Ritchie still doesn’t understand Keynes, does he?

The logic of austerity is based on the theory of the firm, which is that if it is in trouble a firm can get rid of costs (like employees) without worrying about them after they leave as they are no longer on its payroll. But this is not of course true of the state: if someone is made unemployed in the state and there is no alternative work for them they still exist: they still have to be fed, and they still need public services. All that happen is that as a result of their sacking there is now no productive activity from them to help meet that demand, or pay the tax that makes it possible. So, in the economy as a whole sacking people simply means that there is less income and if there is less income than it inevitably follows there is less tax, more benefits are paid, and the pressure on public services is therefore greater, and the capacity to supply such services is reduced.

Thus the government borrows more money and this is fiscal stimulus. “Automatic stabilisers” in the jargon.


49 thoughts on “Ritchie still doesn’t understand Keynes, does he?”

  1. And for an accountant, he doesn’t seem particularly keen on following up his intuitive ‘less’ and ‘more’ with the evidenced arithmetic his profession is normally keen on.

    Assuming that a civil servant produced zero beneficial output, at what level of pay would it be cost neutral to keep them employed rather than putting them on benefits?

  2. I have never understood the argument that sacking a state worker is bad because they then don’t pay tax. The state would still gain the *net* pay of the employee, after PAYE and NI, would they not?

    I don’t mind the argument that the net saving might be less than the benefits payments, fair enough. But to say that sacking a state worker reduces the tax intake and therefore is a bad idea I don’t understand.

    Then again, the only people I have heard making it are astonishingly stupid lefties.

  3. Ritchie has just about grasped the idea – but six years too late. We’ve been through a recession and come out the other side: now the economy is growing, wages are rising, unemployment is low, and we are as close to full employment as possible. Even the most Keynsian of governments wouldn’t want to hire more ditch-diggers under these circumstances.

  4. “Then again, the only people I have heard making it are astonishingly stupid lefties”

    You’d be astonished how often this comes up amongst supposedly educated people (teachers). I invariably point out that if this were true it is therefore beneficial to the state to employ people do nothing at all. Then it goes quiet.

    I think it’s because lefties don’t see tax money as something extracted from workers, businesspeople or whatever. They sort of see it as a free pot of money which magically appears and is bottomless. They certainly behave as if it is.

  5. Off topic, but can I ask a question here?

    Over on Tim’s piece at The Register about Russia’s money woes a commentator weighed in about the common socialist belief that fractional reserve banking ‘creates money out of thin air’.

    I’ve always been confused about this. Who’s right?

    Here’s the comment…
    Re: @Mage
    I love it when people use the phrase “fractional reserve banking”. It just means that the rest of the comment is going to be deluded nonsense. It’s Bullshit Bingo time.
    For the love of God, one final time, here it is: FRB only creates money if you are an idiot that forgets to subtract debt from money. The total assets have gone up, yes, as have the total liabilities. The money isn’t generated from thin air.
    Just think through it: my family lends me some money because they don’t have anywhere to put it, and I know people who need it. I keep a bit of it to one side, in case they need some back, and lend the rest on to someone else at a slightly higher rate than I give my family, to take account of the work I’m doing. How much money is there? I have a few per cent of the original, the people I gave it to have the rest. No money has been created. What also exists now is a debt from the company to me, which I in turn owe to my family, and this is considered a debt on one side of the deal and an asset on the other.
    All FRB means is that there is an intermediary doing the loaning, and the loan appears on both columns of their ledger: asset and liability. If I acted purely as an intermediary, and put my family in touch with the people I knew to lend the money directly, charging a small commission, the effect would be the same, and my profit would be the same, but the bank wouldn’t have assets and liabilities, and people like you would have to find another catchphrase to get frothy about.

  6. Struck Record,

    Mage (or whoever penned that long quote purporting to explain banking) is talking nonsense. He claims that commercial banks simply lend on pre-existing money. They DO DO THAT, but they also create money out of thin air: that is, when a commercial bank lends £X, it DOES NOT NEED to get that £X from anywhere.

    The amount of “thin air money creation” that banks do varies greatly depending on whether they’re in “irrational exuberance” mode or the opposite . E.g. they were expanding the money supply like there’s no tomorrow just prior to the crunch. Then come the crunch, as is normal in recessions, their money creation activities ground practically to a halt.

    The pounds created by Lloyds, Barclays are not quite the same as Bank of England pounds, but they trade at par as long as everyone has confidence in Lloyds, Barclays, etc.

    This is a complicated subject, and the above couple of paragraphs of mine are an ultra-short and totally inadequate introduction to the subject.

  7. No *commercial* banks do not create money out of thin air – they can only lend a multiple of their deposits – so what they do is *inflate* the amount of money printed by the BoE (which, like every Central Bank with an independent currency *can* create money out of thin air). The limit of inflation *used to be* in the UK that every bank had to hold 8% of its deposits in cash or accounts at the BoE until the 1970s. By the “noughties” it had got risen to lending being not more than 33x the bank’s capital. The Vickers reforms reduced that to 25x, which – combined with the reduction in equity caused by the write-down of bad loans, prompted a massive cut-back in lending and more write-downs
    The financial crisis was the bursting of the balloon when some people lost confidence in their bank.
    Murphy naturally blames the private sector for every fault of the public sector. Who did you say pays him?

  8. I did find this mildly amusing. The context is the poster complaining about local government staff being made redundant & then set on as consultants (fair enough com plaint)

    ‘There needs to be a comprehensive, Piketty-like deconstruction of these practices, but who will do it ?’

    To which RM responds:

    ‘Just find me the money… ‘

  9. This guy’s even more ignorant than I thought. By his logic the state should never sack anyone, because we’re always better off if they’re kept on. As Paul said it follows from that that we’re better off if the state hires eveyone, even if they’re paid to do nothing. And that’s the economics equivalent of a perpetual motion machine.

  10. If his argument was valid then Greece would be the most prosperous country in the world from 2000-2010 as the state payroll was enormous.

  11. Off topic, but how much is it worth not to let Keith Hudson know of the existence of this blog and its comment facility?
    Yes, this IS blackmail.

  12. “… and there is no alternative work for them …”

    Therein lies the fallacy in his argument. I doubt very much that Mr Richie would be able to show that many sacked state workers would have no recourse to work.

    Remember this is a critical part of the argument, because an ex-state worker who transfers to the private sector becomes a net contributor, effectively doubling his previous “productivity”, he’ll not only be able to feed himself but someone else too.

  13. I’ve never understood why state workers pay tax anyway. Just pay them less instead. When they sign a contract just say we will pay you x which is the equivalent of y in the private sector before tax. Given the numbers of parasites, sorry, people who are paid by the state wouldn’t this save a ton of cash on accounting too?

  14. Runcie B – all very well in theory, but a large percentage of the people on the state payroll would be unemployable in the private sector, especially those in the higher income echelons.

  15. @Dongguan, because some state workers have other sources of income which affect how much tax they pay, and some of them even declare those other sources of income.

  16. @BiG, Ah yes I suppose that makes sense… still it feels like a colossal waste of time & effort. Ho hum.

  17. Oh, and to jump in on the other thing, don’t listen to Ralph, he’s got a book to sell (buy one, get one free tin foil hat).

    I did a nice demonstration to my colleagues with a stack of 1 euro coins in which we play banker, shopkeeper, customer etc. I played bank and end up holding all the coins, and have lots of assets (those coins, plus the debts to me of those who borrowed to buy stuff) so it looks like I am a stinking rich filthy banker. But I also have an equal amount of liabilities, to those who deposited their savings with me, and from our original 10 euros there are now 50-odd. But there’s no new physical money, just a new ledger of assets and liabilities, because your money in the bank isn’t actually money, it’s a debt the bank owes you. Or, another way of looking at it, most money is actually debt.

    And we don’t even need a bank to do this (in fact call it something else to dispel the “I don’t understand it” high-finance mystique) – just playing a game around a table, or lending a mate a tenner, “creates” money.

    Full reserve banking is a joke that makes banking pointless. You’d have to charge people to deposit their cash as all you can do with it is stick it in a vault (and hope the bank robbers stay away). If you want full reserve banking you might as well just buy a big safe and keep it at home.

  18. @Dongguan – everyone’s doing it anyway, so unless you want to do the continental thing of actively encouraging or even legally permitting your Beamte and Statale to evade taxes on their non-salary income, you gotta go through the mill. And since everyone’s doing it anyway the infrastructure is there. Less marginal cost and more what the Germans might call “eh da Kosten”.

  19. @Dongguan John

    When I was a State worker (Army) we paid board and lodge and when I got married rent and rates.

    When the question was raised about why giving in one hand and taking back in the other it was explained that we had to get used to being back in the real world.

    Also, I want those people at HMRC and Treasury to live by the system the impose and enforce.

    The better question is why do we have PAYE? It would make people much more aware of the taxes they are paying if they had to write out a cheque every year.

  20. You can lend money, as a bank, with full reserve banking. You just have to lend it on the same terms it was deposited on – 90 day deposit can be lent for 90 days. Adam Smith fans can read his account of the introduction of fractional RB in Scotland – it was a jolly good thing.

    But we don’t have it now. We have Basel Rules, which let banks lend a proportion of *assets* which include deposits. None of these things create new money provided the assets are valued accurately. Fractional RB and Basel Rules create liquidity.

    Basel Rules are more subject to problems though, because as people noticed a few years ago, assets like securitised mortgage debt are hard to value accurately, and can contain horrible surprises.

  21. @Stuck-Record

    That type ofefties don’t (want to) get the idea of FRB because they don’t understand the concept of credit and that the borrowed money has to be paid back at some point.

    This is also why they assume that that banks should lend to everyone who puts forward a business plan no matter how batshit the idea is.

  22. @Peter, that proposal fails to fulfil the supposed purpose of full reserve (higher deposit security, because who says a 90 day loan will be repaid on time, or at all? You don’t solve the deadbeat borrower problem this way.

    You also still make banks useless. If I want to loan on 90 days and someone else wants to borrow on 90 days, why not do it direct? And who in their right mind is going to lend on 20 years, as mortgage debtors need?

    The purpose of a bank is to take those short-term deposits and turn them in to long-term loans. And it’s that very function that makes them vulnerable to withdrawal of credit.

    To which my wacky fruitbat solution is not full-reserve banking but a meltdown plan including a state backstop/deposit insurance scheme for failed banks, keeping them alive merely to keep the payments system running, and then winding them up while utterly ruining and destituting the shareholders (which would by law include management). Yes – I’d probably, were I dictator, not let banks set up as limited liability companies, pour encourager.

  23. Also, if you look in the T&C of many of your loans, they are in fact call loans. Just the bank is nice and will let you pay off a little each month. So strictly speaking, the call deposits are indeed loaned out at the same terms. Which is still not my understanding of “full reserve” banking, because if the deposits get called it is not practically possible to call the loans to repay the depositors.

    Full reserve means the bank has the physical cash on hand to repay all depositors today. Which means it isn’t loaning any of that cash to anybody.

  24. “Ha! Keith Hudson- it’s like being cornered at a drinks party by an actuary.”

    Oh come on, we’re not that bad.

  25. John77, Bloke in Germany, Peter Risdon

    Yes I agree, although whoever wrote the algorithms for Bitcoin might not.

    Incidentally, the ASI has hosted a number of articles this year on free banking, advocating allowing banks to issue their own promissory notes. What do you think?

  26. @Ironman,

    That’s actually the origin of paper money and was practised in many countries (including England) until roughly 100-150 years ago.

    Going back to that system would probably solve some problems but create others. As long as the issued cash is recorded as a liability, it’s probably a very very slight net positive in that you can kinda do full-reserve (by having lots of Bankco notes in the vaults in the event of a run), but still lend your cash.

    But, and it’s a big but, you still have the argument about whether or not the central bank should take ultimate responsibility for those liabilities (creating the moral hazard that can lead to the collapse of the banking system) or not (creating the uncertainty that can lead to the collapse of the banking system).

    My gut feeling is therefore that it would make chuff all difference. I think people wildly overestimate the impact doing technical money things differently makes. The easiest ways to damage your currency are for the government to get into excessive debt or set the wrong interest rates (the latter should be left to the market anyway).

    The belief that some techincal tweak to our money would have profound effects comes from same source as all the wild panicking about the unsustainable value of/impending collapse of(delete as appropriate) the euro, or blaming it for the current economic shortcomings of certain countries that, in all honesty, appear to have exactly the same economic shortcomings now as in 1998.

  27. BiG – no: “Full-reserve banking, also known as 100% reserve banking, refers to an alternative to fractional reserve banking in which banks are required to keep the full amount of each depositor’s funds in cash, ready for immediate withdrawal on demand. Funds deposited by customers in demand deposit accounts (such as checking accounts) could not be loaned out by the bank because it would be legally required to retain the full deposit to satisfy potential demand for payments. Proposals for full reserve banking systems generally do not place such restrictions on deposits that are not payable on demand, for example time deposits or savings accounts.

  28. Frederick

    Given he is babbling on about the prospect of the EU calling a new election in Greece if Syriza threaten to get in, I wonder if he is aware of the phenomenon of dead state employees continuing to claim pensions? There is no escaping the ‘Curajus state’, even, it would seem, in death…..

  29. “Why would anyone want to pay for something that is currently free?”

    Because it offered 100% security on their deposits.

    Obviously, this isn’t that attractive in practice, so on the basis of revealed preferences you might say that people prefer the current system.

  30. Well, yes, quite.

    Besides, 100% security wouldn’t be provided anyway as there will be the possibility of fraud, incompetence and bank robberies.

    On top of the admin fee would be the cost of insurance.

  31. More to the point, FRB is a method of creating money out of thin air*.

    Can anyone explain why this is actually a problem?

    * Yes I know that’s not the right phrase, but it’s decent shorthand.

  32. @Jack C,

    Like a lot of things it’s probably the least worst way of doing things. It creates the problem that depositors in a bank that fails lose some (sometimes a lot) of their money, alternatively that the taxpayer loses it, or the central bank loses it (which reduces the incentives on banks to lend wisely). But the alternative means you just don’t have so much credit available to those that want it. If I have understood Peter’s point correctly, you have to match up deposit withdrawal terms with loan repayment terms (or even make loans shorter than deposits, to make up for tardy debtors). And that requirement for coincident needs rather eliminates the point of having a bank.

    Taking it a step further, if we have to make needs for money coincident why not do it with everything else and do away with money altogether.

    So money, and credit, and the way they work create some problems, but it seems they solve an awful lot more problems than they create.

  33. Why would anyone want to pay for something that is currently free?

    In many countries you can find toilets which the public can access for about 30p. When you compare them to the free ones, you’ll see why people would rather pay the charge.

    So it is with banking: the standard of service in paid accounts (which most are outside the UK) is higher than free one.

  34. Please just ignore the monomaniacs.

    Actually, we haven’t seen any of our LVT trolls for a while. Have they been kidnapped by the para-military wing of the Richard Murphy fan-club?

  35. @TimN, the Graun is doubtless about to get on its high horse about how the people who don’t want to pay to use the bog should get a bog as good as the people paying to use the bog get. Paid for by shutting down the paid-for bogs.

    I wish a great, productive, fruitful, successful, and above all pleasurable 2015 to all!

  36. @Ironman “Incidentally, the ASI has hosted a number of articles this year on free banking, advocating allowing banks to issue their own promissory notes. What do you think?”

    Is this not how it works in Hong Kong? Their bank notes appear to be issued by either HSBC, Bank of China or Standard Chartered

  37. @ Dongguan Juan
    In Scotland, bank notes are printed by Bank of Scotland, RBS and Clydesdale.
    The Scots used to run Hong Kong

  38. @ Ironman
    I almost certainly know/knew far more Actuaries than you and very few are. Despite the jokes, far more accountants are boring (I run into a lot of accountants these days, so I can make comparisons)

  39. @Dongguan, the HK banknotes are all US dollar-backed, physical holdings. Same with the dozen or so private issuing banks in the UK (except sterling-backed, obviously).

  40. How ungrateful you lot are.Tim has explained the money- created-out-of-thin-air problem definitively.And twice.
    19 Mar 2014 “The short explanation is that banks do indeed just create money out of thin air.”
    14 July 2012 “No , banks don’t create money”
    The change of mind may have something to do with the publication of the bulletin” Money Creation in the Modern Economy” by the Bank of England in the interim which blamed the banks for creating money out of thin air, probably because they were pissed off with half -arsed libertarian “economists” blaming the BoE for doing it.
    In a moment of inadvertent lucidity Tim chose to attack Martin Wolf of the FT (who wrote the logical “Strip banks of the power to create money”) with a madcap outburst that made Wolf’s point for him ( Forbes 26th April 2014):.”Wolf is running with the idea that, since the banks just create the money supply out of thin air , therefore we should have the State do the money creation and all will be better “.Well we wouldn’t be enduring austerity for one thing because the State could phoney up the money without paying the banks to do it whilst pretending to on-lend existing money. Prof Victoria Chick “Banks don’t lend money” .
    You shouldn’t be discussing Economics on here if you don’t know where money comes from.

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