The Keynesians are split: they are split on the effectiveness of
monetary and fiscal policy on reigniting the capitalist economy and on
whether the size of an economy’s outstanding debt (both public and
private) matters or not. The more conservative wing is worried that the
current talk of monetary policy aiming at targeting, not inflation, but
nominal GDP growth, along with other ‘unconventional’ measures beyond
quantitative easing like having negative interest rates (see my post, http://thenextrecession.wordpress.com/2013/02/21/helicopter-money-and-the-chicago-plan/)
is dangerous and might lead to higher inflation and interest rates and
thus choke off any sustained economic growth; or even reproduce another
credit bubble and financial crash.
A representative of this conservative wing, Paul Ormerod, put it this way in a recent article (http://www.paulormerod.com/): “So-called
Keynesians demand an increase in both public spending and the public
sector deficit. What might Keynes himself have said about the current
situation? “ Well, says Ormerod, “For Keynes, a crucial policy
aim during a slump was to have a low long term rate of interest.
Without it, recovery would just not happen.” If governments start
borrowing too much on top of existing high levels of debt, they risk
driving up the cost of that borrowing as lenders demand more interest on
their loans. That lowers the value of existing government bonds and
becomes “a powerful depressant of private sector spending, both corporate and individual”. Ormerod invokes the increased uncertainty this generates – the ‘confidence fairy’, as more radical Keynesians dismiss it: “the
less confident you are about your view, the less you will spend. High
interest rates add to uncertainty and undermine confidence.” So, according to Ormerod,
“we might end up even worse off and with a higher deficit to boot.
Policy at the moment is much more about psychology rather than the
mechanistic calculations of so-called Keynesians.” Ormerod claims that Keynes would agree with him and not with the radical wing.
A similar criticism of the more radical wing of Keynesianism has been
mounted by the eminent octogenarian Nobel economics prize winner,
Robert Solow. Solow has been a perceptive critic of neoclassical
economics and the Austerians. But in a recent piece, he urges caution
on the question of ignoring the size of ‘national debt’ (http://www.nytimes.com/2013/02/28/opinion/our-debt-ourselves.html).
His main points are that if foreigners own most of that debt, then that
puts the value of the national currency in jeopardy if these foreign
investors switch to other country’s assets. That is less likely to
happen for the US because of the role of the dollar as the world’s main
reserve currency, but it cannot be ignored.
If the debt is mainly owed to other citizens of the same country,
then through inflation and the shifting of the burden of servicing that
debt into the future, it can be made manageable now. But the real
problem, Solow reckons, is that rising debt “soaks up savings that
might go into useful private investment. Savers own Treasury bonds
because they are seen as safe, default-free assets, and the government
can borrow at lower rates than corporations can. If there were less
debt, and fewer bonds for sale, savers seeking higher returns would
invest in corporate bonds or stocks instead. Business investment would
expand and be more profitable.” This is not a problem right now as too much austerity is the issue, but it could become one further down the road.
Comments like these from fellow Keynesians have produced hot
responses from the more radical wing. Randall Wray is one of the
leading exponents of Modern Monetary Theory (MMT), which argues that a
government can spend just as much as it likes because it can create
money to pay for it; so there is no issue of default and no likelihood
of rising interest in the current environment of excess capacity in
production, high unemployment and cash hoarding by corporations (see my
post,
http://thenextrecession.wordpress.com/2012/04/21/paul-krugman-steve-keen-and-the-mysticism-of-keynesian-economics/).
He laid into Solow (http://www.economonitor.com/lrwray/2013/02/28/six-facts-about-our-debt-corrections-to-robert-solows-op-ed/#sthash.OE1yTLPx.dpuf). “Solow
is a “neoclassical synthesis” Keynesian, the type of Keynesian
economics that used to be taught in the textbooks. He was also on the
wrong side of the “Cambridge controversy”, as the main developer of
neoclassical growth theory.” Wray answers Solow point by point.
But what is revealing is on nearly every point that Solow raises, Wray
does not really dispute: foreigners owning debt, Treasury printing of
money for debt, inflation as a way of reducing the real value of debt
and the burden of servicing debt to bondholders for the rest of the
economy.
Indeed, as this debate goes on, the evidence is mounting up on
whether rising debt (public or private) really does matter in the growth
of a capitalist economy. In a recent meeting of the US Federal Reserve
in San Francisco, new papers were presented that seem to back up the
view of the conservative wing (http://erevents.frbsf.org/conferences/130301/agenda.php). Christopher Hanes looked at the impact of monetary policy. He found that “our
statistical analysis shows that higher debt levels would likely lead to
higher interest rates, thereby raising budget deficits and debt levels,
which in turn would raise interest rates further. Government bond
rates shoot up and a funding crisis ensues. A fiscal crunch not only
hurts economic growth because interest rates could rise to unprecedented
levels but also because it could make it difficult for the Federal
Reserve to control inflation. Unsustainable fiscal policy can force a
central bank to pursue inflationary policies, which is known as fiscal
dominance. If the central bank does not monetize the government debt,
then interest rates will rise sharply, causing the economy to contract.
Indeed, without monetization, fiscal dominance may result in the
government defaulting on its debt, which would lead to a significant
financial disruption, producing an even more severe economic
contraction. Hence the central bank will in effect have little choice
and will be forced to purchase the government debt by printing money,
eventually leading to a surge in inflation.“
So if the government expands its borrowing to try and shore up the
economy, it will cause interest rates to rise and choke off growth,
unless the borrowing is done simply by printing more money (just as the
more radical wing of Keynesians are now advocating). But if that policy
is adopted, it will ‘eventually lead to a surge in inflation’. Neither
way of boosting government spending can avoid damaging the capitalist
sector. Indeed, another paper that looked at the impact of nominal GDP
targeting in the Great Depression, found that it did not work.
But where Wray is really rankled is by Solow’s assertion that rising public debt “soaks up saving that might go into useful public investment”. Wray
is convinced this is nonsense and runs directly against Keynes’ own
view. Marxists argue interminably about what ‘Marx really meant’. So
do the epigones of Keynes. And it is just as difficult to know what the
great bourgeois economist meant, as he is contradictory and ambiguous.
But whatever Keynes thinks, Wray puts forward a clear view: “Investment
creates saving. Budget deficits create saving. You need the spending
before you get the income that you then decide to save.” This is
the Keynesian view that consumption leads the economic process. From
extra spending, we get extra employment and investment and then extra
income and saving. As I have explained in numerous posts (http://thenextrecession.wordpress.com/2012/06/13/keynes-the-profits-equation-and-the-marxist-multiplier/),
this analysis of the dynamics of the capitalist economy is flawed
because it denies any role for profit in driving investment (and beneath
that, the role of exploitation) and assumes that there is just an
economy, not a capitalist economy, in the same way as neoclassical
theory does.
The reality is the opposite of the Keynesian equation: under
capitalism, it goes from profits to investment to employment to
consumption (and saving). Indeed, in Keynesian terms, savings do drive
investment, if we mean corporate savings or profits. If profitability
(relative to existing capital stock) is not high enough and profits
(savings) by the corporate sector are hoarded (as now), then investment
will not recover sufficiently to restore growth, employment and spending
by consumers (workers). In that situation, no amount of monetary
easing or expansion or increase in debt will restore economic recovery.
You can take a horse to water, but you can’t get it to drink. It will
require the replacement of private investment for profit with public
investment for need.
And so pro-capitalist monetary policy remains on the horns of a
dilemma, between wanting to boost growth through investment with low
interest rates, while also avoiding reviving a new credit bubble and
accelerating inflation. As Ben Bernanke put it this week in his address
to those central bankers in San Francisco. “Let me finish with
some thoughts on balancing the risks we face in the current challenging
economic environment, at a time when our main policy tool, the federal
funds rate, is near its effective lower bound. On the one hand, the
Fed’s dual mandate has led us to provide strong support for the
recovery, both to promote maximum employment and to keep inflation from
falling below our price stability objective. One purpose of this support
is to prompt a return to the productive risk-taking that is essential
to robust growth and to getting the unemployed back to work. On the
other hand, we must be mindful of the possibility that sustained periods
of low interest rates and highly accommodative policy could lead to
excessive risk-taking in some financial markets. The balance here is not
an easy one to strike. “
Indeed! So far, the effect of Bernanke’s easy money policy has not
been to restore significant investment growth or employment, but to take
bond and equity prices towards all-time highs in a new financial
bubble. The horses are not drinking so the cash is going elsewhere.
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