Category Archives: Proposal

There is no right time for the Fed to raise rates!

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There is no right time for the Fed to raise rates!

Introduction
I reject the belief that economy is strong and operating anywhere near full employment. I also reject the belief that a zero-rate policy is inflationary, supports aggregate demand, or weakens the currency, or that higher rates slow the economy and reduce inflation. Additionally, I reject the mainstream view that employment is materially improving, the output gap is closing, and inflation is rising and returning to the Fed’s targets.

What I am asserting is that the Fed and the mainstream have it backwards with regard to how interest rates interact with the economy. They have it backwards with regard to both the current health of the economy and inflation, and, therefore, their discussion of appropriate monetary policy is entirely confused and inapplicable.

Furthermore, while I recognize that raising rates supports both aggregate demand and inflation, I am categorically against raising rates for that purpose. Instead, I propose making the zero-rate policy permanent and supporting demand with a full FICA tax suspension. And for a stronger price anchor than today’s unemployment policy, I propose a federally funded transition job for anyone willing and able to work to facilitate the transition from unemployment to private sector employment. Together these proposals support far higher levels of employment and price stability.

So when is the appropriate time to raise rates? I say never. Instead, leave the fed funds rate at zero, permanently, by law, and use fiscal adjustments to sustain full employment.

Analysis
My first point of contention with the mainstream is their presumption that low rates are supportive of aggregate demand and inflation through a variety of channels, including credit, expectations, and foreign exchange channels.

The problem with the mainstream credit channel is that it relies on the assumption that lower rates encourage borrowing to spend. At a micro level this seems plausible- people will borrow more to buy houses and cars, and business will borrow more to invest. But it breaks down at the macro level. For every dollar borrowed there is a dollar saved, so any reduction in interest costs for borrowers corresponds to an identical reduction for savers. The only way a rate cut would result in increased borrowing to spend would be if the propensity to spend of borrowers exceeded that of savers. The economy, however, is a large net saver, as government is an equally large net payer of interest on its outstanding debt. Therefore, rate cuts directly reduce government spending and the economy’s private sector’s net interest income. And looking at over two decades of zero-rates and QE in Japan, 6 years in the US, and 5 years of zero and now negative rates in the EU, the data is also telling me that lowering rates does not support demand, output, employment, or inflation. In fact, the only arguments that they do are counter factual- the economy would have been worse without it- or that it just needs more time. By logical extension, zero-rates and QE have also kept us from being overrun by elephants (not withstanding that they lurk in every room).

The second channel is the inflation expectations channel. This presumes that inflation is caused by inflation expectations, with those expecting higher prices to both accelerate purchases and demanding higher wages, and that lower rates will increase inflation expectations.

I don’t agree. First, with the currency itself a simple public monopoly, as a point of logic the price level is necessarily a function of prices paid by government when it spends (and/or collateral demanded when it lends), and not inflation expectations. And the income lost to the economy from reduced government interest payments works to reduce spending, regardless of expectations. Nor is there evidence of the collective effort required for higher expected prices to translate into higher wages. At best, organized demands for higher wages develop only well after the wage share of GDP falls.

Lower rates are further presumed to be supportive through the foreign exchange channel, causing currency depreciation that enhances ‘competitiveness’ via lower real wage costs for exporters along with an increase in inflation expectations from consumers facing higher prices for imports.

In addition to rejecting the inflation expectations channel, I also reject the presumption that lower rates cause currency depreciation and inflation, as does most empirical research. For example, after two decades of 0 rate policies the yen remained problematically strong and inflation problematically low. And the same holds for the euro and $US after many years of near zero-rate policies. In fact, theory and evidence points to the reverse- higher rates tend to weaken a currency and support higher levels of inflation.

There is another aspect to the foreign exchange channel, interest rates, and inflation. The spot and forward price for a non perishable commodity imply all storage costs, including interest expense. Therefore, with a permanent zero-rate policy, and assuming no other storage costs, the spot price of a commodity and its price for delivery any time in the future is the same. However, if rates were, say, 10%, the price of those commodities for delivery in the future would be 10% (annualized) higher. That is, a 10% rate implies a 10% continuous increase in prices, which is the textbook definition of inflation! It is the term structure of risk free rates itself that mirrors a term structure of prices which feeds into both the costs of production as well as the ability to pre-sell at higher prices, thereby establishing, by definition, inflation.

Finally, I see the output gap as being a lot higher than the mainstream does. While the total number of people reported to be working has increased, so has the population. To adjust for that look at the percentage of the population that’s employed, and it’s pretty much gone sideways since 2009, while in every prior recovery it went up at a pretty good clip once things got going:

The mainstream says this drop is all largely structural, meaning people got older or otherwise decided they didn’t want to work and dropped out of the labor force. The data clearly shows that in a good economy this doesn’t happen, and certainly not to this extreme degree. Instead what we are facing is a massive shortage of aggregate demand.

Conclusion
There is no right time for the Fed to raise rates. The economy continues to fail us, and monetary policy is not capable of fixing it. Instead the fed funds rate should be permanently set at zero (further implying the Treasury sell only 3 month t bills), leaving it to Congress to employ fiscal adjustments to meet their employment and price stability mandates.

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Time to say goodbye? Schauble Calls on Italy to Pursue Structural Reform

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Schäuble Calls on Italy to Pursue Structural Reform

By Andrea Thomas

July 16 (WSJ) — German Finance Minister Wolfgang Schäuble called on Italy to pursue its ambitious structural reform efforts if it wants to boost its economic-growth prospects. “Especially since growth forecasts for Italy have been reduced recently, it’s important to reform and cut the debt level convincingly,” he said. Italian Prime Minister Matteo Renzi has presented ambitious and broad-based reforms, he added. “The Stability and Growth Pact is the foundation for politico-economic cohesion in Europe,” said Mr. Schäuble. “The Stability and Growth Pact provides sufficient flexibility. It’s doesn’t stand in the way of structural reforms; quite the opposite, it promotes them.”

This is a direct response to Prime Minister Renzi who asked for what can be described as a minuscule amount flexibility with the deficit rules. (Note that Schauble didn’t even say said reforms would boost growth, only ‘growth prospects’, whatever that means.)

The problem is that for any given level of govt spending (a political decision) tax liabilities are too high to allow ‘savings desires’ to be accommodated. And ‘the debt level’ is best thought of as the ‘money supply’ (deposits at the CB) that’s the euro ‘savings’/net financial assets of the non govt sectors.

Said another way, the currency itself is the EU’s public monopoly, and the mass unemployment is necessarily the evidence that the monopolist is restricting the ‘supply’ of net financial assets demanded by the economy.

Said another way, for all practical purposes said reforms don’t increase aggregate demand. At best they address what I call distributional issues.

My proposal is for Italy to deliver an ultimatum to the EU giving them 30 days to relax the 3% deficit limit and eliminate the 60% debt/GDP limit.

If the EU refuses, Italy has two choices:

1. Do nothing as the destruction of their civilization continues,

2. Begin taxing and spending in ‘new lira’ with fiscal policy that promotes output and employment.

And note that if they do go to ‘new lira’ and retain their now constitutionally mandated balanced budget requirement, it will all get even worse.

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Deficit maths redux- Faulty logic in 2014 GDP forecasts?

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Pretty much all forecasters expect improvement in 2014 largely from what they call a reduction in fiscal drag. Their logic goes something like this (with the actual numbers varying a bit with different analysts):

Without the deficit reduction in 2013 that subtracted 2% from growth, growth would have been 4%. Therefore, when the fiscal drag ends, growth will return to the underlying 4% pace.

I’m suggest their logic is faulty.

The difference is that of ‘adding less’ vs ‘subtracting’

It’s not like the private sector alone was expanding at a 4% clip, and then govt came along and took away 2%.

It’s that by my count the private sector was growing at -2%, and govt was going to add 6% to that for 2013, but proactively reduced its support to only 4% in 2013 by cutting spending and raising taxes, resulting in 2% GDP growth rather than 4%. And for 2014 that ‘lost support’ will not be added back.

Expanding:

Assume, for example, GDP started 2013 at 100, and was forecast to go to 104 as stated above. Assuming nominal growth about 1.5% over real growth, let me push that up to 105.5.

That assumption included, say, federal deficit spending of 6% of GDP (starting at maybe a 7% rate and ending at maybe a 5% rate).

That is govt was forecast to make a net positive 6% contribution to spending by spending that much more than its income, aka ‘credit expansion’. Or, said another way, the total government spending contribution was over 20% of GDP, with all but 6% of that ‘offset’ by taxation that reduced incomes elsewhere.

Also note that the economy is currently ‘demand constrained’ as there is an output gap. In other words GDP could be higher, as a matter of accounting, simply by, for example,
govt hiring more people who are currently not working for pay, via the govt spending that much more than its income (adding to the deficit). Or GDP could be lower simply by govt cutting back, which is what actually happened, as recognized by the analysts.

That is, net govt spending was proactively reduced by about 2% due to tax increases and sequesters.

And federal deficit spending averaged perhaps 4% of GDP rather than 6% of GDP, thereby reducing said GDP..

That is, government contributed that much less to GDP. And that lost contribution will not be restored, as, if anything, there will be further deficit reduction forthcoming from Congress in 2014.

So my point is the 4% forecast for 2013 was not that much private sector growth that was then reduced by the deficit reduction measures. Instead, the growth forecast included the federal deficit contributing 6% to GDP, which was subsequently reduced by Congress to only 4%.

In fact, without the remaining 4% contribution of that net federal spending, nominal GDP might have been -.5% and real -2%.

And 2014 is starting out with federal deficit spending forecast to add only about $600 billion, which is less than 4% of GDP.

So to recap, the original forecast for 4% growth included the full 6% contribution from govt. And when that contribution was proactively reduced to 4%, growth forecasts were correctly cut to 2%.

And my point is that the assumed ‘underlying growth rate’ of 4% in fact presumed the then 6% contribution from govt which was subsequently reduced, thereby lowering ‘the underlying growth rate’ for 2013 to 2%.

It’s not that the private sector was responsible for 4% growth and that the govt took away 2% of that with the tax increases and sequesters.

In fact, it was more that the private sector was -2% on its own due to ‘demand leakages’/unspent incomes/savings desires including non residents) and govt support that was to boost that to +4% was cut back, resulting in a 2% rate of GDP growth for 2013.

I am not saying that GDP growth can’t pick up in 2014.

I am saying that the logic behind the widespread forecasts for a pick up in growth is universally faulty.

And that if growth does pick up it will be from an increase in non govt ‘spending more than incomes’, aka an increase non govt credit expansion.

While this is certainly possible, traditionally it comes from housing, which currently isn’t generating any credit expansion, and cars which are no longer generating meaningful increases.

Worse, in prior cycles we got the private sector credit expansion need to support relatively low output gaps only from expansion we never would have let happen if we had been aware of the consequences. These included the Bush sub prime expansion, the Clinton .com/y2k credit expansion, the Reagan S and L credit expansion, and the earlier Wriston emerging markets credit expansion. And I don’t see anything like that happening currently.

And so without the prerequisite acceleration of non govt credit expansion, the maths tell me 2014 GDP growth will remain at best at approximately the 2% level of 2013. And, with so little support from federal deficit spending, I see serious downside risks should private sector credit expansion falter for any reason.

And note too that the continuation of 2% GDP growth closes the output gap only by reducing estimates of potential output, primarily by assuming the drop in the participation rate is structural.

And even the modest employment gains we’ve seen are at risk. The growth rate of employment has been almost identical to the underlying rate of real growth, which improbably implies no productivity growth. So if there is any positive underlying productivity growth, and real growth remains the same, employment growth will decline accordingly.

Lastly, the ‘automatic fiscal stabilizers’ are continuously at work. So when private sector credit expansion does contribute to growth, the govt ‘automatically’ cuts back its support via reduced transfer payments and increased tax receipts, thereby tempering the positive effect of the private credit expansion, and making it that much more difficult for the growth to continue.

This means that even the current 2% growth rate will at some point get ground down by our current institutional structure. With growing risks that this could be very much sooner rather than later.

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Endorsement of Mosler’s 3-point plan

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Endorsement of Mosler’s 3-point plan

After hearing an explanation of Modern Monetary Theory by Warren Mosler, Occupy Dallas endorses his remedy for our nation’s current economic condition:

1-cut FICA taxes to end this regressive policy and allow greater spending.
2-disbursement of federal funds to states on per-capita basis
3-guaranteed “transitional” employment for anyone seeking a job at $8/hr

We feel these proposals are simple and effective and will serve the interests of the 99% far better than any “austerity” measures being considered by politicians in both major parties.

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How to fix the euro banking system

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The banks need, and I propose, ECB deposit insurance for all euro zone banks.

Currently the member governments insure their own member bank deposits and do the regulation and supervision.

So to get from here to there politically they need to turn over banking supervision to the ECB.

Let me suggest that’s a change pretty much no one would notice or care about from a practical/operational point of view?

The political problem would come from losses from existing portfolios that, in the case of a bank failure due to losses in excess of equity capital, currently would be charged to the appropriate member nations.

So under my proposal, for the ECB to suffer actual losses a member bank that it supervises and regulates would have to suffer losses in excess of its capital.

And none of the member governments currently think that their banks have negative capital, especially if they assume member governments don’t default on their debt to the banks.

And this ‘fix’ for the banking system would help insure the member governments don’t default on their obligations to their banks.

The euro zone has three financial issues at this point. One is bank liquidity which this proposal fixes. Second is national government solvency, and third is the output gap.

They need to allow larger government deficits to narrow the output gap, but that first requires fixing the solvency issue.

The solvency issue can be addressed by having the ECB guarantee all of the member government debt, which then raises the moral hazard issue.

The moral hazard issue can be addressed by giving the EU the option of not having the ECB insure new government debt and forbidding its banks to buy new government debt as a penalty for violators of the debt and deficit limits of the Stability and Growth Pact.

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Video from Venice presentation

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Venice video link here.

Also, Trichet Friday, the German elections, and G8 reports seem to be setting the tone for the euro zone to do something about the solvency issue. This is very good for equities and the rest of the credit stack.

At the same time it does not seem likely that any growth proposals will include fiscal relaxation, so the euro zone will have to get by the best it can with the deficits it has, which I’d guess should mean flat GDP, +/- 1% or so.

The US should also continue to muddle through with modest top line growth, and inflation low enough and the output gap wide enough to keep this Fed from hiking any time soon.

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Greece

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Comes back to the idea that resolving solvency issues in the euro zone doesn’t fix the economy.

And with negative growth the solvency math doesn’t work for any of the euro members.

And what’s with the ECB threatening to back away on liquidity support for the banking system?

So looks to me like the Greek resolution is not the end of the solvency issues, but that the focus simply moves on to the next weaker sister.

And, as previously discussed, the risk remains elevated that if Greece gets to haircut its obligations and gets funding, others will ask for the same, triggering a general, global, catastrophic financial meltdown.

My first order proposal remains an ECB distribution on a per capita basis to the euro member nations of maybe 10% of euro zone GDP per year to put the solvency issue behind them. Along with relaxed budget rules, maybe allowing deficits up to 6% of GDP annually, further supported by the ECB funding a transition job at a non disruptive wage to facilitate the transition from unemployment to private sector employment. I might also recommend deficits be increased by suspending VAT as a way to increase aggregate demand and lower prices at the same time.

Alternatively, the ECB could simply guarantee all national govt debt and rely on the growth and stability pact for fiscal discipline, which would probably require enhanced authorities.

And rather than trying to bring Greece’s deficit down to current target levels, they could instead relax the growth and stability pact limits to something closer to full employment levels. And, again, I’d look into suspending VAT to both increase aggregate demand and lower prices.

Meanwhile, elsewhere in today’s world news:

The likes of Ford adding to pension funds makes the point of the increasing and ongoing demand leakages putting a damper on GDP.

And oil prices have now crept up enough to materially cut into aggregate demand as well.

Nor are banks adding to capital to meet expanding demand for credit, which remains anemic.

Headlines:

Data Suggests Euro Zone May Slide Back Into Recession
German Manufacturing Slows as New Export Orders Fall
China’s Factory Activity Shrinks for Fourth Month
ECB Preparing to Close Liquidity Floodgates
Ford Pours $3.8 Billion Into Pension Plan
Oil Could Turn to Headwind as Dow Flirts With 13,000
UBS to Issue More Loss-Absorbing Capital
Iran ‘Winning’ on Oil Sanctions: Top Trader
Greek Bailout Puts Focus Back on Credit Default Swaps
Iran Fuels Oil-Price Rally—And Prices Could Keep Rising

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Proposal update, including the JG

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My proposals remain:

1. A full FICA suspension:

The suspension of FICA paid by employees restores spending which supports output and employment.
The suspension of FICA paid by business helps keep costs down which in a competitive environment lowers prices for consumers.

2. $150 billion one time distribution by the federal govt to the states on a per capita basis to get them over the hump.

3. An $8/hr federally funded transition job for anyone willing and able to work to assist in the transition from unemployment to private sector employment.

Call me an inflation hawk if you want. But when the fiscal drag is removed with the FICA suspension and funds for the states I see risk of what will be seen as ‘unwelcome inflation’ causing Congress to put on the brakes long before unemployment gets below 5% without the $8/hr transition job in place, even with the help of the FICA suspension in lowering costs for business.

It’s my take that in an expansion the ’employed labor buffer stock’ created by the $8/hr job offer will prove a superior price anchor to the current practice of using the current unemployment based buffer stock as our price anchor.

The federal government caused this mess for allowing changing credit conditions to cause its resulting over taxation to unemploy a lot more people than the government wanted to employ. So now the corrective policy is to suspend the FICA taxes, give the states the one time assistance they need to get over the hump the federal government policy created, and provide the transition job to help get those people that federal policy is causing to be unemployed back into private sector employment in a more orderly, more ‘non inflationary’ manner.

I’ve noticed the criticism the $8/hr proposal- aka the ‘Job Guarantee’- has been getting in the blogosphere, and it continues to be the case that none of it seems logically consistent to me, as seen from an MMT perspective. It seems the critics haven’t fully grasped the ramifications of the recognition of the currency as a (simple) public monopoly as outlined in Full Employment AND Price Stability and the other mandatory readings.

So yes, we can simply restore aggregate demand with the FICA suspension and funds for the states, but if I were running things I’d include the $8 transition job to improve the odds of both higher levels of real output and lower ‘inflation pressures’.

Also, this is not to say that I don’t support the funding of public infrastructure (broadly defined) for public purpose. In fact, I see that as THE reason for government in the first place, and it should be determined and fully funded as needed. I call that the ‘right size’ government, and, in general, it’s not the place for cyclical adjustments.

4. An energy policy to help keep energy consumption down as we expand GDP, particularly with regard to crude oil products.

Here my presumption is there’s more to life than burning our way to prosperity, with ‘whoever burns the most fuel wins.’

Perhaps more important than what happens if these proposals are followed is what happens if they are not, which is more likely going to be the case.

First, given current credit conditions, world demand, and the 0 rate policy and QE, it looks to me like the current federal deficit isn’t going to be large enough to allow anything better than muddling through we’ve seen over the last few years.

Second, potential volatility is as high as it’s ever been. Europe could muddle through with the ECB doing what it takes at the last minute to prevent a collapse, or doing what it takes proactively, or it could miss a beat and let it all unravel. Oil prices could double near term if Iran cuts production faster than the Saudis can replace it, or prices could collapse in time as production comes online from Iraq, the US, and other places forcing the Saudis to cut to levels where they can’t cut any more, and lose control of prices on the downside.

In other words, the risk of disruption and the range of outcomes remains elevated.

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MMT proposals for the 99%

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1. A full FICA suspension to end that highly regressive, punishing tax and restore sales, output, and jobs.
2. $150 billion in federal revenue sharing for the state goverments on a per capita basis to sustain essential services.
3. An $8/hr federally funded transition job for anyone willing and able to work to facilitate the transition from unemployment to private sector employment.
4. See my universal health care proposals on this website (Health Care Proposal).
5. See my proposals for narrow banking, the Fed, the Treasury and the FDIC on this website (Banking Proposal).
6. See my proposal’s to take away the financial sector’s ‘food supply’ by banning pension funds from buying equities, banning the Tsy from issuing anything longer than 3 month bills, and many others.
7. Universal Social Security at age 62 at a minimum level of support that makes us proud to be Americans.
8. Fill the Medicare ‘donut hole’ and other inequities.
9. Enact my housing proposals on this website (Housing proposal).
10. Don’t vote for anyone who wants to balance the federal budget!!!!

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