FT: Letter to the editor


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Published letter to the editor in FT.

Expect public-sector deficits and oil prices to go on rising

by Prof Philip Arestis, Dr John McCombie and Mr Warren Mosler.

Sir, Public-sector deficits and crude oil prices will probably both continue rising. Chris Giles’ reports, “Treasury to reform Brown’s fiscal rules” and “Treasury sees storm clouds gathering” (July 18), recognise the inevitability of growing deficits due to economic weakness while also implying public-sector deficits are per se a “bad thing”.

What the articles fail to appreciate are three dimensions to the argument: the first is that public-sector deficits do not present a solvency issue, only an “inflation” issue. Second, public-sector deficits equal total non-government (domestic and foreign) savings of sterling financial assets and are the only source of non-government accumulation of sterling net financial assets. Third, public-sector deficits provide the net financial equity to the non-government sector that supports the private-sector credit structure.

It is the case that the public-sector deficit will increase in one of two ways. The “nice” way would be pro-actively with sufficient tax cuts or spending increases (depending on one’s politics) that support demand at desired levels. The “ugly” way is from a slowing of demand that reduces tax revenues and increases transfer payments. If, instead, the government tries to suppress the current deficit with any combination of tax increases or spending cuts, the resulting accelerated slowdown of the economy will then increase the deficit the “ugly” way.

In any case, the current “inflation” is the result of Saudi Arabia acting as swing producer as it sets the oil price at ever-higher levels and then supplies all the crude demanded at that price. Our institutional structure then passes these prices through the entire economy over time, and there is nothing interest rates or fiscal policy can do to change these dynamics.

The ability to set crude prices can only be broken by a sufficiently large supply response, such as in the early 1980s when net supplies increased by more than 15m barrels per day, helped considerably by the US deregulating natural gas production, which allowed substitution away from crude oil products.

In sum, the deficit will go up either the nice way or the ugly way, as it always does when markets work to grant the private sector the desired net financial assets, which can come only from government deficit spending. “Inflation” will continue higher as long as the Saudis remain price-setter and continue to post ever-higher prices to their refiners.

Philip Arestis,
University Director of Research,
Cambridge Centre for Economic and Public Policy

John McCombie,
Director,
Cambridge Centre for Economic and Public Policy

Warren Mosler,
Senior Associate Fellow,
Cambridge Centre for Economic and Public Policy,
University of Cambridge, UK


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Re: banking system proposal

Dear Philip,

Yes, as in my previous posts, bank stability is all about credible deposit insurance.

I would go further, and have all regulated, member banks, be able to fund via an open line to the BOE at the BOE target rate.

That would eliminate the interbank market entirely, and let all those smart people doing those jobs go out and do something useful, maybe cure cancer, for example!

This would not change the quantity of retail bank deposits, only the rate paid on those deposits, which would be something less than the BOE target rate. Loans create deposits so they are all still there, but with this proposal all the banks would necessarily bid a tad less than the BOE target rate for deposits. And note this pretty much the case anyway.

With insured deposits market discipline comes from via capital requirements, and regulators also tend to further protect their
insured deposits by creating a list of ‘legal assets’ for banks, as well as various other risk parameters. The trick is to make sure the shareholders take the risk and not the govt.

This would change nothing of macro consequence but it would enhance the efficiency and stability of the banking sector, presumably for further public purpose.

Note to that the eurozone has the same issue, only perhaps more so, as the ECB is prohibited by treaty from ‘bailing out’ failed banks. Hopefully this gets addressed before it is tested!

All the best,

Warren

On Jan 5, 2008 7:46 PM, <noreply@sundayherald.com> wrote:
>
>
> Hi Warren Moslder,
>
> Philip Arestis stopped by Sunday Herald
> website and suggested that you visit the following URL:
>
> http://www.sundayherald.com/business/businessnews/display.var.1945229.0.outbreak_of_common_sense_could_save_british_banking.php
>
> Here is their message …
>
> Dear Warren,
>
>
>
> Interesting developments over here. Would it make much difference I wonder.
>
>
>
> Best wishes, Philip
>
>


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