response to deficit dove letter

The right level of deficit spending, long term or otherwise, is the one that coincides with full employment.

Any nation with a non convertible currency and floating exchange rate policy is necessarily not in any case operationally revenue constrained.

A statement from Professors Paul Davidson, James Galbraith and Lord Skidelsky.

We three were each asked to sign the letter organized by Sir Harold
Evans and now co-signed by many of our friends, including Joseph
Stiglitz, Robert Reich, Laura Tyson, Derek Shearer, Alan Blinder and
Richard Parker. We support the central objective of the letter — a
full employment policy now, based on sharply expanded public effort.
Yet we each, separately, declined to sign it.

Our reservations centered on one sentence, namely, “We recognize the
necessity of a program to cut the mid-and long-term federal deficit..”
Since we do not agree with this statement, we could not sign the
letter.

Why do we disagree with this statement? The answer is that apart from
the effects of unemployment itself the United States does not in fact
face a serious deficit problem over the next generation, and for this
reason there is no “necessity [for] a program to cut the mid-and long-
term deficit.”

On the contrary: If unemployment can be cured, the deficits we
presently face will necessarily shrink This is the universal
experience of rapid economic growth: tax revenues rise, public welfare
spending falls, and the budget moves toward balance. There is indeed
no other experience in modern peacetime American history, most
recently in the late 1990s when the budget went into surplus as full
employment was reached.

We agree that health care costs are an important issue. But health
care is a burden faced by both the public and private sectors, and
cost control is a job for health policy, not budget policy. Cutting
the public element in health care – Medicare, especially – in response
to the health care cost problem is just a way of invidiously targeting
the elderly who are covered by that program. We oppose this.

The long-term deficit scare story plays into the hands of those who
will argue, very soon, for cuts in Social Security as though these
were necessary for economic reasons. In fact, Social Security is a
highly successful program which (along with Medicare) maintains our
entire elderly population out of poverty and helps to stabilize the
macroeconomy. It is a transfer program and indefinitely sustainable as
it is.

We call on fellow economists to reconsider their casual willingness to
concede to an unfounded hysteria over supposed long-term deficits, and
to concentrate instead on solving the vast problems we presently
face. It would be tragic if the Evans letter and similar efforts –
whose basic purpose we strongly support – led to acquiescence in
Social Security and Medicare cuts that impoverish America’s elderly
just a few years from now.

Paul Davidson James K. Galbraith Lord
Robert Skidelsky

Paul Davidson is the Editor of the Journal of Post Keynesian Economics
and author of “The Keynes Solution.”

James K. Galbraith is a Professor at The University of Texas at Austin
and author of “The Predator State.”

Lord Robert Skidelsky is the author, most recently, of “Keynes: The
Return of the Master.”

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MISSION:
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Go to offending articles. Neutralize flaws. Report back to home base.

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EU

This is what I was writing about last week-

China and others buying euro to support exports to that region.

The euro member nations want their debt sold, but they don’t want the loss of ‘competitiveness’ that necessarily comes with it, as the moves to eliminate solvency issues continue to drive up the euro:

China offers vote of confidence in euro

(FT) China delivered a strong vote of confidence in the euro on Friday when Premier Wen Jiabao said that Europe would always be one of the main investment markets for China’s foreign exchange reserves. Mr Wen said “Europe will certainly overcome its difficulties”. “The European market has been in the past, is now and will be in the future one of the main investment markets for China’s foreign exchange reserves,” Mr Wen said. “I want to say that at this time, when some European countries are suffering sovereign debt crises, China has always held out a helping hand,” he added. “We believe that with the joint hard work of the international community, Europe will certainly overcome its difficulties,” he said. According to people familiar with Spain’s recent bond issue, China’s State Administration of Foreign Exchange was allocated up to €400m ($505m) of Spanish 10-year bonds in a debt deal last Tuesday.

Paul Krugman Blog – NYTimes.com

The way I read it, he’s agreed that it’s about inflation, not solvency.

That is, in ratings agency speak, willingness to pay could be an issue, but not ability to pay.

That’s enough for me to declare victory on that key issue, and move on.

Not that I at all agree with his descriptions of monetary operations or his ‘inflation channels.’ I just see no reason to rehash all that and risk loss of focus on the larger point he’s conceded.

This reads like a true breakthrough. Hopefully this opens the flood gates and the remaining deficit doves pile on, and July 17, 2010 is remembered as the day MMT broke through and turned the tide.

And in the real world it’s all about celebrity status.

With Jamie’s credentials and definitive response to the sustainability commission, Paul finally had a sufficiently ‘worthy’ advocate which gave him the opening to respond and concede.


I Would Do Anything For Stimulus, But I Won’t Do That (Wonkish)

By Paul Krugman

It’s really not relevant to current policy debates, but there’s an issue that’s been nagging at me, so I thought I’d write it up.

Right now, the real policy debate is whether we need fiscal austerity even with the economy deeply depressed. Obviously, I’m very much opposed — my view is that running deficits now is entirely appropriate.

But here’s the thing: there’s a school of thought which says that deficits arenever a problem, as long as a country can issue its own currency. The most prominent advocate of this view is probably Jamie Galbraith, but he’s not alone.

Now, Jamie and I are, I think, in complete agreement about what we should be doing now. So we’re talking theory, not practice. But I can’t go along with his view that

So long as U.S. banks are required to accept U.S. government checks — which is to say so long as the Republic exists — then the government can and does spend without borrowing, if it chooses to do so … Insolvency, bankruptcy, or even higher real interest rates are not among the actual risks to this system.

OK, I don’t think that’s right. To spend, the government must persuade the private sector to release real resources. It can do this by collecting taxes, borrowing, or collecting seignorage by printing money. And there are limits to all three. Even a country with its own fiat currency can go bankrupt, if it tries hard enough.

How does that work? A bit of modeling under the fold.

Let’s think in terms of a two-period model, although I won’t need to say much about the first period. In period 1, the government borrows, issuing indexed bonds (I could make them nominal, but then I’d need to introduce expectations about inflation, and we’ll end up in the same place.) This means that in period 2 the government owes real debt service in the amount D.

The government may meet this debt service requirement, in whole or in part, by running a primary surplus, an excess of revenue over current spending. Let’s suppose, however, that there’s an upper limit S to the feasible primary surplus — a limit imposed by political constraints, administrative issues (if taxes are too high everyone will evade), or the sheer fact that tax collections can’t exceed GDP.

But the government also has a printing press. The real revenue it collects by using this press is [M(t) – M(t-1)]/P(t), where M is the money supply and P the price level.

What determines the price level? Let’s assume a simple quantity theory, with the price level proportional to the money supply:

P(t) = V*M(t)

By assuming this, I’m actually making the most favorable assumption about the power of seignorage, since in practice, running the printing presses leads to a fall in the real demand for money (people start using lumps of coal or whatever as substitutes.)

OK, now let’s ask what happens if the government has run up enough debt that the upper limit on the primary surplus is a binding constraint, and it’s necessary to run the printing presses to make up the difference. In that case,

[M(t) – M(t-1)]/P(t) = D – S

But P is proportional to M, so this becomes

[M(t) – M(t-1)]/VM(t) = D – S

Rearrange a bit, and we have

M(t)/M(t-1) = 1/[1 – V[D-S]]

And what does this imply? Since the price level is, by assumption, proportional to M, this tells us that the higher the debt burden, the higher the required rate of inflation — and, crucially, that as D-S heads toward a critical level, this implied inflation heads off to infinity. That is, it looks like this:

So there is a maximum level of debt you can handle. In practice, if it makes sense to say such a thing with regard to a stylized model, at some point lower than the critical level implied by this model the government would decide that default was a better option than hyperinflation.

And going back to period 1, lenders would take this possibility into account. So there are real limits to deficits, even in countries that can print their own currency.

Now, I’m sure I’m about to get comments and/or responses on other blogs along the lines of “Ha! So now Krugman admits that deficits cause hyperinflation! Peter Schiff roolz” Um, no — in extreme conditions they CAN cause hyperinflation; we’re nowhere near those conditions now. All I’m saying here is that I’m not prepared to go as far as Jamie Galbraith. Deficits can cause a crisis; but that’s no reason to skimp on spending right now.

Final sales

Haven’t yet hit the ‘get a job buy a car’ accelerator.

Watch for car sales to be the indicator of more rapid growth.

Meantime, muddling through with modest growth remains an ok equity environment as fear of becoming the next Greece is turning us into the next Japan.

And, of course, we continue to underestimate the deflationary effect of the Fed’s zero rate policy which should be a good thing in that it allows us to have lower taxes for a given size govt.

1934 Cartoon

We went off the gold standard in 1934 and solvency was never again an issue for the Federal government.

Those ‘sound money’ people were wrong then and are wrong now as taxes function to regulate aggregate demand and not to raise revenue per se.

This cartoon is claimed to be from the Chicago Tribune in 1934. Look carefully at the plan of action in the lower left corner.

euro zone issues


Asian players are a worry for eurozone

By Gillian Tett

July 14 (FT)

The saga behind next week’s stress test release is a case in point. During most of the past year, governments of countries such as Germany, Spain and France have resisted the idea of conducting US-style stress tests on their banks, in spite of repeated, entreaties from entities ranging from the International Monetary Fund to the Bank for International Settlements, and the US government.


However, after a meeting of G20 leaders in Busan last month, those same eurozone governments performed a U-turn, by finally agreeing to publish the results of such tests.


Some observers have blamed the volte-face on lobbying inside the senior echelons of the European Central Bank. Others point the finger to American pressure. In particular, Tim Geithner, the US Treasury secretary, had some strongly worded discussions with some of his eurozone counterparts in Busan, where he urged – if not lectured – them to adopt these tests.

However, Europeans who participated in the Busan meeting say it was actually comments from Asian officials that created a tipping point. In the days before and after that G20 gathering, eurozone officials met powerful Asian investment groups and government officials who expressed alarm about Europe’s financial woes. And while those officials did not plan to sell their existing stock of bonds, they specifically said they would reduce or halt future purchases of eurozone bonds unless something was done to allay the fears about Europe’s banks.

That, in turn, sparked a sudden change of heart among officials in places such as Germany and Spain. After all, as one European official notes, the last thing that any debt-laden European government wants now is a situation where it is tough to sell bonds. “It was the Asians that changed the mood, not anything Geithner said,” says one eurozone official.

This raises some fascinating short-term issues about how the bond markets might respond to the stress tests. It is impossible to track bond purchase patterns with any precision in a timely manner in Europe, since there is no central source of consolidated data.

However, bankers say there are signs that Asian investors are returning to buy eurozone bonds. This week, for example, China’s State Administration of Foreign Exchange bid for €1bn (£1.27bn, £835m) of Spanish bonds, helping to produce a very successful auction.

Yes, it’s a two edged sword.

Asian nations want to accumulate euro net financial assets to facilitate exports to the euro zone.

Before the crisis euro nations were concerned that the strong euro, partially due to Asian buying, was hurting euro zone exports

However, as the crisis developed, euro nations got to the point where they were concerned enough about national govt solvency and the precipitous fall of the euro (which was in some ways welcomed by exporters but worrying with regards to a potential inflationary collapse) to agree to measures to support their national govt debt sales which also meant a stronger euro.

So now the pendulum is swinging the other way. Solvency issues have been sufficiently resolved by the ECB to avert default, but at the ‘cost’ of a resumption Asian buying designed to strengthen the euro to support Asian exports to the euro zone.

As before the crisis, however, the euro zone has no tools to keep a lid on the euro (apart from re introducing the solvency issue to scare away buyers, which makes no sense), as buying dollars and other fx is counter to their ideology of having the euro be the world’s reserve currency.

So the same forces remain in place that drove the euro to the 150-160 range, which kept net exports from climbing.

The export driven model is problematic enough without adding in the additionally problematic idiosyncratic financial structure of the euro zone.

As for the stress tests, as long as the ECB is funding bank liabilities and buying national govt debt banks and the national govts can continue to fund themselves with or without Asian buying.

I’d have to say at this point in time the euro zone hasn’t gotten that far in their understanding of their monetary system or they probably would not be making concessions to outside forces.

Good quote

“All the perplexities, confusion and distress in America arise not from defects in the Constitution
or Confederation, nor from want of honor or virtue, so much as downright ignorance of the
nature of coin, credit, and circulation.” – John Adams in a letter to Thomas Jefferson

Fed Minutes

The staff still expected that the pace of economic activity through 2011 would be sufficient to reduce the existing margins of economic slack, although the anticipated decline in the unemployment rate was somewhat slower than in the previous projection.


Karim writes:

Staff still forecasting above trend growth, though not as firm as before. Activity indicators coming in as expected, with financial strains in May and June the cause for the revision.

Table below is average of FOMC members, not staff, but appears to have similar profile. Average expectations for 2011 growth at 3.85% from 3.95% prior..

A few participants cited some risk of deflation. Other participants, however, thought that inflation was unlikely to fall appreciably further given the stability of inflation expectations in recent years and very accommodative monetary policy. Over the medium term, participants saw both upside and downside risks to inflation.


Deflation talk still seems contained to a ‘few’ members.

Members noted that in addition to continuing to develop and test instruments to exit from the period of unusually accommodative monetary policy, the Committee would need to consider whether further policy stimulus might become appropriate if the outlook were to worsen appreciably.


This was only mention of QE2 – not very extensive.