Ritchie on macroeconomics

Of course the USA needs to cut its deficit, but any government’s deficits can, as a matter of fact, only be cut when private sector consumption, net invetsment and net exports grow.


80 thoughts on “Ritchie on macroeconomics”

  1. A lot of keynsians don’t realise they are keynsians. Their starting point is that the economy has an agenda to it rather than being the result of voluntary human actions

  2. Dinero’s ideas on Keynsianism are pure hogwash. Keynsians are perfectly well aware that economic activity results from “voluntary human actions”. E.g. the decision as to how much work to do per week is a voluntary decision.

  3. Not Keynsianism. Sectoral balance:

    Private (savings – investment) = Government (spending – income) + External (net exports – imports)

    But he hasn’t understood it. Private sector growth is not the only way of cutting the public deficit. Obviously we would like the government deficit to reduce because exports are growing, people are spending more and there is more net investment. But it is also possible to reduce the deficit without any change in the external balance. You do this by taxing savings in some way – whether by direct taxation, higher inflation (which is a tax on savings), or by reducing government spending, which has the effect of reducing private sector savings if investment and the external balance remain constant. I think that is obvious from the equation.

    If the private sector wants to save but its savings are constantly eroded by the desire of government to cut its deficit, it fights back by reducing investment – which tends to push the economy towards recession. It also tends to reduce imports, though – so the external balance may improve. It’s all rather fluid, really.

    But what IS clear is that government deficit-cutting is not possible if the private sector wants to save (or cut its own debt, which is the same thing) AND the external balance is negative. That’s the problem in the UK, and that is why the Government has been utterly ineffective at cutting the deficit. Their macro is rubbish. But then so is Ritchie’s.

  4. Not Keynsianism. Sectoral balance:

    Private (savings – investment) = Government (spending – income) + External (net exports – imports)

    That’s a Keynesian paradigm analysis 🙂 Macro-economics is fundamentally and inescapably Keynesian.

    Drawing in the other above comments, I think the point is that Keynesianism reduces individual actions to mere responses to aggregate stimuli (“investment”, “confidence”, “money illusion”) etc. It is thus fundamentally incapable of indentifying problems in the economy due to anything other than aggregate variables; since recession is due generally to economic imbalance it doesn’t have the tools to analyse the situation, hence the simplistic sledgehammer type theories of gross income, gross “output”, gross “spending” etc.

    The other problem is that Keynes’s aggregate variables are variouslly useless and irrationally defined- the most egregious example perhaps being when Keynes initially derives “investment” as the savings portion of income and then, arbitrarily, starts using it to mean “any government spending”, even though (besides all else) a child from an unconcacted tribe in the Amazon could realise that the spending ought to go on the left-hand “income” side of the equation anyway- if a simple equation were any use (rather than a partial differential), which it isn’t.

    So far as one can tell, the limit of Keynes’s understanding of calculus was his ability to write “marginal” in front of things and then pretend he’s got a derivative. Hence my earlier assertion that caused a bit of a debate, that he seems to have been borderline innumerate.

    But that’s another issue.

  5. Ian B

    Sectoral balance is not Keynesian. It is an accounting identity, not an economic theory. Though its definition is usually attributed to Wynne Godley.


    I did explain what would happen if the government stopped spending so much. The private sector would have to make up the difference either by drawing on its savings or by reducing investment.

  6. The unsaid starting point for Dickie’s claim must be that government spending cannot be reduced?

    That’s fundamental to Keynes. If output is below “full output”, government cannot reduce spending as this will reduce output further, because Keynesianism is based on a false paradigm of spending “driving” the economy. The basic idea is that a recession is due to people for some supernatural reason deciding to spend less, en masse, so the State has to make up the difference by spending more.

    This is why the banksters like Keynes, because the solution to every problem is to spend more money, which is borrowed from the banks either directly by consumers or indirectly by the State.

  7. Frances, I’ve read The General Theory and numerous commentaries on it.

    Which is why I understand how disastrously wrong it is. Unfortunately, a lot of people have a vested interest in pretending it’s true, particularly those who currently profit from mismanaging the economy. Hence, it is one of those stupendously wrong theories that refuses to die, like Marxism, Freudianism, etc.

  8. Reduced government spending does not nessasariliy also require private sector drawing on savings or investment. Money can circulate and be savings in private sector without government spending featuring.

  9. Is Keynsianism really economics. Its focus is maximising work , thats not what most people would call economics.

  10. We can just automagically create government debt out of thin air? Some person in this world will have to buy that debt, and that money can then not be used for consumption or investment in the private sector.

  11. ” Their starting point is that the economy has an agenda to it rather than being the result of voluntary human actions”

    Classic leftist thinking is taking the collective and making a separate entity from whatever that collective was made up of. Thus, the “economy” can somehow magically exist without people. See also “state”, “government”, “companies”, “society”, etc.

  12. “it is one of those stupendously wrong theories that refuses to die, like Marxism, Freudianism”

    Freudianism is wrong? Seriously? Because humans are not at all driven by sex? That really is a bizarre thing to suggest.

    Still, one of your three examples actually being an example of what you suggest isn’t a terrible hit-rate. Although I’m afraid you didn’t quite meet Meatloaf’s standard for ‘ain’t bad’.

  13. Dinero,

    I’m afraid that simply isn’t true. The money supply is not fixed – it is affected by government behaviour: reducing “government” in the equation doesn’t leave more money for the private sector, as you seem to think.

    Cutting government spending is fiscal tightening, which has the effect of reducing the money supply – it’s the fiscal equivalent of raising interest rates. If the private sector maintains its savings level, then unless money comes into the economy from outside (via exports, FDI etc.) the amount of money actually circulating in the economy must fall, which tends to push the economy towards recession. Alternatively, the private sector may reduce its savings in order to maintain spending, leading to higher levels of personal and corporate debt. The government is expecting the second of these: in 2010 the OBR forecast significantly increased household debt due to government fiscal tightening. The trouble is that households and businesses already carrying high levels of debt either can’t or won’t take on more, so they are cutting spending instead.

    Monetary policy can counteract this effect to some extent, but there is considerable debate at the moment as to how effective monetary easing is when interest rates are on the floor and the entire economy is wearing hair shirts. There does seem to be some effect: M4 is growing, though at a snail’s pace, and corporate bond yields have fallen, reducing large companies’ borrowing costs (not that they were short of money anyway, though). But how much of this feeds through into productive activity in the real economy is much less clear.

  14. Ian,

    If you’ve read Keynes, you haven’t remotely understood him – or you wouldn’t misrepresent Keynesian thinking so massively. Unless of course you are simply using “Keynesian” in the way that Ritchie uses “neo-liberal” – a catch-all term for every economic theory that you don’t like. In which case there is no point debating with you, because you aren’t approaching this from a rational standpoint.

  15. Frances, does the economy really work that way? Does the money supply falling cause recession, or is it merely a symptom? Remember, when you’re using the term “money supply”, you actually mean the quantity of borrowing against M0. M3 isn’t “the money”. It’s credit.

    The problem with Keyensian-style macro is that it tries to describe the whole world in terms of tehse few aggregate variables. But, consider the tulipomania. What was the problem? Too many people growing too many fucking tulips because of a false assessment of the future value of tulip bulbs. What was the cure? Drastic reduction of the tulip sector of the economy (particularly the tulip bulbs futures market).

    Point is, no amount of mithering about the money supply, or aggregate investment, or state infrastructure spending, or government borrowing or government spending or encouraging Dutchmen to increase their consumer spending could do a damned thing about it. The problem was the tulips.

    A Keynesian Dutchman would have been entirely incapable of analysing the problem. It’s the wrong conceptual model. It just doesn’t work.

  16. Oh, I’ve thoroughly understood him Frances. But what do we mean by “understanding”?

    Consider Freud. You can “understand” him in the sense of reading all his books, and internalising his every word, and how to apply his theory, and become a Freud expert. But something is missing. You won’t know that the theory is bollocks.

    This is the second form of understanding, which is to analyse whether the theory is correct, using some form of critical rationalism. By applying broader scientific reasoning, you will realise that the theory is bollocks, which the Freud expert will never know, because he has limited his knowledge of Freud to the internals of the theory.

    Keynes is an internally consistent system. It can be thoroughly understood in that sense; so can many other internally consistent systems, such as Freud, or homeopathy, or astrology. But we should surely be more interested in the second meaning of “understanding” above, which is to consider whether this this internally consistent system is consistent with the external world. And then, as with astrology, we find that it isn’t.

  17. Ian B>

    Popper was a pompous ass. His theory of science is itself unscientific by his own standard. I suggest you need to encounter more of Feynman’s work in order to understand how science is actually done, rather than Popper’s fantasies of how science is done.

    Freud’s ‘experimental’ work is neither here nor there. The value of Freudianism is the recognition of Darwinian imperatives amongst humans – and that those exist is indisputably true.

  18. So is it correct that you do concur that central banks issue currency in exchange for cooporate bonds and commercial bank bonds making money available for the private sector without government spending

  19. Oh my, Dave.

    When the theory is bollocks, pretend it has some more general “good message”. That’s a truly desperate rescue operation. Freudianism doesn’t “recognise Darwinian imperatives” or anything else. It’s a pile of mystical cobblers.

    However, I think it probable that your anger at my criticism of it is due to your repressed sexual desires for your mother. Obviously, if you disagree with that analysis, it proves me correct.

    On science itself, I’m probably more of a Kuhnian. The point of bringing up Popper was that his impetus for developing his theory of science was a worthy attempt to try to provide a system for distinguishing between meritous scientific theories, and obvious pseudo-science like Marx and Freud (which were enormously popular among academics at the time). It was a worthy attempt.

  20. – Frances

    Drawing the conclusion you do from the sectorial balance equation is no more than a re-statement of the Keynsian paradigm to insert governmental demand. As Ian B says the money supply is a symptom of economic activity. If the private sector want spending money it is available from banks (technically via long term repurchase agreements of commercial banks with the cental bank.)

  21. Frances
    This part of your explanation eludes me:
    “Private (savings – investment)”
    All savings, unless in hoarding actual physical items or buying government bonds, surely end up being some other actor’s investment, don’t they? Doesn’t matter where the money’s put. Bank accounts. Building societies. The stock market. It doesn’t just sit there. It ends up being passed to another actor to spend. And I do prefer the term spending to investment. Be it spending today’s money for tomorrow, or tomorrows money today. Trying to give it a virtuous tag ‘investment’ can’t hide it’s spending. Whether it turns out to have been an ‘investment’ only the future can show. You can’t bank hopes.

  22. Ian B: good, let’s talk about tulipmania instead.

    no amount of mithering about the money supply, or aggregate investment, or state infrastructure spending, or government borrowing or government spending or encouraging Dutchmen to increase their consumer spending could do a damned thing about it. The problem was the tulips

    Oh, I thought the Austrian School you’re so fond of believes that bubbles are caused by an excessive supply of money. Are they wrong?

    In this case, probably not. The underlying problem was Amsterdam’s adherence to a strict Gold and Silver Standard, at a time when bullion was flooding into Europe.

  23. Bloke in Spain,

    Yes, the term “investment” is much misused. In the sectoral balance equation it really means spending, but that includes investment spending for a future return (e.g. project finance) as well as consumption spending. Trouble is if you put “spending” in the sectoral balance equation people always misunderstand it as meaning consumption. Another way of looking at this is that if the external balance is zero (net exports = imports), government deficit = private sector surplus.

    The point I was trying to make is that unless the government can some how magically conjure up a trade surplus – which as the entire world is trying to do this at the moment seems unlikely – then cutting the deficit in the absence of growth must reduce the private sector surplus, which will show itself as reduced savings, higher debt, and/or reduced discretionary spending.

    Whether deficit reduction is achieved through spending cuts or tax increases is not the point from a sectoral balance point of view, though they do have different economic effects: spending cuts are thought to do less long-term damage than tax rises, though I suspect it depends on the nature of the spending and the nature of the taxes.

  24. Ian,

    Oh dear. I give a monetarist explanation of the sectoral balance and you STILL witter on about Keynes…..

    Please go and do some reading. I suggest Friedman, in this case.

  25. Oh, I thought the Austrian School you’re so fond of believes that bubbles are caused by an excessive supply of money. Are they wrong?

    No. The general argument is that any artificial dicking around with money (increasing it, decreasing it, state directing its deployment, centralising interest rates, what have you) will tend to cause economic actors to make errors which lead to malinvestment. Which is why the general rule is that, wherever you are right now- boom, bust, whatever- the first rule for fixing things is to stop dicking around with the money. Which is of course the opposite of Keynes, who advises that the best cure for a disaster caused by dicking around is more dicking around.

    He was very fond of dicking around, was Keynes.

    And again, the basic problem in Amsterdam was too many fucking tulips.

  26. Oh dear. I give a monetarist explanation of the sectoral balance and you STILL witter on about Keynes…..

    Because they’re both interpretations of the same dicking around with the money supply paradigm. It really is not unreasonable to observe that Keynes set the “macro vs. micro” ball rolling, and all the various varations (including the weirdness of Knight and the Chicago school) are simply different interpretations of the same Keynes-derived paradigm. It’s the same as the various different Marxisms, in that sense.

    Really Frances, I do know what I’m talking about. This sort of “go and read a book” argument is rarely fruitful and generally smacks of desperation.

  27. Marx: wrong about communism, mostly right about everything else

    Hitler: Wrong about the Jews, lebensraum and the Aryan destiny through conquest, but other than that…

  28. Dinero

    “If the private sector want spending money it is available from banks”

    I really, really don’t want to get into another huge debate about how the money supply works. But I would like to make these points:

    1) Banks only make money available via lending if they want to. Which at the moment they don’t, much.

    2) If banks want to make money available they can do so without any help from the central bank. Most of the money in circulation is created by commercial banks, not the central bank. Loans create deposits, and those deposits don’t have to be backed by reserves. Reserves are needed for deposit withdrawals (payments), not lending. Banks do NOT “lend out” central bank borrowings – or customer deposits, either.

    3) I’m well aware that believers in the money multiplier myth (such as Ian) like to distinguish between “money” and “credit”. But I don’t care which I use for my shopping – and the reality is that the money that people use for shopping is created by commercial banks in the form of credit. The only “real money” in circulation is notes & coins. The rest is commercial bank credit.

    You seem to want to exclude government completely from the sectoral balance equation. If you do so, then it becomes this (I’ve amended it in the light of Bloke in Spain’s comment):

    Private (savings – (consumption + investment)) = External (net exports – imports)

    This is, of course, a country that does not have its own currency. Or a country where the private sector does not use the sovereign currency – Zimbabwe springs to mind. In fact it’s effectively a country that has no government.

  29. Ian B.

    Oh. So every macro-economic theorist is simply recycling Keynes, then. Wow.

    Presumably that includes Hayek, and Mises, and Rothbard.

  30. “Zimbabwe springs to mind. In fact it’s effectively a country that has no government.”

    Go to Harare , stand on a soapbox in the centre and expound in a loud voice about what a sack of shite Robert Mugabe is. You will soon find out if they have a govt or not.

  31. Mr Ecks

    So Mugabe’s thugs can beat you up. Doesn’t make them a government. As far as economic activity in Zimbabwe is concerned, there is no government.

  32. Govt is about beating people up and killing them if a beating (or being sodomised in jail) is not enough. Sure, if enough people have been bullshitted–like you–you don’t need to show the fist as much–but it is always there.

  33. Frances-

    Hayek, von Mises and Rohbard all rejected the very existence of “Macro”.

    (Well, the last two certainly did, not sure about Hayek. He had a tendency to be a bit tepid).

    The multiplier is a “myth” is it?

    Look. In a gold (or other commodity standard) system, you have your gold reserves, which are the money. And certificates circulating for the gold. In a fiat system, the M0 takes the place of the gold, and the M3 is the gold certificates. The number of certificates in circulation expands and contracts in response to market conditions. The more lending there is, the more there are.

    It’s not hard. If you think I’m one of those fellows who wants to end fractional reserve banking, I’m not; if that is the justification for your “myth” barb. But you really ought, in thinking about economics, to “care” about what the money is, because it’s pretty fundamental.

    If you don’t, you mind start believing some crazy shit about how expanding the M3 might drive economic growth, and you’re not that stupid are you?

  34. So anyway, I’ll reiterate. When the economy is doing well, there is more lending (investment) and so the supply of gold/M0 certificates in circulation rises. When the economy crashes, the number of them falls due to the reduction in economic activity. This is not a reversible cause and effect.

  35. Ian B,

    Oh, and about those tulips. According to you, the cause of the tulip mania was TOO MANY tulips, and the price crash was achieved by reducing their supply. Blimey. For some supernatural reason the normal laws of supply and demand must have been reversed, then…..

    Over-supply drives DOWN prices, not up. If the problem was too many tulips the price would have been on the floor, not heading for the moon. And how on earth would cutting the supply of something reduce its price?

    Paul’s explanation makes far more sense. Excessive inflows of bullion caused a vast increase in the money supply, leading to hyperinflation in a particular asset class. Now, remind me, where recently have we seen high inflation in an asset class driven by excess inflows of hot money, followed by a crash when investors realised they had been sold a pup?

    Oh, and of course the tulip mania had nothing whatsoever to do with Keynesian gubmint nutters dicking around with the money supply…..

  36. Frances-

    Well, it’s a warning about money supply manipulations. It’s a warning that increasing the money supply doesn’t lead to economic growth. It leads to too many fucking tulips.

    A crash occurs every time somebody expects a future return in excess of what return they actually get (or realise they are going to get). Every failed business is a local crash. In the case of big crashes, it’s when everyone thinks the future return is far in excess of the actual return (tulips, railways, dot coms, houses). The actual point of the crash, the sudden crash, is the moment that that realisation dawns.

    In the case of tulips, the realisation that “we’ve got all these fucking tulips and nobody is going to buy them”. So, the price of tulips at that moment falls to the actual excessive supply (caused by over-investment) level; i.e. bugger all. Meanwhile, everyone who wagered their life savings on tulip prices rising forever starts jumping off… windmills, presumably in that case.

    So, it’s a case of price lagging supply. It does drive prices DOWN. That’s the crash.

    The cause of the boom is over-enthusiasm; a commonplace expectation that everyone can win. The availability of money (flood of bullion, state fiscal expansion) thus enables the boom. It allows for far too many fucking tulips.

    So, this brings us back to Macro. Once the price crash occurs, it’s not a money supply problem that can be fixed by the State spending more money. It’s caused by all these fucking tulips, or rather all these people in the tulip industry who need to go off and find another product that people actually want. And no amount of macro can fix that.

  37. Ian,

    It is precisely because I DO care what money is, and how it works, that I made those comments. The role of bank lending in the creation and circulation of money is widely misunderstood – not least by you.

    The multiplier is a myth. Bank lending simply does not work in the way you describe. It didn’t work that way even under a gold standard. Someone invented the money multiplier as a simplified explanation of the multiplication effect of fractional reserve lending, but they started from the wrong place. It starts with loans, not deposits – and that makes all the difference.

    I was right that there’s no point debating with you. Your considered opinion seems to be that macro is bollocks. That’s not rational.

  38. Frances,

    For a start, I’m not at all clear about what you think I think about the “money multiplier”. So I don’t know whether what you think I think is what I actually think. As I said, I’m not anti-frac. I’m anti-government borrowing, but that’s a different thing.

    Anyway, you’ll find that it’s pretty much central to the Austrian School that there ain’t no macro; that the attempt to arithmetical (and econometric) economics is fundamentally flawed for logical reasons. In that sense, I may not be rational, but I’m being pretty orthodox (to the Austrian School).

  39. Anyway, all I claimed (I think) is that the measure of broad money is simply proportional to the quantity of lending by banks. That doesn’t seem particularly la-la-loopy to me. Im rather mystifed as to what else you think it is. Come to that, I didn’t even mention a multiplier, did I?

  40. Ian,

    The tulip story actually demonstrates that gubmints CAN’T control the money supply. Which is exactly the point I have been making throughout these comments. The sectoral balance describes what HAPPENS, not what governments aim to achieve. You’ve completely misunderstood it – despite the fact that I have TWICE pointed out that the sectoral balance is not an economic theory, it is an accounting identity. It is not any sort of Keynesian macroeconomic paradigm. It’s the law of unintended consequences.

    If a government has a deficit it can only cut it by extracting money from the private sector. If the private sector is growing, it can accommodate government deficit cutting without much pain, though it tends to grumble (which is why politicians don’t like to do it). But when the private sector is NOT growing, extracting money from it to reduce a government deficit causes actual damage. I’m amazed that someone as keen on private sector activity as you wants an already-damaged private sector to take even more pain in order to reduce the size of government. If I explain it that way does it make more sense?

    That doesn’t mean I agree with Ritchie, though. It is in theory possible to cut a deficit when the private sector is not growing. All the sectoral balance shows us is that reducing the deficit and increasing private sector growth cannot happen at the same time. Government deficit-cutting causes economic activity to reduce even more. It’s inevitable.

    Ritchie makes me laugh. He is apparently blind to the fact that all of his proposals for increasing tax take amount to fiscal tightening. So much for his ideas about restoring economic growth.

  41. Ian,

    You claimed that M3 was proportional to M0. That is the multiplier. And it is wrong. If you look at Friedman’s book on the Great Depression, he produced some fascinating charts that showed M3 actually FALLING while M0 was rising. In the UK in 201o-11 M4 did the same – it continued to fall due to private sector deleveraging while M0 was rising due to QE. M4 is now rising, but M0 is rising faster. They aren’t really related at all at the moment because of QE.

    Banks simply don’t “leverage” central bank money. The Fed has shown that M0 lags M3, which is consistent with the view that reserves creation responds to commercial bank lending, not the other way round. And it has always been like that – even under the gold standard. Really only a pure bullion standard or strict full reserve banking would force reserve creation to precede lending.

  42. Frances, I didn’t claim that M3 is proportional to M0. I said the opposite. I said it’s proportional to the lending in the economy (i.e. it *is* the lending in the economy). M0 simply acts as an ultimate limit on how much of it you can have, hence expanding M0 allows for more M3, but does not *cause* an increase in M3. In fact I specfically stated that M3 falls during a recession due to economic conditions (ergo, not due to a fall in M0).

    So Keynesian spending is a deliberate attempt to push more M3 (via government purchases) into the economy when it *should* be naturally falling.

    We may be at crossed purposes.

  43. … also though, if you look at QE, you’ve got the government trying to create more M3 by creating more M0, which suggests that *they* do believe in a simple multiplier.

  44. Ian,

    Yes, M3 IS the lending in the economy. But M0 does not act as any sort of brake on lending. Reserves are needed for payments, not lending. No central bank would refuse to create reserves needed to settle aggregate payments across its RTGS system. So central banks create reserves on demand, without limit.

    Bank lending is not limited by reserve availability. Increasing bank reserves doesn’t make them lend – as QE has shown us all too clearly. And reducing bank reserves doesn’t stop them lending, either. It is all a myth.

    The constraints on bank lending are:

    – regulatory capital requirements

    – cost of funding (which is affected by central bank policy rates, of course – that’s how monetary policy influences bank lending)

    – the banks’ view of risk versus return.

    At present capital requirements are being tightened and banks are horribly risk-averse because of their awful balance sheets. So the only thing keeping bank lending going is the fact that funding is very cheap due to historically low interest rates and because of government intervention (the Funding for Lending scheme, for example). Are you really sure you don’t want gubmint dicking around with the money supply – which is of course what this is?

    The government believes all manner of things that aren’t right. But the Bank of England’s view is more nuanced. The stated purpose of QE is to drive down real interest rates, reducing corporate borrowing costs and therefore encouraging large corporates to invest and expand. It was also hoped that some investors might actually spend their QE money on goods and services, too. However, the Bank of England noted in its literature on QE that although increasing bank reserves might encourage banks to lend more, there was no guarantee of this and they weren’t relying on it – which suggests the Bank, at any rate, is unconvinced by the multiplier.

  45. Ian

    We have been at crossed purposes ever since you decided that I was describing a Keynesian economic paradigm when I wasn’t.

  46. I’ve really got to stop torturing myself like this. As an economics graduate, I find the amount of ignorant shit that people like PaulB and Frances come out with is simply staggering. Of course I can go to the peer-reviewed literature to generate a rebuttal in my own mind (recent papers by the Minneapolis Fed are particularly illuminating), but I’m afraid the only way I can take ownership of this situation is to stop butting my head against the ferroconcrete wall of religious faith in gov’t intervention. “This time will be different!!” That’s nice.

  47. Richard Allan

    Where exactly did I demonstrate “religious faith in government intervention”? Or say “this time will be different”? All I did was explain the sectoral balance, which is not an economic theory – it is an accounting identity which simply recognises that whether you like it or not government is part of national accounting.

    Do you think I don’t read peer-reviewed literature? Of course I bloody do. Peer-reviewed literature does not agree on the value or otherwise of government intervention.

    All you’ve shown is that you haven’t read what I’ve said properly and have forgotten all the economics you’ve ever learned.

  48. Ian B:

    And again, the basic problem in Amsterdam was too many fucking tulips.

    Here‘s an article which explains tulipmania by reference to ” a large increase in the supply of coin and bullion in 1630s Amsterdam.”

    But it was published in the notoriously Keynesian Quarterly Journal of Austrian Economics, so it must be wrong.

  49. – Francis

    Thanks for clarifying your comment .

    You have overlooked that private activity can grow without Government or External involvelment, so there is noththing left of the sectoral balance equation.

  50. Gamecock.

    If the government spends less, the private sector must spend more. Which reduces its net savings. Which is what I said.

  51. Paul, I have that feeling I always have when debating with you, of trying to nail a jelly to a ceiling.

    It was me that brought up the tulipomania. It’s thus my perogative to decide what it is supposed to be illustrating in the discussion. What it isn’t illustrating s what caused the problem. It was to illustrate that at the moment the economic collapse happens, a Keynesian analysis is useless.

    The Amsterdam problem was not describable in aggregates- income, investment, saving, etc. It was caused by a specific malinvestment- in tulips and all things associated with them. This defines the whole (or much of) the disagreement beween Austrians and Keynesians (and other “macrophiles”). If you are the King of Dutchland looking at the economic chaos in Amsterdam, what do you need to know?

    The answer is, you need to know that there are too many fucking tulips. And that the only solution is liquidation of the escess tulip production in the Amsterdam economy. That’s what you need to know.

    Which is why an Austrian would know the solution, and a Keynesian with his little slate and chalk trying to measure aggregate investment and aggregate spending and aggregate output wouldn’t. It’s not because there is too much stuff being produced, too little being produced, or too much or too little being spent. It’s because the wrong things are being produced.

    Do you get the point now Paul? Too many tulips. Too many fucking tulips. You see?

  52. @ Frances #6
    Why do you assume that the government is *not* trying to reduce the external deficit? It is not making much headway since the Eurozone crisis cut spending and imports therein but that was clearly part of their plan and the VAT rise was one of the few moves open to it under EU and WTC rules towards that end.

  53. Dinero

    No, I haven’t overlooked that.

    I have not suggested that private sector growth, or export growth, require government involvement. The sectoral balance does not indicate anything about causation – it is simply a balance. All I said was that cutting the government deficit requires extraction of money from the private sector in some manner, which is money that could have gone into private sector saving, investment and consumption. Therefore government deficit-cutting tends to impede private sector growth. That is obvious from the equation.

    I’d guess you find it easy to understand that tax rises extract money from the private sector, but more difficult to understand that spending cuts also do so. Spending cuts and tax rises don’t extract money from the same groups. But anything that forces the private sector to reduce its savings level in order to maintain spending – or vice versa – is a brake on private sector growth. Private sector spending cuts obviously reduce economic activity, but so does savings reduction, since longer-term investment in the economy comes from savings.

    If you like, we can have a separate debate about “crowding out” and whether reducing government activity encourages private sector growth. The sectoral balance doesn’t tell us anything about this.

  54. Dinero…..books have to balance…..if the government spends less and the external balance doesn’t change, the private sector either has to spend more or overall economic activity reduces. Which is what I have been saying all along.

  55. And to conclude from your equationat the sum is to be maintined is simply a formal definition of Keynsianism which you said it was not – yes

  56. John77

    I’m not assuming the government is not trying to improve the external balance. I know it is, but as I pointed out somewhere (probably to Ian), so is everyone else. When everyone wants to increase exports and cut imports, no-one can.

  57. Dinero

    This is not Keynsianism – it’s accounting, that’s all. The sectoral balance shows the effect of policy but does not define it. That’s why Ritchie doesn’t understand it – he thinks it supports the Keynsian view that deficit-cutting is only possible in a growing economy. But the sectoral balance is actually neutral. It is equally compatible with the liquidationist view that cutting government spending and allowing the economy to go into recession is a good thing, because it would clear out malinvestment and enable the private sector to expand into the gaps left by government.

    I don’t argue that deficit cutting makes private sector growth impossible in the long term, only that private sector growth is impeded WHILE THE DEFICIT IS BEING REDUCED. Why do you have a problem with this?

  58. I’d like to clarify something I said in my first comment. I suggested that government deficit-cutting was not possible when the private sector is saving (or deleveraging) and the external balance is negative. Here’s my clarification:

    – It is actually possible to cut the deficit under these circumstances, but only at the price of recession, which may be severe and prolonged. This is what is happening in Greece, which has managed to cut its deficit by an historically unprecedented amount but is now in the sixth year of deep recession. The view of the EU leadership is that severe and prolonged recession is better than allowing the Greek government to continue spending at an unsustainable level.

    – However, Irving Fisher suggests that in an indebted economy, if the private sector contracts too far deficit-cutting becomes impossible. Once the amount of money needed to service the debt exceeds what can be extracted from the private sector, the government is forced to borrow more in order to pay its debts. Or print money, of course – and we all know what happens when a distressed government in a deeply recessed economy starts printing money to pay its debts, don’t we?

  59. Or, it can just default on the debt. As Stalin said, “how many divisions do the banks have?”

    The simple answer to all this is, of course, for governments not to borrow money. They do not need to, because they have the legal money creation power. The borrowing of money stems from the days when money was gold; not a gold standard but actual gold, and the only way to get more gold, even for a king, was to borrow it (unless he could expect a good ROI from invasion and plunder of some other kingdom). So, they borrowed money. Mainly, ironically, to finance the invasion and plunder of other kingdoms. Whatever.

    It’s an anachronism.

    Ideally, the money supply (M0) would then just be static. Private banks would be free, like everyone else in the economy, to do what they wished with it; including crediting promisory credit to their account holders, etc etc.

    If the government really was still silly enough to want to expand the money supply, they would then simply mint it (electronically, these days) and spend it. And have no interest to pay.

    It’s been a long time since we paid for anything with bags of gold. It’s time government finances caught up with that. There’s no reason for an economy, as a whole, to be indebted. It’s lunacy.

  60. IanB: yes, I understand thank you. You are anxious to tell us why it would be problematic to attempt to maintain a tulip bulb price of several thousand guilders. No doubt we are all suitably grateful.

  61. I’m grateful that you’re grateful Paul. Now, can you guess what this tells us about recessions due, not to tulips but, say, railway shares, dot coms or subprime mortgage lending?

  62. IanB

    Yes, indeed, it could default on the debt. In fact triggering hyperinflation by printing money to pay debts amounts to default anyway. Debts paid with worthless money haven’t been paid.

    Not all governments have the power to print money, of course. Those that don’t – notably the Eurozone governments – have no choice but to borrow.

    We do tend to treat our fiat currency system as if it is a gold money system, don’t we! I think a lot of people are still intrinsically unhappy with the idea of governments just creating money.

  63. Well Frances, that was what I meant back up the thread about the M0 being the gold and the M3 being the gold certificates. We still think that way.

    History seems to tell us why goldbuggery won’t work; you start with gold, then people start circulating the certificates, then they start thinking of the certificates as “the money” and at that point you’re into something virtual, and inevitably will end up with a fiat anyway. So, we may as well live with that reality. In which case, we may as well just try to find some constitutional means to limit the money printing (“no more than 3% in any one year”) and save ourselves the interest. Which is pretty much what our mate Milton Friedman suggested.

    I can’t see any way forward for the likes of Greece that *doesn’t* amount to a default, anyway.

    BTW, have you read, “When Money Dies”? One thing that interested me was that the ultimate solution to the Weimar inflation was to cobble together a new currency that was actually no more sound than the old one; but simply because it was a new one, it got the confidence back that the old mark had lost, which brought the hypervelocity to an end. A lot of the Weimar problem was actually velocity. People were being paid first thing in the monring, then getting an hour off work to go spend it before it lost its value!

  64. Yes Ian, it tells us not to try to maintain prices of, say, railway shares after a railway share price bubble bursts. Does anyone say otherwise?

  65. I don’t think anyone but you has said anything about maintaining the price of anything Paul. So no, nobody has said anything otherwise.

    What it tells us is that the recession isn’t a monetary phenomenon.

    It might also tell us that there is no such thing as the marginal propensity to consume tulips, but I think you’ve already guessed that part.

  66. Ian: a few years ago I broke my ankle in a running accident. I went to the hospital where the doctor carefully examined me and told me that since the injury hadn’t been caused medically it would be quite wrong to treat it medically.

    So I went to a different hospital.

  67. Ian,

    I’m pretty much in agreement – especially as government debt is becoming more and more like cash anyway. It is nearly as liquid as a demand deposit and carries little more in the way of interest. And its nature and purpose is changing. We all know it isn’t really needed for government financing any more, but that doesn’t mean it isn’t needed. The financial world is a very, very strange place these days…..

    I read a paper from BIS the other day that suggested that, in order to ensure there was a sufficient supply of safe assets for investment and funding collateral, major governments should issue unlimited debt in response to financial system demand – rather as central banks issue unlimited reserves in response to bank demand. But to ensure that these debt assets remained “safe”, governments should also maintain strict control of government spending and run balanced budgets or primary surpluses. I think that’s sort of full reserve banking for governments, isn’t it – borrow the money, but put it safely away in a vault so there is no possibility of not being able to return it…..My mind boggled, anyway. We really have to reform this idiotic system.

    Greece has already technically defaulted twice (PSI early last year, and the recent PSI/OSI deal). And as its underlying problems haven’t been solved and its debt pile is not even remotely sustainable, it is bound to do so again. Whether or not it remains in the Euro, its debt will eventually have to be written off, I reckon. That outcome is already priced in – there isn’t really a market for Greek debt.

    I’ve read “When Money Dies”. It’s absolutely riveting. Yes, you’re right about velocity – I hadn’t thought it like that, but V of course rises exponentially in hyperinflation. We normally think of increasing V as a good thing, but not like that. And confidence – really the renewed confidence was not so much in the currency but in the government. Creating a new currency was symbolic of the government regaining control. Political chaos seems to be strongly associated with hyperinflation.

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