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Hey, I must have learned something from you from following you all these years.

I made this exact same point in my own blog just last week.

http://www.chrisofrights.com/2011/01/raising-debt-ceilingor-why-everyone-in.html

I trust your analysis over mine. I'm just a layman and likely screwed something up. Still, it's heartening to know I haven't gone completely off my rocker.

Steve,

I don't think anyone wants to see a default, if in fact that would occur. Another alternative would be a selective governmental agency shutdown. The case for the current spending level is extremely weak to say the least. I do think it is reasonable for the few fiscally responsible people in the congress to use all the leverage they have - particularly public opinion that is already opposed to the current spending level and resultant increases in debt. The most they can achieve without default is to secure agreement to spending reductions in exchange for raising the ceiling. As to whether the measure of debt should be a "ceiling" or a percentage of GDP - would it really matter since the percentage could be changed as readily as the ceiling?

You're preaching to the choir in advocating growth - but do politicians really influence that significantly except in the negative sense? The current drive by the administration to transform the U.S. into a highly regulated "social democracy" with increased "social justice" doesn't seem to be much of a growth strategy. If there were genuine interest in a new tax system and in effective but minimally intrusive regulation, that would be an excellent start.

Jerry,

I think changing the "ceiling" to a percentage of GDP rather than a fixed dollar amount would matter greatly. For one, the debate would shift, and that's what's most important.

Second, these showdowns would happen much less frequently. The fixed dollar amount of debt is always going up (which isn't necessarily a bad thing), and it will inevitably reach the fixed ceiling within a short period of time.

However, a percentage-based ceiling will only be reached if the % increase in debt continues to outpace GDP growth year-after-year. That scenario may never happen, especially with the debate shifting to what's really important.

Jerry,

Based on what our politicians say (as opposed to what they are actually thinking, which I cannot read), I've had to conclude that a supermajority of them simply don't see any other way to reduce the debt burden than by cutting spending or increasing the tax rate. If they do have a broader understanding than that, then they must think we wouldn't understand it, so they'd better not talk about it. Either way (whether it's their ignorance or their deceptiveness) there's a problem I'd like to see fixed. One way to nudge the debate in the right direction is to introduce a second number into the mix: the size of the economy. The broader debate would then become much more difficult to avoid.

Back in 1994, the oversimplified message was that "big government" and "spending" were out of control. That message won the day, unfortunately, with the result that "big government spending" was cut way back -- by cutting national security spending to the lowest %GDP since before WW2. I've always wondered whether two subsequent (very expensive) wars could have been prevented if we had instead invested that cutback in sufficient security measures against the new, asymmetrical threats.

Of course, I'll never know the answer to that, but I definitely lost all respect for the naive, nonspecific mantra against "government spending" as soon as the late-1990s surplus-mania took the headlines away from the surprise attacks on our defenseless embassies, ships, and buildings -- until war took the surplus away.

Not all spending is not created equal. We had much higher debt to GDP ratio in WWII, but the spending was temporary. Entitlement and debt service spending are as close as you can get to permanent spending commitments. The greater a percentage of the budget we devote to this type of spending, the less flexibility we have to reduce in when the economy retracts. Simply concerning ourselves with the ratio ignores this reality. Of course we should grow the denominator, but that's not always that easy to do, and some of this taxing and spending 'crowds out' other form of economic activity that would be more conducive to growth. So, while the debt ceiling raw number is indeed relative, the percent of debt/GDP becomes less and less controllable the more we commit to spending that is next to impossible to reduce when needed.

After having studied this MMT theory for a few years I think I understand the basics. What is telling is that for many decades many people, much smarter and more educated and experianced than I,still can't agree on what is really going on. The human factor will always confound any economic theory. I think the MMT comes very close operationally. What I don't understand is why no one is talking about the money created by the banking system. This amount dwarfs any deficit spending by the government, yet very few ever mention it. According to my reasearch this money is often 20 times the deficit in normal economic times. Doesn't it make more sense to have government do what only the government can do and then be structured to support this type of growth?

Ronne,

I'm not sure Steve is a proponent of MMT although, IMHO, MMT presents the most comprehensive and powerful set of arguments against "deficit hysteria" of any paradigm. Regardless, I'm not sure what your concern with bank money or credit money actually is. As a banker and a MMT acolyte, I'd be happy to discuss your concerns if you want to elaborate on those concerns.

Regards,

E-

E, Back when Steve was posting more often he laid out an explanation of how our system operates. He used an analogy of a cloud of thin air. This is what finally sold me on MMT. I have been following this discussion on several sites and what seems to be missing from them is any discussion of the money that is created by our banking system. From what I can see, in an healthy economy, the banks are creating more money than the gov. is by deficit spending, a lot more. It seems to me that this money would be the source of any inflation before gov. spending. However, I also believe that if the politicians thought they could deficit spend without causing inflation we would shortly be in big trouble. I prefer a less intrusive gov. that would inact policies to encourage growth in our private economy and leave us to inovate ways to make money on our own. I realize that this is very simplistic, but I like to keep it simple.I am curious as to how much of the loans in the private sector are actually new money and how much is being recycled. By the way, if it is not obvious, I have no formal training in economics. I do run a small business and try to stay informed.

I don't think the govt can control the debt ratio. The MMT position is the govt spends by crediting a bank account. Tax revenue is not required for this action to take place. If the recipient of the govt spending then spends the money, it is income to another. The govt taxes income. So each time the money is spent on down the line the govt gets a cut. Eventually the govt will get all the money bank as long as each person spends 100% of the income derived from the initial spending. But if each person saved a portion of the income they derived from the spending, the govt would not collect a tax on the money saved (because the saved money would not be available has income to another). The total money saved by each person would equal how much the govt initally spent minus how much the govt was able to collect back in taxes. Ultimately, it is the public's (including foriegners) desire to save that determines the debt ratio. There a many factors that determine how much the public wants to save. To put an exact ratio on those factors is impossible (Japan is currently at 200%).
Glad to see you posting again Steve.

markg,

I have a lot less time for this these days, but wanted to make a couple points.

1. Money "saved" doesn't necessarily stop at the bank. Much of the time it becomes backing for productive loans, which do create jobs, income, tax revenues, and more private sector consumption and investment. (Fwiw, the liberal party line that the rich would "just put tax cuts in the bank" is simple-minded, first-order thinking, suitable mainly for bumperstickers. Banks are in the business of supplying investors with capital.)

2. The govt indirectly influences GDP with its policies towards business and entrepreneurship. Its influence is indirect and longer than short-term -- e.g., many of the companies that led the 1990s growth were created in the mid-80s. Nonetheless, govt can and does influence the rate of real GDP expansion, and an expanding economy increases the size of the taxable pie, which increases tax revenues with no change in tax rates.

Hi Steve,
The point I was making is the govt debt is determined endogenously. The public's desire to net save financial assets (I am sure you know Treasury Securities are listed on the asset side of private sector balance sheets) can vary based on demographics, asset mix preferences and many other factors. That means the debt ratio could vary. There is no "right" or "maximum" debt/gdp ratio.
Also, the govt can influence the economy by its policy torwards the demand side. If taxes are too high on the consumer side output will not be sold. Business and entreprenuers will not invest if they can not sell their goods. Case in point, are auto sales down because car manufacturers cannot build enough cars, or because they cannot sell enough cars?

Hey Ronne,

I’ll have to look for that post from Steve to examine the analogy.

In order to make the concept of bank credit more accessible I would ask you to consider that there are essentially two types of currency; the first is money supplied via the government which is sometimes referred to as “high powered money” (HPM) or “vertical money”. The second is typically referred to as “bank money”, “credit money” or horizontal currency”. High powered money is introduced into the system via government spending and drained via taxation. Picture this as a bathtub with the government as the faucet, the non-government sector as the tub, and the drain as taxation. The government fills the tub with water (HPM) and can adjust the amount of HPM via the flow into the tub (spending) and out of the drain (taxation). Banks essentially use the HPM to clear payments between banks or supply currency for those customers that want to withdraw currency. When a bank makes a loan it is not creating additional HPM but is instead creating bank money or credit money. The credit money is a liability of the bank. When a bank lends no new “Net Financial Assets” (NFAs) are created. Basically, you can think of this as no new HPM is created. “But I now have $100 I didn’t have a moment ago!” you respond. Think about this carefully, when a bank gives you a loan for $100 you get an asset ($100 cash) but you also have a new liability which is the $100 you owe the bank. When looked at from an accounting perspective you are no richer than you were a moment ago as your new $100 in cash is completely offset by your new $100 liability. No matter what the non-government does, it cannot increase the amount of HPM or NFAs in circulation as every increase in someone’s worth will be offset by a decline in another’s. The only way that new HPM can be introduced into the economy is via the government. Hope that helps a bit.

E, I've got the gov. part down. I understand how it creates and destroys money. What I am not clear on is how the banks create money. I need a bathtub or cloud of thin air type of analogy for that. Even though there is a corresponding debt(loan) created with the asset(deposit), isn't the amount of money in the economy increased? And instead of being destroyed by taxation, doesn't it end up back in the bank's pocket?

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