Tuesday, August 24, 2010

Paul Davidson Joined the Advisory Board of the Institute for New Economic Thinking...

New York, NY, August 24, 2010 – The Institute for New Economic Thinking (INET) has appointed Paul Davidson, Editor of the Journal of Post Keynesian Economics and Holly Chair of Excellence Professor Emeritus, University of Tennessee, to its advisory board. Paul Davidson, is the 31st distinguished individual to join INET’s Advisory Board, including five Nobel Prize winners.

Professor Paul Davidson is currently a Senior Fellow at the Schwartz Center for Economic Policy Analysis, The New School. He has taught at number of prestigious institutions including: University of Pennsylvania, Rutgers University, and Bristol University (UK). Davidson served as the Assistant Director of the Economic Division of the Continental Oil Company and has testified before 20 congressional committees over the years on various economic questions. He has authored co-authored or edited 22 books, including: The Keynes Solution: The Path to Global Economic Prosperity, Economics For A Civilized Society (co-author), Financial Markets, Money and the Real World, and Post Keynesian /macroeconomic Theory: A Foundation For Successful Economic Policies For the Twenty-first Century.

“I share the Institute’s commitment to education, open dialogue, and the support of the next generation in effecting change,” commented Paul Davidson. “I am dedicated to advancing the Institute’s vital initiatives and honored to join its distinguished Advisory Board.”

“As a distinguished educator and champion of Keynesian Economics, Paul Davidson is a invaluable addition to the INET community that held its inaugural conference at King’s College, University Cambridge, where Keynes himself debated economic theory and instigated reform,” commented Dr. Robert Johnson, Executive Director of INET. “His presence and counsel will undoubtedly have an important impact on the Institute and its work.”

About the Institute for New Economic Thinking:
Launched in October 2009 with a $50 million pledge from George Soros, the Institute for New Economic Thinking promotes changes in economic theory and practice through conferences, grants and education initiatives. The Institute embraces the professional responsibility to think beyond the inadequate methods and models of the world’s financial infrastructures and will support the creation of new paradigms in the understanding of economic processes. For more information please visit http://www.ineteconomics.org/
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Paul Davidson
Editor, Journal of Post Keynesian Economics
Bernard Schwartz Center for Economic Policy Analysis
66 Country Club Drive
Monroe Township, New Jersey 08831
email: pdavidson@utk.edu
Paul Davidson

The Myth of the “Credibility of Markets”

by Marshall Auerback...

It is time to distinguish between the truths and the myths propagated by Wall Street.

A few days ago, I wrote a piece suggesting that President Obama’s attack on the proposed GOP threat to Social Security masked a more fundamental threat posed by members of his own party. Sadly, this analysis appears to be confirmed today in Mike Allen’s politico playbook:

“–ADMINISTRATION MINDMELD: The virtue of action on Social Security is that it demonstrates the ability to begin to affect the long-run deficits. Social Security isn’t the biggest contributor to the problem - that’s still health-care costs. But it could help a little bit, buy time, and strengthens the odds of a political consensus behind other spending cuts or tax increases. Most importantly, it would establish more CREDIBILITY with the MARKETS. The mood of the world at the moment (slightly excessive, from the administration’s point of view) is that if you don’t do anything with spending cuts, it doesn’t get you credibility.” (My emphasis).

This, in a word, encapsulates the Administration’s perverse Wall Street-centric thinking. Credibility with the American people takes a back seat to this amorphous concept called “the markets”, and the corresponding need to maintain “credibility”.

But how are we to divine the true aspirations of the markets? Is this really a legitimate basis for government policy? Private portfolio preference shifts (which are manifested daily in the capital markets) are probably the area least amenable to economic analysis. There are no cookie cutter models here (and economists LOVE models).

Consider the case of a currency: How does one respond to a weaker currency? The conventional response seems to be, “Raise interest rates and eventually you’ll re-attract the capital because you will re-establish ‘credibility’ with the markets”. That was essentially the IMF advice to East Asia in 1997. But, as that experience demonstrated, sometimes raising rates can actually trigger additional capital flight if it is perceived to be a panicked reaction to something. And Japan today clearly demonstrates that low rates per se do not necessarily prefigure a weaker currency. What does a 10 year Japanese government bond yielding less than 1% tell us about “the markets”? Does it reflect approval with a country that has a public debt to GDP ratio about 2.5 times higher than the US?

To paraphrase Milton (the poet, not Friedman), sometimes they also serve who only stand and wait!

Markets are an amorphous concept, which reflect heterogeneity of viewpoints. Some people today are buying gold because they foresee a Weimar style hyperinflation emerging in the face of all of this government spending. Some buy it because they envisage the death of fiat currencies and view the yellow metal as the ultimate insurance policy. Some invest because they consider gold the only real form of money. Some people view it as a barbarous relic and ignore it altogether. How does a government respond to these varying points of view? What’s the right policy response?

The myth that markets, not governments, ultimately determine rates has, of course, been legitimized to some degree by virtue of the fact that our institutional monetary arrangements still reflect archaic gold standard type thinking (whereby a certain amount of gold on hand was required to fund government operations). But we went off the gold standard decades ago. Still we have laws which mandate that all net government spending is matched $-for-$ by borrowing from the private market. So net spending appears to be “fully funded” (in the erroneous neo-liberal terminology) by the market. But in fact, all that is actually happening is that the Government is coincidentally draining the same amount from reserves as it adds to the banks each day and swapping cash in reserves for government paper.The resultant bond market drain is there to ensure that the central bank maintains control of its reserve rate. It has nothing to do with “funding” government operations itself.

If you think that sounds radical then consider the following question posed by my friend, Professor Bill Mitchell: If a government bond auction “fails” (i.e. the government doesn’t find enough buyers for the paper it issues during that particular sale), does this mean that your Social Security cheque is going to bounce? Will national infrastructure projects be suddenly halted because the net spending is not “funded”? Do we have to stop fighting a war in Afghanistan? The answer to all of these questions is the same: Of course not! The net spending will go wherever the Government intends it to go - after all the Government needs no funds to spend because it first creates the currency which is ultimately required to be spent in the real economy. The private sector does not produce dollars (if it did, it would represent a jailable offence called counterfeiting).

More fundamentally, how, pray tell, does one presume that the private sector can net save (in this case, dollars) something it cannot net produce?

Isn’t it true that the government is in a unique position because only it has the capacity to create new net financial assets? Now, granted, this simple observation does not readily apply to the euro zone because the individual countries concerned have effectively ceded that authority, thereby circumscribing an adequate fiscal response to their crisis (a point I have made before). But when the operations of government are examined in this light, it establishes that the Obama Administration’s ongoing fixation with “long term deficit reduction” and “establishing credibility with the markets” is as foolhardy as conducting human sacrifices to placate a deity.

Yet government policy responses today on issues like Social Security or Medicare reflect a misguided belief system and a genuine failure to understand the basis of modern money. Scaling back Social Security will certainly drive unemployment up higher than it is already going becomes it robs people of the very income required to sustain growth. Not a very sensible strategy if you truly care about implementing “change that people can believe in”.

Unfortunately, until these Wall Street-centric beliefs are fully exposed for the myths that they are, we can expect to see more dispiriting headlines of the sort reflected in Mike Allen’s latest politico playbook.

Marshall Auerback is a Senior Fellow at the Roosevelt Institute, and a market analyst and commentator.

Monday, August 02, 2010

Making Dollars and Sense of the U.S Government Debt...

Paul Davidson

Abstract: This paper explain why, given Keynes’s General Theory, worries over
the size of the government’s national debt per se is foolish. It is more important
to educate politicians and the public that government fiscal policy should be designed to make sure that aggregate market demand will produce sufficient profits
so that entrepreneurs will hire all domestic workers willing and able to work.
Empirical evidence is provided to demonstrate the correctness of this concept
of fiscal policy of the balancing wheel for full employment effective demand.

Key words: deficits, national debt.

No economic topic encourages more political demagoguery than the
“unsustainable” national deficits that face the Obama administration as
it tries to extricate the economy from this Great Recession that began
in 2007. Even President Obama has appointed a commission to develop
a plan to assure a reduction in future deficits by lowering government
expenditures or raising taxes.

A sage once said, “Those who cannot remember the past are condemned
to repeat its errors.” So let us review the past history of the national debt
to make sure we avoid its errors and repeat its successes.

Is the national debt too large? In 1790, the newly founded U.S. government
assumed the debts that had been incurred during the Revolutionary
War. Thus, from the very beginning, the U.S. national debt was
approximately $75 million. In 1835, President Jackson reduced the debt
to close to a zero balance. By 1837, however, the economy went into a
steep recession that lasted approximately six years and the national debt
increased dramatically. Since then, the U.S. government has always had
a significant outstanding debt.

During World War I, the national debt increased substantially from approximately
$6 billion in 1916 to over $27 billion in 1919. The prosperous
decade of the “roaring twenties” saw a decline in the national debt
as tax receipts exceeded government spending. By 1929, the total debt
had been reduced to $16.9 billion. This 1920s experience indicates that
when the private sector is spending sufficiently to buy all the products
that industry can produce in a fully employed economy, then there is no
need for the government to deficit spend merely to maintain a prosperous
economy. The 1920s prosperity, however, was partly the result of
significant bubbles in the stock market and in real estate. (Shades of the
dot.com bubble of the 1990s and the housing bubble of early 2000s.)

In 1929, private spending suddenly slowed causing a devastating drop
in business profits. Unemployment rose rapidly as the United States
entered the Great Depression. Tax revenues fell from $4 billion in 1930
to less than $2 billion in 1932. When Roosevelt took office in 1933, the
national debt was almost $20 billion; a sum equal to 20 percent of the
U.S. gross domestic product (GDP).

During its first term, the Roosevelt administration ran large annual
deficits between 2 and 5 percent of GDP. By 1936, the national debt had
increased to $33.7 billion or approximately 40 percent of GDP. Many
“experts” of that era said disaster awaited the nation if the government
continued to deficit spend and thereby burden future generations with this
huge debt. Accordingly, as a part of his reelection campaign, Roosevelt’s
fiscal year 1937 budget submitted to Congress in 1936 cut government
spending dramatically. As a result, in 1937, the economy fell into a steep
recession. Tax revenues declined and the national debt increased to $37
billion. The government resumed significant deficit spending in 1938
and the economy quickly recovered. By 1940, the economy had grown
substantially while the national debt rose to $43 billion.

When the United States entered the war in 1941, the fear of deficits and
the size of the national debt were forgotten. The important thing was to
defeat the enemy. In the war years from 1941 to 1945, the GDP doubled
while the national debt increased by more than 500 percent as Roosevelt
financed much of the war expenditures by government borrowing. By the
end of the war in 1945, the national debt had increased to $258 billion
and was equal to approximately 120 percent of GDP.

Rather than bankrupting the nation, this large growth in the national
debt promoted a prosperous economy. By 1946, the average American
household was living much better economically than in the prewar
days. Moreover, the children of that Depression–World War II generation
were not burdened by having to pay off what then was considered
a huge national debt. Instead, for the next quarter century, the economy
continued on a path of unprecedented economic growth and prosperity
with the Eisenhower administration launching the biggest public works
project—the interstate highway system—and the Kennedy–Johnson
administration spending large sums on sending a man to the moon and
the escalating Vietnam War. At the same time, the inequality in the distribution
of income was significantly narrowed. It was the golden age
of economic development for the United States as the rich grew richer
while the poor gained even more in a rapidly rising level of income that
created a large American middle class.

As a child of the Depression and a young teenager during the World
War II, I have never felt burdened by the huge government deficits that
accrued due to government spending during the Great Depression and
the war that followed. The legacy that the Great Generation who were
adults during the depression and the war left to their children was an
economy of abundance and prosperity. I inherited an economy that made
finding a good job easy for me and all of my cohorts and provided excellent
opportunities to improve our living standards. If this is burdening
children and grandchildren, I hope the current generation can create such
a “burden” for their progeny.

The moral of this history of the national debt and the economy during
the Great Depression and World War II is that we have nothing to fear
about running big government deficits when, during a recession with
significant unemployment, the federal government is the only spender
that can take the responsibility to sufficiently increase the market demand
for the products of our industries and thereby maintain a profitable entrepreneurial
system. For government to spend less in the hopes of keeping
down the size of the national debt will cause market demand to remain
slack, thereby impoverishing both our business firms and our workers.
The idea that capitalism works best when spenders cause healthy growth
in market demands and thereby generate profits and jobs for the community
was the basic message of Keynes theory.

This was clearly demonstrated when government spending increased
during the years 1933–36 and 1938–45. When Roosevelt cut spending
in 1937, the sharp recession showed that at that stage of recovery, no
other spenders were willing or able to take over from government the
role of generator of market demand and profits for American businesses.
Had Roosevelt, in 1938, continued on the path of keeping government
spending in check in order not to increase the total national debt, the
result would have been to propagate the poorly performing economy
of 1937. When the war broke out and no further thought was given to
the size of the national debt, government spending quickly pushed the
economy to a profitable full employment status. Keynes’s ideas that the
role of government fiscal policy was to make sure that the total demand
for goods and services provided profit opportunities to encourage business
firms to hire all workers who wanted a job was validated by this
historical record.

Business firms will hire more workers only when they expect the market
demand for their products is increasing. Today, who are these buyers who
will be willing to buy significantly more products from factories located
in the United States in order to end this Great Recession? Clearly households
suffering from high unemployment, decreasing market values for
their homes, large credit card debt, and shrinking pension funds are not
likely to rush to buy significant more goods and services. Entrepreneurs
with existing excess facilities and facing declining or at most not rapidly
rising market demands are unlikely to invest significantly in new plant and
equipment. Moreover, foreigners such as China with its large savings of
U.S. dollar earnings appears unlikely to spend more dollars to buy more
U.S.‑produced goods. With falling property and sales tax revenues, local
and state governments such as California are cutting spending on public
services and reducing purchases from domestically located firms. Only
the Federal government can afford to buy significant additional products
to stimulate market demand for American products.

Just as we expect the Federal government to spend whatever is necessary
to protect us from foreign enemies during a war, we should also
expect the government to spend whatever is necessary to protect us
from the economic terrorism of a great recession. The public must be
educated to understand that a civilized society is one that assures both
domestic workers and enterprises prosper and that the intelligent use of
government fiscal policy can assure that total market demand is always
sufficient to generate domestic profits large enough to create a fully
employed economy.

Some argue that tax revenues must finance all government spending
so that the federal budget is always balanced without deficits, or at least
annual deficits do not increase the debt-to-GDP ratio. As history shows,
however, even during World War II when America was attacked by foreign
nations (remember Pearl Harbor?) the U.S. government did not finance
the entire defense of this nation by raising taxes. Instead, during the war
years, deficits expanded dramatically while no one worried (correctly)
about burdening future generations with debt.

If wars are not sufficient (or necessary) reasons to raise taxes or cut
government spending sufficiently to balance the budget while protecting
the nation, then why should defending the nation against serious economic
threats require a balanced budget or a lower deficit? Our politicians and
the public must be educated to understand that when total demand for
domestically produced goods is low so that recession and depression
threaten, then government must deficit spend as much as necessary to
encourage domestic entrepreneurs to hire all American workers who
are willing and able to work. If, on the other hand, market demand for
domestically produced goods and services exceed America’s full employment
productive capacity, then government must increase taxes and
reduce spending in order to reduce aggregate demand to a level that can
be met by a fully employed labor force.

When the public and politicians recognize that a primary function of
government fiscal policy is to act as a balancing wheel for aggregate
demand to be sufficient to encourage America’s entrepreneurs to create
jobs for all our workers, we will have developed the political will to
develop a perpetual prosperous American civilized society.
At that point of time, our next task will be to develop an international
financial and payments system that will provide for global full employment
and prosperity.