Posted by: Dirk | March 2, 2013

Two types of European Keynesians

Wolfgang Münchau, director of Eurointelligence, divides European Keynesians into two classes, as the Spanish newspaper EL PAIS reports:

  1. those that have not read Keynes
  2. those that did read him but do not understand him

The situation is dire in Europe, where Keynesian economists are not heard because, well, there are only handful. Neo-classical mainstream economics with its equilibrium models has taken over economics departments of universities almost 100%, and the few Keynesian professors remaining are in no position to get heard. This intellectual failure is the cause of the crisis, since when economists stopped caring about regulation and embraced the free market people started to act as if regulation is best avoided, and corruption was helped tremendously by putting people into regulation jobs that have strong industry ties and no specific knowledge. This was the case especially in the US under the Bush jun. administration. At least the US has Keynesian economists like Krugman and Stiglitz, who understand a bit about how to work scientifically and who, by the way, do not claim that government spending should always rise/be high. Nevertheless, most US economists that appear in the US press do not understand much about economics. The latest example is Robert Solow in the NY Times.

“I want to present a calmer view, by emphasizing six facts about the debt that many Americans may not be aware of.” Whenever you have a social scientist presenting facts be warned: this is almost sure to go wrong. The only facts you have in economics can be derived from how institutions technically work. Let me briefly comment on the six “facts”.

1. Roughly half of outstanding debt owed to the public, now $11.7 trillion, is owned by foreigners. This part of the debt is a direct burden on ourselves and future generations.

That is almost true. Given that the US dollars is the world reserve currency and keeps its status, this debt is not a direct burden on ourselves. However, it is one for the future generation that lives when the US dollars are used to buy stuff from the US.

2. The Treasury owes dollars, America’s own currency (unlike Greece or Italy, whose debt is denominated in euros).

That is correct.

3. One way to effectively repudiate our debt is to encourage inflation.

That is technically correct, although the way that the Fed is build, it seems assured that bankers always beat inflationistas.

4. Treasury bonds owned by Americans are different from debt owed to foreigners. Debt owed to American households, businesses and banks is not a direct burden on the future.

Correct again. Tax payers give money to the government, which turns around and gives it to the bond holders. This is pure redistribution of income (in favor of the rich, in case you haven’t noticed).

5. The real burden of domestically owned Treasury debt is that it soaks up savings that might go into useful private investment.

That is wrong as it is stated. Savings do not finance investment, money does. And money can be created endogenously by banks, which are giving loans to people. Actually, it would be helpful for banks to have more sovereign bonds while they do that since they use these for clearing. Here is a picture of government and private sector debt in the US:

debtThere does not seem to exist a “crowding out” in the sense that rising government debt crowds out private sector (households + non-financial firms) debt.

5. But in bad times like now, Treasury bonds are not squeezing finance for investment out of the market.

That, although it sounds not so bad, is wrong because the logic is wrong. The crowding out does not happen on the financial side, it would happen on the real side. And we can’t see any big fight for resources between public and private sector. The observation of inflation rates tells us that there is no huge competition for scarce resources.

Robert Solow is not a Keynesian, and I think he really gets the last two points completely wrong. Nevertheless the US ran a more or less pragmatic approach among other things because their economists are better. Even Robert Solow, a non-Keynesian, understands that in times of weak demand the government can and should spend more and that this will not lead to neither higher interest rate nor high inflation. The two parties understand that, too, but the sequestration is about distribution, not intellectual failure to understand economics.

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Responses

  1. Excellent post: “Savings do not finance investment, money does. And money can be created endogenously by banks, which are giving loans to people. ” (Yes).
    “Tax payers give money to the government, which turns around and gives it to the bond holders. This is pure redistribution of income (in favor of the rich, in case you haven’t noticed).” (Yes).
    ” The crowding out does not happen on the financial side, it would happen on the real side.” (Yes!).
    “Given that the US dollars is the world reserve currency and keeps its status, this debt is not a direct burden on ourselves. However, it is one for the future generation that lives when the US dollars are used to buy stuff from the US.” – (This is what concerns me as an American) – Will this hardship be present in the form of inflation? Won’t the US currency devalue against the reserve dollar holders e.g. China?

    • If US dollars are flowing back to the US to buy imports it is a policy question of how this will effect the exchange rate and/or the price level and probably other macroeconomic variables. Just as the People’s Bank of China has fixed the exchange rate the US might do something similar, but probably the Fed will interfere only when the US dollar falls too strong too quick. Of course, a falling US dollar will make imports more expensive, but then the US doesn’t import much. I guess that the US could turn into a net exporter without elevated inflation, especially if this would happen soon. Inflation is very low already, and it seems that some – mostly raw material – prices could come in the near future because of a bubble. More demand would then actually be beneficial for the US economy. If you have to export stuff, why not do it when you have elevated unemployment? People will have more jobs, and if they have the power they can increase the wage share so that the burden falls partly on capital.


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