The economy doesn't operate like your household budget, so why

[jtuck004]

are all these wingers on tv and radio trying to convince us that we are in big trouble, that soon we won't even be able to pay the "interest" on our loans? Are they completely oblivious to the fact that we manufacture our own zeroes? That we haven't REALLY had to borrow money to fund the government since 1971? Do people who insist on using the economics of the first half of the century have something else to gain other than the good of this country? Are their oars not fully in the water? Is the...well, you got it.

Modern Monetary Theory, MMT, is still considered a heterodox theory and a bit outside the mainstream. That’s largely because of two factors. First, graduate economics education in money is largely stuck in quasi-gold standard era stuff from pre-1971. Milton Friedman and his disciples still dominate, despite the facts. Empirical evidence and knowledge of how banks & central banks actually work doesn’t support the theories, but we publish the stuff anyway.
...
Anyway, I came across this quote from Thomas Edison from 1928.
...
“That is to say, under the old way, any time we wish to add to the national wealth, we are compelled to add to the national debt.

“Now, that is what Henry Ford wants to prevent. He thinks it is stupid, and so do I, that for the loan of $30 million of their own money, the people of the United States should be compelled to pay $66 million — that is what it amounts to with interest. People who will not turn a shovel full of dirt nor contribute to a pound of material, will collect more money from the United States than will the people who supply the material and do the work.
...
“If our nation can issue a dollar bond, it can issue a dollar bill. The element that makes the bond good, makes the bill good also. The difference between the bond and the bill is that the bond lets the money brokers collect twice the amount of the bond and an additional 20 percent, whereas the currency pays nobody but those who contribute directly to Muscle Shoals in some useful way…
...

So, when you hear the pontificating congressperson going on about how we will soon be unable to pay the interest on our debt, please ask yourself why we are paying interest on money we create? Our money is manufactured by us, it is zeroes in a computer. We pay interest as a convenience, as a way to put more dollars into the economy so people can pay our government to operate, not out of necessity. For example, the $1+ trillion dollars of excess reserves sitting in the banks are paying them hundreds of billions of dollars, essentially off the books (except for the books that show it being subtracted from the taxpayers account, that is), and quite apart from TARP or the Extended Bailout programs. All paid to people who caused much of our current financial tragedy, and aren't lifting a shovel to help.

Who profits from that argument? Ask yourself, who has the money...

Jim Luke's econoprof blog - he teaches at Lansing - is here, as is the rest from the excerpt above.

[OhioBlue]

1. interesting. n/t

[whyverne]

2. It's a disingenuous argument that appeals to people who not

only don't understand the economy, they don't understand business. I think that a lot of people don't even realize that most retail businesses operate by borrowing the goods that they sell and paying for them after they're sold. If one uses the "household budget" argument for business, the retailer would have to save up enough money to buy the product before he could stock it. Which would put a lot of retailers out of business.

[eridani]

3. And what they refuse to consider at all is that we already ARE--

--operating the federal budget like we operate our household budgets. How else to explain the $14 trillion in consumer debt?

[Imperialism Inc.]

4. We can do it interest free if we want.

The Fed refunds, back to treasury, any interest they earn on government bonds. I don't think it is sound to have the Fed be Treasury's only customer. It seems to me that, though far from perfect, it is helpful to know the market's opinion too. That's actually what the scare cases like Zimbabwe and the Wiemar Republic did. In their case they did it because there was no real market for their government debt. That isn't the case for us but if we didn't sell on the market how would we ever know?

[pscot]

5. Interesting blog

Edison really cuts through all the bullshit. I've suspected since the campaign that Obama was a closet Friedmanite. There's been nothing since to prove otherwise.

[Taitertots]

6. Why doesn't he just say Monetize the Debt?

Then everyone would see it is bad advice. Add 14 trillion to the economy and empirical data suggests that there will be massive inflation and super high interest rates.

The Fed isn't monetizing the debt, because they can still resell the securities into the market after the recovery which will decrease the money supply after the recovery.

[girl gone mad]

8. What empirical data points to massive inflation and high interest rates?

[Taitertots]

10. All the data involving Interest rates, Price levels, unemployment, and production

If you have something that demonstrates otherwise than you are certain to win a nobel prize.

I'm basing this on the data presented in my economics books (Ball and Mankiw) and the econometric analysis of widely available data regarding those factors. I've seen the relevant data and used SPSS to show a statistically significant relationship for my economics classes.

If you are going to bother doing this: Buy SPSS or similar computer statistics program. Plot Price levels against unemployment. Plot Interest rates against Unemployment. Plot Interest rates against Price levels. You can get all this data online in 15 mins.

[FreeJoe]

7. I remember this...

I remember something like this as a question in one of my Econ classes many, many years ago. If I recall, my answer was something like this:

When the government purchases goods or services, it generally as to pay for them. It can do so from one of three sources - current income (primarily taxes), borrowing, or the creation of new money. All three approaches are similar. Taxes take money from taxpayers so that the government can use it purchase goods and services. In return for their taxes, taxpayers gain the benefits of government goods and services.

When the government borrows money, it takes the money from lenders. In return, the lenders receive their money plus interest at a later date.

When the government creates dollars, it proportionally reduces the value of dollars already in existence. This is because the total number of dollars increases but the amount of goods and services does not change, so each dollar controls fewer resources. The net effect of creating new dollars is like a tax levied in proportion to the dollars that people hold.

[girl gone mad]

9. It's a bit more complicated.

Government creation of money will not automatically lead to inflation. There is so much slack in our economy right now that deflation remains a bigger threat.

The deficit is an insignificant issue by comparison with our employment crisis, but we need a fiscal solution, not a monetary solution. Quantitative easing is a fool's errand. The government needs to put people back to work and implement a payroll tax holiday. Once our productive capacity shrinks, the government can consider inflationary risks and raise taxes to reduce the amount of money in the economy.

[Taitertots]

11. Printing more dollars only increases the Monetary Base

The Money Supply depends on reserve ratios, consumer attitudes, and Bank actions. For example QE#1 won't cause high inflation because the Money Multiplier was decreasing during that time. The Money Supply wasn't increased by QE#1.

Monetizing the debt will cause inflation because it won't be timed correctly to shifts in other macroeconomic variables. Add $1 Trillion to the Money supply for no good reason and we are certain to see inflation.

[girl gone mad]

12. Monetizing the debt will not cause inflation.

Not in the face of 20% real unemployment, massively underutilized productive capacity, $30 Trillion+ in debt left to unwind, etc.

Quantitative easing is swapping high yield assets for low yield assets. No new money is pumped into the system. The money created by the Fed will never pass through into the real economy.

Money multiplier is another neo-classical theory that should have been discarded ages ago. I suggest that you throw away your textbooks when your class is finished and try to forget this nonsense as quickly as possible.

We are no longer on a reserves-based money system so base money is not a constraint on money supply. When the dollar was backed by gold, the Fed's gold holdings did determine a hard limit on the quantity of US dollars that could be created by the banking system. At $35 per oz, for every oz of gold held by the central bank, for example, the banking system could create $35 of loans ("money" or "money supply"). So there was a hard cap on US dollar money supply, imposed by the 'discipline of gold'. We now have a sovereign fiat currency, the gold standard having failed to prevent external imbalances.

Even the Fed has tacitly admitted the money multiplier is broken, long ago shifting policy from direct concerns with measures of the money supply to focus almost exclusively on the value of the short-term interest rate.

The supply of money is a function of our GDP and fluctuates continuously. Commercial banks lend money into existence and the limiting factor is demand for credit. The money supply expands as new debts(credits) are created and shrinks as old debts(credits) are repaid. The central bank can influence the price of “money” by setting the interest rate on bank reserves, but it does not control the money supply.

[Taitertots]

13. If nothing else changes, it will without question cause inflation

Quantitative easing is buying assets to increase the money supply. Qualitative easing is changing the make up of the fed's balance sheet. The money from quantitative easing is certainly effecting the real economy. Qualitative easing is about keeping interest rate stability.

Your comments about "Base money" show that you have a fundamental lack of understanding regarding the monetary base and the money supply. No one is talking about the gold standard.

The central bank doesn't directly control the money supply, it controls the money base and several important variables in the money supply. The Fed controls the required reserve ratio, the interest rate it pays on reserves, the money base, and the discount rate. It doesn't directly SET the money supply, but it certainly has the ability to change it when it wants to.

The Fed uses interest rate targeting because the fluctuations in the multiplier and thus the money supply. This doesn't mean that changes to the money base are disconnected from changes to the money supply. It means that setting an interest rate target is more likely to have the planned outcomes.

[bemildred]

14. LOL.

:popcorn::popcorn:

[girl gone mad]

15. Please re-read my comments and your own.

You brought up the money multiplier theory, which more appropriately describes how the Federal Reserve functioned when the gold standard was in place.

Fractional reserve banking is also a relic of a bygone era.

The http://www.newyorkfed.org/aboutthefed/fedpoint/fed45.html">New York Fed highlighted the limitations of reserve requirements:

In practice, the connection between reserve requirements and money creation is not nearly as strong as the exercise above would suggest. Reserve requirements apply only to transaction accounts, which are components of M1, a narrowly defined measure of money. Deposits that are components of M2 and M3 (but not M1), such as savings accounts and time deposits, have no reserve requirements and therefore can expand without regard to reserve levels.

The Fed's required reserve ratio applies only to deposits by individuals. Banks have no reserve requirement at all for deposits by businesses so most deposits are not subject to any reserve requirements. After Glass-Steagall was repealed, these deposits were used for investment speculation at ratios far in excess of 10 to 1. The use of derivatives allowed for leveraged speculation exceeding 100 to 1.

The Federal Reserve has not used reserve ratios as a monetary tool for decades and, in fact, Bernanke has proposed doing away with reserve requirements altogether. The reserve requirement is considered virtually irrelevant to modern money creation because the Fed allows banks meet their reserve requirements by borrowing from the money markets at the prevailing federal funds rate.

To quote William C. Dudley, President of the Federal Reserve Bank of New York:

Based on how monetary policy has been conducted for several decades, banks have always had the ability to expand credit whenever they like. They don’t need a pile of “dry tinder” in the form of excess reserves to do so. That is because the Federal Reserve has committed itself to supply sufficient reserves to keep the fed funds rate at its target. If banks want to expand credit and that drives up the demand for reserves, the Fed automatically meets that demand in its conduct of monetary policy. In terms of the ability to expand credit rapidly, it makes no difference.

[Yo_Mama]

16. But in the long run, the economy does operate like a household budget

This is a rather complex topic.

Just printing money destroys the value of savings, if everything else holds constant. Of everything else does not always hold constant.

Just borrowing money without restraint and at an ever-growing ratio to the economy eventually does produce a government unable to pay its debts, unless the money can be used to generate growth higher than the additional interest. At the current time, our structural deficit is the real problem. Borrowing for a temporary purpose can be overcome; borrowing as much as we have already when we know we are structurally forced to borrow over the next decades is not a long-term stimulus.

And QE only produces stagflation in an environment such as we now have. Because circulation of money (velocity) is impaired, putting extra money into the economy at the top just forces assets bought by those at the top to increase in value, and since a large portion of those assets are commodity-related, the poorest persons are paradoxically hurt the worst. Any savings they may have will be derogated in value, and since the bulk of their spending is spent on necessities (food, fuel, medicine) their personal inflation rates will be much higher than for the country as an average.

Since at least 60% of the economy is composed of households with moderate means or those who expect to be living on moderate incomes soon (near-term retirees), this implies that most households will correctly readjust their future living standard expectations downwards, and will therefore readjust their spending lower, which will tend to create a deflationary trend in a big chunk of the economy.

Talking about "money" seems to make people crazy and confused.

Money is simply a proxy for the interchanges of resources to create goods and services and the interchange of goods and services. Changing the money supply does not necessarily change the creation rate of goods and services.

Broadly speaking, if the production and interchange of essential goods and services is constrained by external circumstances, raising the money supply will cause the cost of goods and resources, at least, to go higher.

If the production and interchange of goods and services is rising, raising the money supply will be necessary in order to keep the price of goods from dropping and does little or no harm.

If the production and interchange of goods and services is dropping, it may be doing so from external circumstances (famine, shortages) that are utterly disconnected from the money supply. However, gaining the resources to offset the shortages may require an injection of money - if that is POSSIBLE. It may not be. However it is more often a circulation problem with money, and in that case, simply dumping more money into the system may make the imbalances worse. Fixing the circulation problem is not within the capacity of a central bank.

We have both a fundamental constraint on the production of goods (energy costs) and a circulation problem, and dumping more mythical money into the system is probably going to make our problems worse.