words, the cyclical upswing will automatically reduce the budget deficit. The scenario ignores the “automatic stabilizers” that cause the budget deficit to swing counter-cyclically.

What if the economy runs up against a full employment constraint, but government stubbornly keeps spending more, driving up prices toward hyperinflation? Even though incomes and thus tax revenues rise, government spending always keeps one step ahead so that the deficit rises. This is Krugman’s “infinite inflation” scenario.

OK, we never claimed that a sovereign government will necessarily adopt good economic policy. The last time the US approached such a situation was in the over-full employment economy of WWII. Rather than bidding for resources against the private sector, the government adopted price controls, rationing, and patriotic savings. In that way, it kept inflation low, ran the budget deficit up to 25% of GDP, and stuffed banks and households full of safe sovereign debt. By the way, Jamie Galbraith’s father, John Kenneth Galbraith, was the nation’s chief inflation fighter. After the war, private spending power was unleashed, GDP grew relatively quickly, and government debt ratios came down (not because the debt was retired but because the denominator — GDP — grew more quickly than the numerator — debt; see here). In other words, Galbraith, senior, used rational policy to avoid the Zimbabwean fate. I do not understand why Krugman prefers to believe that our policymakers would choose hyperinflation over more rational policy. If there is anything that policymakers of developed nations in the postwar period appear to hate, it is rapid inflation. In other words, the policy choice will not be between hyperinflation and default, but rather rational use of inflation-fighting policy should the need arise in order to prevent hyperinflation.

If we can get beyond the fears of national insolvency then there are many issues that can be fruitfully discussed. While inflation will not be a problem for many years, price pressures could return some day. Impacts of exchange rate instability are important, at least for some nations. Uemployment is a chronic problem, even at business cycle peaks. Aging does raise serious questions about allocation of resources, especially medical care. Poverty and homelessness exist in the midst of relative abundance. Simply recognizing that our sovereign government cannot go bankrupt does not solve those problems, but it does make them easier to resolve. We may well need more government spending, and, yes, even budget deficits to tackle some of those problems.

So, yes, deficits do matter, but not for solvency.

L. Randall Wray is Professor of Economics at the University of Missouri-Kansas City.

Welcome to the World of the “New Normal,” UK Style, Huffington Post 11.8.2010
from Marshall Auerback
We are now starting to see the economic impact of the ‘new normal’ in practice, as Paul Krugman outlined the other day. Having been bullied into adopting austerity measures apparently thinking they will help their economies grow, it is beginning to dawn on many “Austerian” governments that their embrace of hair shirt economics is beginning to undermine growth.

Exhibit A is the United Kingdom. The NY Times gave an account of British towns “reeling” from the implementation of nationwide expenditure cuts of some $130 billion introduced in last June’s budget. “A mass execution without appeal” is how the Times described it.

Along with this article comes a report from the Financial Times, “Economic Fears Rise as House Prices Dip”, documenting how UK house prices have began to fall for the first time in over a year this past July. The article notes that this setback has come “after a year when the recovery in house prices surprised almost everyone and brought relief to Britain’s stretched banks, [so] the return of a buyers’ market threatens to increase jitters in a fragile economy.”

Well, to us neither today’s news about British municipalities reeling from the impact of the new Tory coalition government’s budget cuts, nor last year’s recovery in UK housing, was at all “surprising.” Beset by the greatest financial crisis in the post World War II period, the last UK Labour Government did what any sensible administration ought to do when there is not enough activity in the economy to maintain employment and labor force growth: they increased public demand via increased net government spending……

Having publicly deprecated the impact of fiscal policy and warned of the long term deleterious effects of climbing public debt, of course, the Federal Reserve and/or the Bank of England cannot now reverse course and credibly back more fiscal stimulus. To cover up the flaccid nature of their respective central banks’ ineffectual monetary policy response, a number of economists present the current high levels of unemployment as “structural”, implying that there is little that can be done about it. It is simply the “new normal”, which in reality represents the ultimate in political failure. Our policy elites don’t dare concede the futility of fiscal austerity. Hence, they resort to invoking theories like the “equilibrium unemployment rate”, or “non-accelerating inflation rate of unemployment” (NAIRU, for short), the implication being that attempts to reduce labor underutilization by expansionary fiscal policy would be inflationary in the absence of “structural reforms” , such as privatization, labor market deregulation, anti-union legislation and harsh welfare measures. But these “supply side” measures in effect reflect the agenda preferences of the late 20th century, which have destroyed incomes and eviscerated the middle class. Our “new normal”, then, represents a collective shrug of our policymakers’ shoulders, ignoring a growing undercurrent of anger and despair.

Cross-posted from New Deal 2.0.

“The best way to cut the deficit is to put people to work. To do that, we need to make investments vital to our future and get the economy going, even as we address deficits. To address the deficits directly, we should make the rich and corporations pay their fair share of taxes and end wasteful spending on entrenched interests. It isn’t right to cut Social Security and Medicare to pay for deficits caused by foolish wars abroad, bailouts of the big banks and wasteful special interest spending. Common sense, but this is not the agenda of today’s conservatives. “  (link to full article)

….”Tim Congdon from International Monetary Research said the Fed has been wasting its powder by using the wrong mechanism to inject monetary stimulus. Instead of buying bonds from pension funds, insurance companies and other bodies outside the banking system, as the Bank of England did with its £200bn gilts purchase, it has been buying from banks. This method has different effects. It has gained less traction because banks have sat on “dead cash”. This has not increased the deposits held by companies and households.

“A really powerful way for the Fed to boost the economy is to buy bonds directly from the public, which will increase the quantity of broad money. They won’t do that because they have a totally different model and in my view they are confused about the transmission mechanism. If they bought say $1.5 trillion of long-dated Treasuries from non-banks I believe they would get the US out of its liquidity trap very quickly,” Mr Congdon said.

Even better to give it to households