Deficit spending may be ‘working’
Who would have thought???…
On Mon, Jul 20, 2009 at 5:41 AM, Milo wrote:
- U.K. Mortgage Lending May Gain After Approvals Rose, BOE Says
- U.K. June Mortgage Lending Rises 17% From May, CML Says
- U.K. Office Demand Rises for First Time in Two Years
- U.K. Property Asking Prices Rebound, Rightmove Says
- Nissan to Build Battery-Manufacturing Plants in U.K., Portugal
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Originally posted March 9th, 2009
Yes, but unspoken is the automatic stabilizers are quietly adding to the deficit with each move down, and the curves will cross and the economy start to improve when the deficit gets large enough, whether it’s the ugly way via falling revenues and rising transfer payments, or proactively via a proactive fiscal adjustment.
With income and spending turning mildly positive in January and other indicators such as the commodities also beginning to move sideways as the deficit passes through 5% before the latest fiscal adjustment kicks in, we may be seeing GDP headed towards 0 by q3 or sooner as most forecasters now predict. Unemployment, however, will continue to rise until real growth exceeds productivity growth.
Bottom line, there will be a recovery with or without a proactive fiscal adjustment. the difference is how bad it gets before it turns north.
Behind the Curve
by Paul Krugman
Mar 8 (NYT) — President Obama’s plan to stimulate the economy was a massive, giant, enormous. So the American people were told, especially by TV news, during the run-up to the stimulus vote. Watching the news, you might have thought that the only question was whether the plan was too big, too ambitious.
Yet many economists, myself included, actually argued that the plan was too small and too cautious. The latest data confirm those worries  and suggest that the Obama administration’s economic policies are already falling behind the curve.
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Deficits saved the world
By Paul Krugman
July 15 (NYT) — Jan Hatzius of Goldman Sachs has a new note (no link) responding to claims that government support for the economy is postponing the necessary adjustment. He doesn’t think much of that argument; neither do I. But one passage in particular caught my eye:The private sector financial balance—defined as the difference between private saving and private investment, or equivalently between private income and private spending—has risen from -3.6% of GDP in the 2006Q3 to +5.6% in 2009Q1. This 8.2% of GDP adjustment is already by far the biggest in postwar history and is in fact bigger than the increase seen in the early 1930s.
That’s an interesting way to think about what has happened — and it also suggests a startling conclusion: namely, government deficits, mainly the result of automatic stabilizers rather than discretionary policy, are the only thing that has saved us from a second Great Depression.
The following figure makes the argument:
Here I show the private sector surplus and the public sector deficit, both as functions of GDP; the private sector line is upward-sloping because higher GDP means higher income and more savings, the public-sector line is downward-sloping because higher GDP means higher revenues. In equilibrium the private surplus equals the government deficit (not strictly true for any one country if you add in international capital flows, but think of this as a picture for the world economy). To make the figure cleaner I’ve shown an initial position of balance in both sectors, but this isn’t important.
What we’ve had is a sharp increase in the desired private surplus at any given level of GDP, due to a combination of higher personal saving and reduced investment demand. This is shown as an upward shift in the private-surplus curve.
In the 1930s the public sector was very small. As a result, GDP basically had to shrink enough to keep the private-sector surplus equal to zero; hence the fall in GDP labeled “Great Depressionâ€.
This time around, the fall in GDP didn’t have to be as large, because falling GDP led to rising deficits, which absorbed some of the rise in the private surplus. Hence the smaller fall in GDP labeled “Great Recession.â€
What Hatzius is saying is that the initial shock — the surge in desired private surplus — was if anything larger this time than it was in the 1930s. This says that absent the absorbing role of budget deficits, we would have had a full Great Depression experience. What we’re actually having is awful, but not that awful — and it’s all because of the rise in deficits. Deficits, in other words, saved the world.
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This says a lot more about the IMF than the UK:
IMF Says U.K. Can’t Afford 2010 Stimulus, Telegraph Reports
The U.K. is alone with Argentina as the only members of the Group of 20 that cannot budget for temporary spending increases next year to aid economic growth, the Sunday Telegraph cited the International Monetary Fund as saying. The Washington-based fund presented a paper at a G-20 meeting in Basel saying the average fiscal stimulus among member countries will be 1.6 % next year, the Telegraph reported. Britain’s fiscal position has left it unable to budget for an increase in expenditure or tax cuts in 2010 to boost the economy, the Telegraph cited the IMF as saying.
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> (email exchange)
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> On Tue, Jul 14, 2009 at 11:10 AM, wrote:
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> Why do you think Germany is looking at issuing dollar bonds?
>
Good question!
They think the odds of the Fed bailing them out in a pinch are better than the ECB?
They have banks with dollar debt who need to repay the dollar swap line advances from the ECB?
The dollar interest rate is lower?
They are concerned about borrowing so many euro?
They want to bet the dollar will go down?
Some investment banker has talked them into believing there is some advantage to diversify their borrowings by currency?
None of these possible explanations make any sense so it must be something else.
Germany ‘Closely Monitoring’ Dollar Bonds for Sale
By Anchalee Worrachate
July 10 (Bloomberg) — Germany is “closely monitoring†the dollar-denominated bond market for a possible sale, the head of the nation’s debt agency said.
“Dollar bonds are looking more attractive now from the issuer’s perspective than a couple of months ago,†Carl Heinz Daube, head of Germany’s Federal Finance Agency, said today in an interview from Frankfurt. “Nevertheless, there’s still no cost advantage for us at this point. If the price is right, we won’t say no.â€
Selling dollar bonds would allow Germany to appeal to a wider range of investors, including money managers in the U.S. who don’t want to take on foreign-exchange risk. The agency issued five-year dollar bonds in 2005, the only time it sold debt denominated in the U.S. currency.
A meeting with U.S. investors suggested there’s “strong†interest in the debt, Daube said.
“I met investors in the U.S. last week and a number of institutional investors seemed to be keen to invest in Germany’s dollar bonds,†he said. “The final decision is with the Ministry of Finance.â€
Germany hired banks to sell the five-year securities that come due in 2010 and may do so again should it proceed with a dollar-bond sale, Daube said on June 23.
“We tend to do less funding in the summer because of the holiday season,†Daube said. “But I might not say no if there’s a great cost advantage next week.â€
Record Sales
The German debt agency will sell an unprecedented 346 billion euros ($481 billion) of government securities this year, 157 billion euros of which are bonds, with the remaining 189 billion euros in shorter-dated money-market instruments.
Bank bailouts and economic stimulus packages are swelling budget deficits in some of Europe’s largest economies, forcing governments to compete for cash. Poland last week sold $2 billion of dollar bonds after getting about $8 billion of investor orders. Spain sold $1 billion of three-year securities in dollars in March. Greece said in April it may sell debt denominated in either Japanese yen or the U.S. currency during the latter half of the year.
“Governments are diversifying their issuance as there’s so much funding to be done,†said Harvinder Sian, a senior bond strategist at Royal Bank of Scotland Group Plc in London. “There’s a cost element that needs to be looked at. At the moment, it’s relatively attractive to issue dollar bonds.â€
The German government is looking at overall costs, including hedging fees against the dollar’s appreciation, before deciding whether to offer the bond, Daube said. The dollar rose more than 13 percent versus the euro in the past 12 months.
“We are not allowed to carry any currency risk,†he said. “The whole package will have to be good because we must be able to save taxpayers money to issue such bonds.â€
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Objections to deficit spending-
1. Deficits now mean higher taxes later.
Response — Taxes function to regulate aggregate demand, not raise revenue per se.
Taxes will go up ‘later’ only if aggregate demand is ‘too high’ later which means unemployment becomes ‘too low.’
that is exactly the point of deficits today- to bring down unemployment and excess capacity
So what that statement actually says is that deficits ‘work’ and will bring down unemployment and close the output gap, hopefully to the point that taxes need be raised to cool things down.
2. How will the govt pay back all that debt?
Response — When treasury securities mature the BOE debits the holders security account and credits his transactions account.
End of story.
3. The currency will go down.
Response — maybe, maybe not, but in any case the level of the currency does not alter the real wealth of the nation. It is only an internal distributional issue and those issues can be addressed with other domestic policies.
4. We need to wait for the lower interest rates and quantitative easing to work.
Response — It is working- policy makers have it backwards- it reduces aggregate demand
Quantitative easing increases the BOE’s balances sheet as it buys securities.
It removes higher yielding securities from the private sector and replaces them with lower yielding balances at the BOE,
this reduces non government incomes and accumulations of net financial assets, and thereby reduces aggregate demand.
Lower rates reduces savers incomes more than borrowers as borrowing rates remain high due to credit concerns.
Banks net interest margins increase adding to bank earnings which have a 0 marginal propensity to consume.
Therefore lower rates reduce aggregate demand.
5. What can be done?
Response — Immediate suspension of VAT at least until aggregate demand is restored to desired levels.
However, income tax receipts will ‘automatically’ increase as GDP recovers which will ‘automatically’ moderate aggregate demand.
Keep the BOE rate at 0 to keep costs of production and investment low and thereby help control prices and promote supply to areas of demand. (removing VAT also keeps prices lower than otherwise.)
Use taxes to moderate demand when excess demand becomes a problem, not to raise revenue per se.
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This gets more ridiculous by the hour.
The dependence on China already was zero.
And, as in my previous post, the high savings rate of the non government sector
comes dollar for dollar from the deficit and is not necessarily indicative of
low spending.
If it were, that would imply there is no inflation risk to deficit spending on the grounds that it all gets added to savings.
So once again one of our opinion leaders is making a statement that supports the opposite of what he thinks it supports.
Federal deficit spending is clearly adding to incomes, savings, and spending.
As it always does.
Surging U.S. Savings Rate Reduces Dependence on China
by Rich Miller and Alison Sider
June 26th (Bloomberg) — Saks Fifth Avenue is cutting orders 20 percent after postinglosses in the last four quarters. Kia Harris says some customers at the Washington shoe store where she works are buying one pair rather than three.
Incomes and spending were up in yesterday’s report.
In the recession following a borrowing binge that sent consumer debt to the highest level ever, Americans are shutting their wallets and building their nest eggs at the fastest pace in 15 years.
Non government savings and income is ‘funded’ by federal deficit spending — to the penny
While the trend will put the country’s finances in better balance and reduce its dependence on Chinese investment,
Dependence on Chinese investment remains at zero where it’s always been.
it may also restrain economic growth in 2010 and beyond,
No, in fact the higher income and savings added by the federal deficit tends to expand aggregate demand and real economic growth.
said Lyle Gramley, a senior economic adviser with New York-based Soleil Securities Corp. and a former Federal Reserve governor.
Who would have thought???…
“There’s been a fundamental change in people’s behavior,†he said. “It will affect the economy for years.â€
Government data today showed that the household savings rate rose to 6.9 percent in May, the highest since December 1993, as personal spending increased less than incomes. The rate in April 2008 was zero.
1993 was also a year of very high federal deficit spending.
This stuff is not that hard…
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Lending follows the markets.
As the economy improves banks and other lenders figure it out and jump in.
Also, today’s news on personal income is very bullish as well.
It shows fiscal policy ‘works’ as it did for q2 last year.
The concern is that the ‘savings rate’ is high which takes away from spending.
Not necessarily.
The ‘savings’ comes from federal deficit spending.
Net federal spending adds financial assets to someone’s account in the non government sector that can’t ‘go away.’
The federal spending can be spent many times over and savings will still go up by the same amount.
So to me it looks like the deficit spending is currently high enough to have sufficiently restored savings to levels that promote at least modest increases in consumption.
But not yet enough to bring unemployment down as the output gap continues to grow.
JPMorgan, Citigroup Expand in ‘Jumbo’ Home Mortgages
by Jody Shenn
June 26 (Bloomberg) —JPMorgan Chase & Co. and Citigroup Inc. are expanding in “jumbo†mortgages used to buy the most expensive homes, helping revive a market that shriveled amid a three-year jump in homeowner defaults.
JPMorgan resumed buying new jumbo loans made by other lenders this month, after halting purchases in March, spokesman Tom Kelly said. Borrowers must have checking accounts with the bank, he said. Citigroup is again offering the loans through independent mortgage brokers, spokesman Mark Rodgers said.
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Yes, infinite, in fact.
Put that into your debt to income calculations…
S&P SAYS JAPAN HAS ENOUGH FUNDS TO SERVICE RISING DEBT COSTS
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India Should Rely on Lower Rates to Stimulate Growth, OECD Says
by Kartik Goyal
June 24 (Bloomberg) — India should cut interest rates
rather than boost government spending if further measures are
needed to stimulate growth, the Organization for Economic
Cooperation and Development said.
They need to read Bernanke’s 2004 paper which makes it clear lower interest rates are contractionary via the fiscal channel and need to be matched by fiscal expansion to overcome that effect.
Additionally, in today’s environment, lower rates hurt savers a lot more than the help borrowers. Rates for savers have fallen a lot more than rates for borrowers due to risk perceptions and implied capital costs as net interest margins for lenders have increased to over 4%. This also means reduced aggregate demand and begs additional fiscal measures to sustain GDP.
So while I strongly favor lower rates, I also recognize that one of the benefits of lower rates is that they allow reduced taxes or increased public expenditure to sustain output and employment at desired levels.
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