fiscal policy

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Are Concerns over Growing Federal Government Debt Misplaced?

Published by Anonymous (not verified) on Thu, 11/11/2021 - 8:02am in

If the global financial crisis (GFC) of the mid-to-late 2000s and the COVID crisis of the past couple of years have taught us anything, it is that Uncle Sam cannot run out of money. During the GFC, the Federal Reserve lent and spent over $29 trillion to bail out the world’s financial system,[1] and then trillions more in various rounds of “unconventional” monetary policy known as quantitative easing.[2] During the COVID crisis, the Treasury has (so far) cut checks totaling approximately $5 trillion, often dubbed stimulus. Since the Fed is the Treasury’s bank, all of these payments ran through it—with the Fed clearing the checks by crediting private bank reserves.[3] As former Chairman Ben Bernanke explained to Congress, the Fed uses computers and keystrokes that are limited only by Congress’s willingness to budget for Treasury spending, and the Fed’s willingness to buy assets or lend against them[4]—perhaps to infinity and beyond. Let’s put both affordability and solvency concerns to rest: the question is never whether Uncle Sam can spend more, but should he spend more.[5]

If the Treasury spends more than received in tax payments over the course of a year, we call that a deficit. Under current operating procedures adopted by the Fed and Treasury, new issues of Treasury debt over the course of the year will be more-or-less equal to the deficit. Every year that the Treasury runs a deficit it adds to the outstanding debt; surpluses reduce the amount outstanding. Since the founding of the nation, the Treasury has ended most years with a deficit, so the outstanding stock has grown during just about 200 years (declining in the remainder).[6] Indeed, it has grown faster than national output, so the debt-to-GDP ratio has grown at about 1.8 percent per year since the birth of the nation.[7]

If something trends for over two centuries with barely a break, one might begin to consider it normal. And yet, strangely enough, the never-achieved balanced budget is considered to be normal, the exceedingly rare surplus is celebrated as a noteworthy achievement, and the all-too-common deficit is scorned as abnormal, unsustainable, and downright immoral.

First the good news. The government’s “deficit” is our “surplus”: since spending must equal income at the aggregate level, if the government spends more than its income (tax revenue), then by identity all of us in the nongovernment sector (households, businesses, and foreigners) must be spending less than our income.[8] Furthermore, all the government debt that is outstanding must be held by the nongovernment sector—again, that is us. The government’s debt is our asset. Since federal debt outstanding is growing both in nominal terms and as a percent of GDP, our wealth is increasing absolutely and relatively to national income. Thanks Uncle Sam!

But the dismal scientists (economists) warn that all this good news comes with a cost. Deficits cause inflation! Debt raises interest rates and crowds out private investment! Economic growth stagnates because government spending is inherently less efficient than private spending! All of this will cause foreigners to run out of the dollar, causing depreciation of the exchange rate!

With two centuries of experience, the evidence for all this is mixed at best. Deficits and growing debt ratios are the historical norm. Inflation comes and goes. President Obama’s big deficits during the GFC didn’t spark inflation—indeed, inflation ran below the Fed’s target year after year, even as the debt ratio climbed steadily from the late 1990s to 2019. The initial COVID response—that would ultimately add trillions more to deficits and debt—did not spark inflation, either. (Yes, we’ve seen inflation increasing sharply this year—but as I noted, the evidence is mixed and many economists, including those at the Fed, believe these price hikes come mostly from supply-side problems.)

Interest rates have fallen and remained spectacularly low over the past two decades.[9] Anyone looking only at those 20 years could rationally conclude that interest rates appear to be inversely correlated to deficits and debt. While I do believe there is a theoretically plausible case to be made in support of that conclusion, the point I am making is that the evidence is mixed. And if you were to plot the growth rate of GDP against the deficit-to-GDP ratio for the postwar period, you would find a seemingly random scatterplot of points.[10] Again, the evidence is mixed at best.

Finally, the dollar has remained strong—maybe too strong for some tastes—over the past 30 years in spite of the US propensity to run budget deficits, and even trade deficits for that matter. Both of these are anomalies from the conventional perspective.

So, while there are strongly held beliefs about the negative impacts of deficits and debt on inflation, interest rates, growth, and exchange rates, they do not hold up to the light of experience. When faced with the data, the usual defense is: Just wait, the day of reckoning will come! Two centuries, and counting.

 

[1] http://www.levyinstitute.org/pubs/ppb_123.pdf

[2]  http://www.levyinstitute.org/pubs/wp_645.pdf

[3] http://www.levyinstitute.org/publications/can-biden-build-back-better-yes-if-he-abandons-fiscal-pay-fors

[4] https://www.forbes.com/sites/afontevecchia/2013/07/17/bernanke-to-congress-we-are-printing-money-just-not-literally/?sh=7271b3a8109b

[5] http://www.levyinstitute.org/pubs/e_pamphlet_2.pdf

[6] Kelton, S. 2020. The Deficit Myth: Modern Monetary Theory and the Birth of the People’s Economy. New York: Public Affairs..

[7] https://www.tandfonline.com/doi/full/10.1080/05775132.2019.1639412

[8] http://www.levyinstitute.org/pubs/e_pamphlet_2.pdf, p.13.

[9] http://www.levyinstitute.org/pubs/e_pamphlet_2.pdf, p. 17.

[10] http://www.levyinstitute.org/pubs/e_pamphlet_2.pdf, p. 20.

Are Concerns over Growing Federal Government Debt Misplaced?

Published by Anonymous (not verified) on Thu, 11/11/2021 - 8:02am in

If the global financial crisis (GFC) of the mid-to-late 2000s and the COVID crisis of the past couple of years have taught us anything, it is that Uncle Sam cannot run out of money. During the GFC, the Federal Reserve lent and spent over $29 trillion to bail out the world’s financial system,[1] and then trillions more in various rounds of “unconventional” monetary policy known as quantitative easing.[2] During the COVID crisis, the Treasury has (so far) cut checks totaling approximately $5 trillion, often dubbed stimulus. Since the Fed is the Treasury’s bank, all of these payments ran through it—with the Fed clearing the checks by crediting private bank reserves.[3] As former Chairman Ben Bernanke explained to Congress, the Fed uses computers and keystrokes that are limited only by Congress’s willingness to budget for Treasury spending, and the Fed’s willingness to buy assets or lend against them[4]—perhaps to infinity and beyond. Let’s put both affordability and solvency concerns to rest: the question is never whether Uncle Sam can spend more, but should he spend more.[5]

If the Treasury spends more than received in tax payments over the course of a year, we call that a deficit. Under current operating procedures adopted by the Fed and Treasury, new issues of Treasury debt over the course of the year will be more-or-less equal to the deficit. Every year that the Treasury runs a deficit it adds to the outstanding debt; surpluses reduce the amount outstanding. Since the founding of the nation, the Treasury has ended most years with a deficit, so the outstanding stock has grown during just about 200 years (declining in the remainder).[6] Indeed, it has grown faster than national output, so the debt-to-GDP ratio has grown at about 1.8 percent per year since the birth of the nation.[7]

If something trends for over two centuries with barely a break, one might begin to consider it normal. And yet, strangely enough, the never-achieved balanced budget is considered to be normal, the exceedingly rare surplus is celebrated as a noteworthy achievement, and the all-too-common deficit is scorned as abnormal, unsustainable, and downright immoral.

First the good news. The government’s “deficit” is our “surplus”: since spending must equal income at the aggregate level, if the government spends more than its income (tax revenue), then by identity all of us in the nongovernment sector (households, businesses, and foreigners) must be spending less than our income.[8] Furthermore, all the government debt that is outstanding must be held by the nongovernment sector—again, that is us. The government’s debt is our asset. Since federal debt outstanding is growing both in nominal terms and as a percent of GDP, our wealth is increasing absolutely and relatively to national income. Thanks Uncle Sam!

But the dismal scientists (economists) warn that all this good news comes with a cost. Deficits cause inflation! Debt raises interest rates and crowds out private investment! Economic growth stagnates because government spending is inherently less efficient than private spending! All of this will cause foreigners to run out of the dollar, causing depreciation of the exchange rate!

With two centuries of experience, the evidence for all this is mixed at best. Deficits and growing debt ratios are the historical norm. Inflation comes and goes. President Obama’s big deficits during the GFC didn’t spark inflation—indeed, inflation ran below the Fed’s target year after year, even as the debt ratio climbed steadily from the late 1990s to 2019. The initial COVID response—that would ultimately add trillions more to deficits and debt—did not spark inflation, either. (Yes, we’ve seen inflation increasing sharply this year—but as I noted, the evidence is mixed and many economists, including those at the Fed, believe these price hikes come mostly from supply-side problems.)

Interest rates have fallen and remained spectacularly low over the past two decades.[9] Anyone looking only at those 20 years could rationally conclude that interest rates appear to be inversely correlated to deficits and debt. While I do believe there is a theoretically plausible case to be made in support of that conclusion, the point I am making is that the evidence is mixed. And if you were to plot the growth rate of GDP against the deficit-to-GDP ratio for the postwar period, you would find a seemingly random scatterplot of points.[10] Again, the evidence is mixed at best.

Finally, the dollar has remained strong—maybe too strong for some tastes—over the past 30 years in spite of the US propensity to run budget deficits, and even trade deficits for that matter. Both of these are anomalies from the conventional perspective.

So, while there are strongly held beliefs about the negative impacts of deficits and debt on inflation, interest rates, growth, and exchange rates, they do not hold up to the light of experience. When faced with the data, the usual defense is: Just wait, the day of reckoning will come! Two centuries, and counting.

 

[1] http://www.levyinstitute.org/pubs/ppb_123.pdf

[2]  http://www.levyinstitute.org/pubs/wp_645.pdf

[3] http://www.levyinstitute.org/publications/can-biden-build-back-better-yes-if-he-abandons-fiscal-pay-fors

[4] https://www.forbes.com/sites/afontevecchia/2013/07/17/bernanke-to-congress-we-are-printing-money-just-not-literally/?sh=7271b3a8109b

[5] http://www.levyinstitute.org/pubs/e_pamphlet_2.pdf

[6] Kelton, S. 2020. The Deficit Myth: Modern Monetary Theory and the Birth of the People’s Economy. New York: Public Affairs..

[7] https://www.tandfonline.com/doi/full/10.1080/05775132.2019.1639412

[8] http://www.levyinstitute.org/pubs/e_pamphlet_2.pdf, p.13.

[9] http://www.levyinstitute.org/pubs/e_pamphlet_2.pdf, p. 17.

[10] http://www.levyinstitute.org/pubs/e_pamphlet_2.pdf, p. 20.

Is Climate Change a Fiscal or Monetary Policy Challenge?

Published by Anonymous (not verified) on Thu, 11/11/2021 - 6:00am in

Lekha Chakraborty
(Professor, NIPFP, and Member of Governing Board, International Institute of Public Finance, Munich)

Climate change is about risks and uncertainty. How well the monetary policy stance can incorporate such risks and uncertainties is questioned by many economists. There is a broad consensus among economists that fiscal policy is capable of dealing with the climate crisis but monetary policy is not, due to the latter’s lack of tools. It is widely acknowledged that public finance commitments are essential to lowering carbon emissions. Public finance interventions—through taxation to reduce carbon prints or through public expenditure to support green energy and technology—have proven to be effective in reducing emissions. However, such empirical evidence is absent in the case of monetary policy.

India was the first to integrate a climate change criterion in its inter-governmental fiscal transfers. The macroeconomic policy channel of these “ecological fiscal transfers” works through the prioritization of public expenditure on climate change commitments by subnational governments, to make a “just transition” towards a sustainable climate-resilient economy.

Within the environmental federalism framework, the “principle of subsidiarity” demands that the responsibility for providing a particular service should be assigned to the level of government closest to the people. This tax transfer also compensates for the cost burdens faced by subnational governments, due to foregone revenue and opportunity costs associated with establishing protected areas in their path towards economic growth. However, ecological fiscal transfers are only one among many fiscal policy tools to meet climate change commitments.

On the monetary policy front, climate-focused stress tests conducted by central banks are an upcoming policy tool to address the issue. Such green stress tests assess how the banking system is exposed to climate risks and uncertainties. Such a test was first conducted by the Bank of England. Christine Lagarde of the European Central Bank (ECB) is very supportive of greening monetary policy and the ECB will conduct such tests of the risk exposure of top banks in the European Commission in 2022. However, the US Federal Reserve has not yet begun such tests. Fed Chair Jay Powell explained that the Fed has asked lenders to articulate their risk exposure and how they can mitigate such risks. The Reserve Bank of India has published a chapter on greening monetary policy; however, there is no further communication regarding toolkits. The response to the question of whether the RBI is open to conducting such green stress tests on the top banks is awaited.

Recently, Professor Lars Peter Hansen, an economist at the University of Chicago (and winner of 2013 Nobel Prize for economics), mentioned that there can be “reputation risks” if central banks go beyond their mandates. Raghuram Rajan, another Professor at the University of Chicago and the former Central Bank Governor of India, said that central banks should turn their focus to the financial stability of green investments instead of asking whether to buy only green bonds (versus brown bonds), which is primarily a “fiscal” decision in his view. The broad consensus is that central banks should focus on price stability and financial stability. However, this can be refuted by the concern that climate change is a crucial determinant of financial stability and it is crucial to integrate such climate-related risks and uncertainties in financing investment decisions.

In Brazil and Portugal, ecological fiscal transfers are conditional grants in nature, which incentivizes decentralized environmental conservation efforts, while in India, thclimate change criterion is incorporated in formula-based unconditional tax transfers. The point to be noted here is that the Twelfth and Thirteenth Finance Commissions of India designed specific purpose grants of Rs 1000 crores and Rs 5000 crores, respectively, for the conservation of the forestry sector. In addition to these intergovernmental fiscal transfers, the CAMPA (Compensatory Afforestation Management and Planning Authority) funds are also there, with the objective to enhance forest cover to maximize carbon sequestration. However, these conditional grants and CAMPA funds were not significant enough to make a “just transition” towards a sustainable climate-resilient economy. The District Mineral Fund, which is earmarked from mining royalties and intended to redress spatial inequalities in the districts from which it is extracted, has also not been an effective policy tool towards “just transition.”

Against this backdrop, the Fourteenth Finance Commission was the first to integrate climate change criteria in intergovernmental fiscal transfers. The Fifteenth Finance Commission has retained the criterion.

In addition to these fiscal transfers, the long-term Public Financial Management (PFM) tool, like climate-responsive budgeting at national and subnational levels, is crucial to address climate change commitments. This PFM tool links national climate action plans to budgetary commitments. The roadmap and the analytical matrices to prepare climate-responsive budgeting can also eliminate the “fragmented approach” by line ministries towards adaptation and mitigation in India. However, differential tax rates can lead to a “race to the bottom” to attract mobile capital and create “pollution havens” through trading lower environmental quality for more mobile capital.

In general, economists are apprehensive about the efficacy of central banks in dichotomizing green bonds and brown bonds in their asset portfolio and moving towards a low-carbon-emission enterprise. This skepticism is mainly because of the political economy perspectives in such decisions and whether central banks are equipped with knowledge and toolkits to engage in such a mandate.

Economists and policymakers underestimate the information asymmetries and knowledge gaps of a central bank in tackling climate change commitments. The financing of green investment and technology might lead to a de-carbonization process in future. But the question is how effective are the available expertise and toolkits of central banks to engage in such goals. Policy prioritization and political will are the prime determinants towards climate change commitments.

Is Climate Change a Fiscal or Monetary Policy Challenge?

Published by Anonymous (not verified) on Thu, 11/11/2021 - 6:00am in

Lekha Chakraborty
(Professor, NIPFP, and Member of Governing Board, International Institute of Public Finance, Munich)

Climate change is about risks and uncertainty. How well the monetary policy stance can incorporate such risks and uncertainties is questioned by many economists. There is a broad consensus among economists that fiscal policy is capable of dealing with the climate crisis but monetary policy is not, due to the latter’s lack of tools. It is widely acknowledged that public finance commitments are essential to lowering carbon emissions. Public finance interventions—through taxation to reduce carbon prints or through public expenditure to support green energy and technology—have proven to be effective in reducing emissions. However, such empirical evidence is absent in the case of monetary policy.

India was the first to integrate a climate change criterion in its inter-governmental fiscal transfers. The macroeconomic policy channel of these “ecological fiscal transfers” works through the prioritization of public expenditure on climate change commitments by subnational governments, to make a “just transition” towards a sustainable climate-resilient economy.

Within the environmental federalism framework, the “principle of subsidiarity” demands that the responsibility for providing a particular service should be assigned to the level of government closest to the people. This tax transfer also compensates for the cost burdens faced by subnational governments, due to foregone revenue and opportunity costs associated with establishing protected areas in their path towards economic growth. However, ecological fiscal transfers are only one among many fiscal policy tools to meet climate change commitments.

On the monetary policy front, climate-focused stress tests conducted by central banks are an upcoming policy tool to address the issue. Such green stress tests assess how the banking system is exposed to climate risks and uncertainties. Such a test was first conducted by the Bank of England. Christine Lagarde of the European Central Bank (ECB) is very supportive of greening monetary policy and the ECB will conduct such tests of the risk exposure of top banks in the European Commission in 2022. However, the US Federal Reserve has not yet begun such tests. Fed Chair Jay Powell explained that the Fed has asked lenders to articulate their risk exposure and how they can mitigate such risks. The Reserve Bank of India has published a chapter on greening monetary policy; however, there is no further communication regarding toolkits. The response to the question of whether the RBI is open to conducting such green stress tests on the top banks is awaited.

Recently, Professor Lars Peter Hansen, an economist at the University of Chicago (and winner of 2013 Nobel Prize for economics), mentioned that there can be “reputation risks” if central banks go beyond their mandates. Raghuram Rajan, another Professor at the University of Chicago and the former Central Bank Governor of India, said that central banks should turn their focus to the financial stability of green investments instead of asking whether to buy only green bonds (versus brown bonds), which is primarily a “fiscal” decision in his view. The broad consensus is that central banks should focus on price stability and financial stability. However, this can be refuted by the concern that climate change is a crucial determinant of financial stability and it is crucial to integrate such climate-related risks and uncertainties in financing investment decisions.

In Brazil and Portugal, ecological fiscal transfers are conditional grants in nature, which incentivizes decentralized environmental conservation efforts, while in India, thclimate change criterion is incorporated in formula-based unconditional tax transfers. The point to be noted here is that the Twelfth and Thirteenth Finance Commissions of India designed specific purpose grants of Rs 1000 crores and Rs 5000 crores, respectively, for the conservation of the forestry sector. In addition to these intergovernmental fiscal transfers, the CAMPA (Compensatory Afforestation Management and Planning Authority) funds are also there, with the objective to enhance forest cover to maximize carbon sequestration. However, these conditional grants and CAMPA funds were not significant enough to make a “just transition” towards a sustainable climate-resilient economy. The District Mineral Fund, which is earmarked from mining royalties and intended to redress spatial inequalities in the districts from which it is extracted, has also not been an effective policy tool towards “just transition.”

Against this backdrop, the Fourteenth Finance Commission was the first to integrate climate change criteria in intergovernmental fiscal transfers. The Fifteenth Finance Commission has retained the criterion.

In addition to these fiscal transfers, the long-term Public Financial Management (PFM) tool, like climate-responsive budgeting at national and subnational levels, is crucial to address climate change commitments. This PFM tool links national climate action plans to budgetary commitments. The roadmap and the analytical matrices to prepare climate-responsive budgeting can also eliminate the “fragmented approach” by line ministries towards adaptation and mitigation in India. However, differential tax rates can lead to a “race to the bottom” to attract mobile capital and create “pollution havens” through trading lower environmental quality for more mobile capital.

In general, economists are apprehensive about the efficacy of central banks in dichotomizing green bonds and brown bonds in their asset portfolio and moving towards a low-carbon-emission enterprise. This skepticism is mainly because of the political economy perspectives in such decisions and whether central banks are equipped with knowledge and toolkits to engage in such a mandate.

Economists and policymakers underestimate the information asymmetries and knowledge gaps of a central bank in tackling climate change commitments. The financing of green investment and technology might lead to a de-carbonization process in future. But the question is how effective are the available expertise and toolkits of central banks to engage in such goals. Policy prioritization and political will are the prime determinants towards climate change commitments.

The UK has embraced the big state — but lacks a vision for it

Published by Anonymous (not verified) on Tue, 02/11/2021 - 8:56pm in

Photo by Marcin Nowak on Unsplash

This week the UK Chancellor Rishi Sunak delivered the 2021 Autumn Budget in the House of Commons. The Budget confirms that this government has accepted a permanently larger role for the state in the economy. Spending will grow in real terms by 3.8% across government, amounting to a £111bn annual increase by 2024–25. Analysis by the Office of Budget Responsibility (OBR) shows total public spending levelling out around 42% of GDP once the huge rises associated with the pandemic wear off. This is not high by European standards. However given the figure averaged around 37% in the 30 years preceding the Great Financial Crisis it marks a step change, in particular for the Conservative party.

But Rishi Sunak and the Treasury remain fiscal conservatives. The Chancellor has created a new ‘fiscal rule’ (the fifteenth since 1997) which requires balancing day-to-day spending, excluding investment, within three years and keeping public sector investment from averaging more than 3% of GDP. Instead of achieving this through spending cuts, the Chancellor is embarking on major tax rises. Post-budget analysis by the Resolution Foundation finds that by 2026–27, tax revenue as a share of the economy will be at its highest level since 1950 (36.2%), amounting to an increase per household since Boris Johnson became Prime Minister of around £3,000.

The fiscal rule itself is arbitrary and appears to be more driven by politics than economics. With interest rates on long-dated government debt remaining at record lows, there is no obvious reason to balance the budget over the short-term when the economy faces longer-term ‘scarring’ effects from the pandemic, which the OBR estimates will be around 2% of GDP.

More generally, the Budget lacks any real vision for how to achieve the ‘high skill, high productivity, high wage’ economy that Boris Johnson spoke about in his party conference speech.

On the spending front, the biggest increases will go towards the NHS, social care and pensioners. With an ageing population and technological advances in healthcare, such increases are inevitable. They should arguably be higher, in particular for social care, which ultimately could help reduce costs on the NHS in the long run.

Disappointment

The biggest disappointment, ahead of the UK’s hosting of the COP26 summit next week in Glasgow, is the lack of any new plans to support a green transition. Keeping public sector investment to below 3% suggests the Chancellor is not yet taking seriously the massive transformation of our energy, housing and transport infrastructure required to meet the UK’s net Zero 2050 targets. The Treasury appears unable to see the potential of policies such as a national home insulation program to reduce carbon emissions, create good quality jobs and reduce the cost of living for those many poorer households in leaky homes. The announcement of a tax break on short haul flights — which are already significantly cheaper for equivalent journeys than trains in this country — confirms the Treasury’s myopic views on the net zero transition.

Sunak made much of the announcement of reduction of the rate at which universal credit is taxed for those who are in work. How the remaining four million or so households on universal credit who haven’t found work are supposed to survive the £1,050 per year reduction in their incomes from the reversal of the £20 uplift remains to be seen.

But the broader point here is that if the Treasury was genuinely interested in ‘making work pay’ as Sunak emphasised in his speech, they would be taxing wealth and not wages. A recent analysis found that the Treasury could raise £16bn a year if shares and property were taxed at the same rate as salaries. Currently, the richest 1% of the population take 13% of their income in the form of capital gains.

Given that the bulk of new spending announced in the budget will mainly support older, wealthier people, the case for a gradual shift towards taxing some of the assets they have built up over their lifetimes rather than the income of the wider population seems strong. This should also encourage more private investment into productive activities rather than property. But, just as with climate change, this kind of broader strategic vision seems missing from the Chancellor and the Treasury’s thinking.

Originally published on the UCL Institute for Innovation and Public Policy blog.

The post The UK has embraced the big state — but lacks a vision for it appeared first on The Progressive Economy Forum.

Where Has All the Money Gone?

Published by Anonymous (not verified) on Sat, 25/09/2021 - 3:35am in

Quantitative easing risks generating its own boom-and-bust cycles, and can thus be seen as an example of state-created financial instability. Governments must now abandon the fiction that central banks create money independently from government, and must themselves spend the money created at their behest.

LONDON – Amid all the talk of when and how to end or reverse quantitative easing (QE), one question is almost never discussed: Why have central banks’ massive doses of bond purchases in Europe and the United States since 2009 had so little effect on the general price level?0

Between 2009 and 2019, the Bank of England injected £425 billion ($588 billion) – about 22.5% of the United Kingdom’s 2012 GDP – into the UK economy. This was aimed at pushing up inflation to the BOE’s mandated medium-term target of 2%, from a low of just 1.1% in 2009. But after ten years of QE, inflation was below its 2009 level, despite the fact that house and stock-market prices were booming, and GDP growth had not recovered to its pre-crisis trend rate.

Since the start of the COVID-19 pandemic in March 2020, the BOE has bought an additional £450 billion worth of UK government bonds, bringing the total to £875 billion, or 40% of current GDP. The effects on inflation and output of this second round of QE are yet to be felt, but asset prices have again increased markedly.

A plausible generalization is that increasing the quantity of money through QE gives a big temporary boost to the prices of housing and financial securities, thus greatly benefiting the holders of these assets. A small proportion of this increased wealth trickles through to the real economy, but most of it simply circulates within the financial system.

The standard Keynesian argument, derived from John Maynard Keynes’s General Theory, is that any economic collapse, whatever its cause, leads to a large increase in cash hoarding. Money flows into reserves, and saving goes up, while spending goes down. This is why Keynes argued that economic stimulus following a collapse should be carried out by fiscal rather than monetary policy. Government has to be the “spender of last resort” to ensure that new money is used on production instead of being hoarded.

But in his Treatise on Money, Keynes provided a more realistic account based on the “speculative demand for money.” During a sharp economic downturn, he argued, money is not necessarily hoarded, but flows from “industrial” to “financial” circulation. Money in industrial circulation supports the normal processes of producing output, but in financial circulation it is used for “the business of holding and exchanging existing titles to wealth, including stock exchange and money market transactions.” A depression is marked by a transfer of money from industrial to financial circulation – from investment to speculation.

So, the reason why QE has had hardly any effect on the general price level may be that a large part of the new money has fueled asset speculation, thus creating financial bubbles, while prices and output as a whole remained stable.

One implication of this is that QE generates its own boom-and-bust cycles. Unlike orthodox Keynesians, who believed that crises were brought on by some external shock, the economist Hyman Minsky thought that the economic system could generate shocks through its own internal dynamics. Bank lending, Minsky argued, goes through three degenerative stages, which he dubbed hedge, speculation, and Ponzi. At first, the borrower’s income needs to be sufficient to repay both the principal and interest on a loan. Then, it needs to be high enough to meet only the interest payments. And in the final stage, finance simply becomes a gamble that asset prices will rise enough to cover the lending. When the inevitable reversal of asset prices produces a crash, the increase in paper wealth vanishes, dragging down the real economy in its wake.

Minsky would thus view QE as an example of state-created financial instability. Today, there are already clear signs of mortgage-market excesses. UK house prices increased by 10.2% in the year to March 2021, the highest rate of growth since August 2007, while indices of overvaluation in the US housing market are “flashing bright red.” And an econometric study (so far unpublished) by Sandhya Krishnan of the Desai Academy of Economics in Mumbai shows no relationship between asset prices and goods prices in the UK and the US between 2000 and 2016.

So, it is hardly surprising that, in its February 2021 forecast, the BOE’s Monetary Policy Committee estimated that there was a one-third chance of UK inflation falling below 0% or rising above 4% in the next few years. This relatively wide range partly reflects uncertainty about the future course of the pandemic, but also a more basic uncertainty about the effects of QE itself.

In Margaret Atwood’s futuristic 2003 novel Oryx and Crake, HelthWyzer, a drug development center that manufactures premium-brand vitamin pills, inserts a virus randomly into its pills, hoping to profit from the sale of both the pills and the antidote it has developed for the virus. The best type of diseases “from a business point of view,” explains Crake, a mad scientist, “would be those that cause lingering illness […] the patient would either get well or die just before all of his or her money runs out. It’s a fine calculation.”

With QE, we have invented a wonder drug that cures the macroeconomic diseases it causes. That is why questions about the timing of its withdrawal are such “fine calculations.”

But the antidote is staring us in the face. First, governments must abandon the fiction that central banks create money independently from government. Second, they must themselves spend the money created at their behest. For example, governments should not hoard the furlough funds that are set to be withdrawn as economic activity picks up, but instead use them to create public-sector jobs.

Doing this will bring about a recovery without creating financial instability. It is the only way to wean ourselves off our decade-long addiction to QE.


Robert Skidelsky

The post Where Has All the Money Gone? appeared first on The Progressive Economy Forum.

Green party’s housing platform

Published by Anonymous (not verified) on Fri, 17/09/2021 - 6:00am in

With Canadians headed to the polls next week, I’ve written a 650-word overview of the Green Party’s housing platform.

Here’s the link: https://nickfalvo.ca/ten-things-to-know-about-the-green-partys-housing-p...

Green party’s housing platform

Published by Anonymous (not verified) on Fri, 17/09/2021 - 6:00am in

With Canadians headed to the polls next week, I’ve written a 650-word overview of the Green Party’s housing platform.

Here’s the link: https://nickfalvo.ca/ten-things-to-know-about-the-green-partys-housing-p...

Should we tax wealth to fund social care?

Published by Anonymous (not verified) on Wed, 15/09/2021 - 2:21am in

Photo by Jingming Pan on Unsplash

PEF Council members recently discussed, via email, the government’s plans for social care and its financing. We were unanimous in agreeing on the bad design of the scheme, on the absence of real funding and reform for social care. And we also agreed on the need for a significant shift in the balance of taxation towards wealth. The points of contention are around how the latter should take place and a macroeconomics that might help explain why.

Stewart Lansley

The case for financing social care through wealth is overwhelming. There are two broad options: first, the 2010 Burnham Plan, which means all those needing care would keep their home and a charge made at death. Alternatively, an annual property charge of say 1% pa up to say a maximum of 5%. Both of these could be paid into a social care fund, as argued in Remodelling Capitalism.

The last two decades have seen a great surge in asset values and unearned wealth (what John Stuart Mill called “getting rich in your sleep”), notably in property. The total value of personal wealth in the UK in 2018 was £14.6 tr of which property is £5tr and financial wealth £2.2tr – so a hypothetical one per cent tax on all property and financial wealth would yield £70bn a year, and just on property would be £50bn per year. Any such tax should be charged on assets above a certain level, which would then yield less than the estimates given here.

Yet the tax take from wealth is tiny, with the UK tax system disproportionately dependent on taxing income. In 2015/6, the combined revenue from existing capital taxes – stamp duty on property transactions and shares, capital gains and inheritance tax but excluding council tax – raised about £27bn a year, some 3.9% of all tax revenue.  This accounts for less than one per cent of total private asset holdings.

The case for higher taxation on personal and corporate wealth is being widely recognized. Before the 2017 November budget, the National Institute of Economic and Social Research proposed an annual tax on net wealth (assets minus liabilities) above £700,000 (including residential property) to replace three existing capital taxes on inheritance tax, capital gains and dividends. A tax set at 2 per cent would raise £72 billion (gross).

The scheme would may have been unpopular in 2010, but might be much more popular now given that the public accept that we need to find a way of paying for social care and are unconvinced by Johnson’s plan. This is surely an area where KS should be out with all guns blazing!

Danny Dorling

I was one of the people earlier suggesting taxing wealth would be difficult. I don’t think I explained myself well. It is not the taxing of wealth that is difficult, that is easy. Ireland showed how it could be done on property with a progressive property tax where the percentage taken rose according to the value of property. They did it in an extremely short amount of time when forced to by the Troika in the Eurozone crisis at the start of the last decade. When that process began, they had no “gazetteer” – no universal register of properties – let alone any decent sets of valuations.

The best systems of wealth taxation make paying the tax annually part of the way you claim and maintain a record of your ownership of property. You can chose not to pay the wealth tax if you wish to gift that wealth to the state. You can also argue that your property is worth less than the valuation of the state. However, when you then come to sell that property, you may find that buyers don’t wish to pay more than you have said it is worth. Wealth taxes should also decrease the value of property which would not be a bad thing. So my concern is not with the idea of wealth taxes.

My concern is with suggesting it – and suggesting introducing a wealth tax to pay for the NHS/Social Care, without suggesting all the other mitigations you would do at the very same time that would make it appear plausible to many people.

But so many mitigations are needed that you end up needing a whole manifesto to explain them. I’ll give just one example. A large group of people in their 40s and 50s who have managed to get a mortgage now talk of their home as their pension. Their various precarious jobs have meant they have no decent pension, and although they may now be being auto enrolled into a pension. It is not one where they can envisage a future of being able to “keep the thermostat on 17 in their old age” as it was recently put to me by one home owner (still paying off their mortgage, and with the annual average income of the UK). What they plan to do is sell their home when they retire, downsize and use part of the savings to (among other things) pay the gas bill in winter.

If we suggest a wealth tax, taxing away a slice of what they see as their savings every year without also suggesting how pensions will be improved, then in the mind of someone in that position your policy will condemn them to an old age of being cold. Gas and electric bills have just risen very quickly so these bills are on peoples’ minds at the moment. In effect, for them a wealth tax is an annual tax on their future pension. And quite a low pension at that.

I think this is one of the dangers of talking about raising a new tax to pay for one thing, when all the others things are not considered.

My preference is to keep taxing and spending separate, not hypothecated. So talk about rebalancing the tax system to make it fairer – with the emphasis always on fairness. And I would bring the overall level up to what is normal in Germany (almost identical to what Labour promised in their 2019 manifesto). Talk about bringing in taxes on wealth solely for the purpose of increasing fairness, not to pay for a particular policy, but also partly to allow other less fair taxes to be reduced, and partly to allow overall public spending to be at normal European levels.

On spending, we shouldn’t talk too much about the amounts of money in each sector, but much more about what it is you actually want to see. Something that is very good need not be very expensive. The Finns spend less as a share of GDP on their school than we do on ours, but their schools are much better. In contrast, we spend an enormous amount on our now almost entirely privatised universities, but we don’t see that as a tax. In the USA, they have the highest spending on health care in the world – and in general poor health.

I’ll stop there, but hope it helps explain my worry about suggestions of introducing a wealth tax to pay for health and social care.

Josh Ryan-Collins

I agree governments should not hypothecate (and I’m amazed HMT broke its own golden rule on that in this case) both because it can lead to less politically popular services getting neglected but also because it embeds the idea that we can’t pay for stuff unless we raise the money first which is simply not the case in sovereign currency issuing nations.

Having said this, the Tories have hypothecated and they have just implemented the biggest tax rise in living memory indicating (perhaps) a seismic shift towards the centre on economic policy. This threatens Labour in quite a serious way if they can’t differentiate themselves effectively.  The way to differentiate is to focus less on the amount of tax needed and for what (as you say Danny and Sue) but on how that tax should be raised and from whom in a way that is both socially just and economically sensible.

It is not sensible to be withdrawing purchasing power from workers and businesses when the economy remains fragile. But the even bigger issue is that tax needs to be seen as a key tool via which issues like inequality and falling productivity can be addressed via pushing against economic rents and favouring investment and wages.  This NIC tax hike broadly does the opposite. If you make your money from rental income, interest fees or capital gains, don’t pay a penny more, in contrast to workers and firms. The chart below from Resolution Foundation shows how crazy the situation is:

Source: Resolution Foundation

Will Hutton

I am all for taxing capital and am in violent agreement that too much capital taxation has been allowed to atrophy: no revaluation of residential property since 1991 so that council tax yields a fraction of the old rates, de facto semi-voluntary inheritance tax, too low capital gains tax, etc. During the 1945-50 Labour government tax on estates ran at 10 per cent of all tax revenues. There is huge scope to increase capital taxes, and as Josh has argued, property is immovable.

Stephany Griffith-Jones

I agree with Will on practically all points – including the extraordinary absence of  a revaluation of residential property since 1991, which includes periods when Labour was in power! An effective and fairly high inheritance tax is very desirable, as one of the structural problems is perpetuation of wealth concentration via inheritance.

Stewart Lansley

Just on Danny’s points:

1. ONS wealth figures are net wealth and any wealth tax on residential property would be net of mortgage debt, so Danny’s examples would not be affected. 

2. Yes, we must do more to make the existing taxation of income fairer, for example by reform of National Insurance system, but this would not be enough on its own to create a more equal society. 

3. As I argued in Return of the State, we are close to the limits of income taxation, So if we want to raise funds for improving social provision we need to turn to  asset-redistribution, though this would require taking public with us. Wealth is much more unequally distributed than income –  Top fifth hold 64 % of personal net wealth and 80% of financial wealth – and unless we tackle that we will not be able to reduce inequality and poverty on a sustainable basis.  It’s perfectly possible to design a wealth tax system that is concentrated on top wealth holders. 

Geoff Tily 

The TUC have argued that reforming Capital Gains Tax is a much fairer way to fund social care than hiking workers’ and businesses’ national insurance contributions.  But like President Biden’s notion of “work not wealth”, I want to make a broader macro argument that the interests of wealth and of labour are fundamentally opposed.  

My Keynes Betrayed was concerned with restoring Keynes’s conclusion that the long-term rate of interest must be set permanently low. Since I have been at the TUC, it occurs to me that this rate should interpreted more broadly as the return to capital/wealth and should be compared with the return to labour. Keynes’s conclusion that “we must avoid [dear money] … as we would hell-fire” (Collected Works XXI, p. 389) then means that we orient the system to the interests of wealth at our peril.    

The below chart shows a measure of the real (inflation-adjusted) long-term interest on US corporate debt, going beyond the normal comparisons of rates on government bonds. Even this doesn’t capture well the experience since the global financial crisis, but plainly we know full well what has happened to the broader return to wealth versus the return to labour over the past decade. (I suspect US investment grade corporate debt has simply become increasingly regarded as retreating from risk – and this goes right back to dot.com bubble.) “Dear money” can be seen coming in rapidly from 1979 (in parallel to the ‘Volcker shock’), and interest rates were sustained some way above the post-war levels (and back to the 1920s).  

US real interest rate

Source: Federal Reserve for BBA corporate debt and BEA for GDP deflator; y-axis truncated for years of severe deflation.   

Josh’s chart from the Resolution Foundation is a nice one, not least because the timing of the key dislocation matches well the restoration of dear money on the above. Above all, this rise in returns to assets is a consequence, not a cause, of dear money.

Previously I had argued (following the General Theory chapter 22) that macroeconomic disarray comes in through overinvestment, but now I like a broader over-production/under-consumption (or rather, under-compensation) approach (it’s trade union friendly, has recently been revived by Matthew Klein and Michael Pettis [though Stuart Lansley had done so nearly a decade sooner], and is likely to be more correct!). Rather than spending to compensate for the underspending of labour, the wealthy speculate and so exacerbate over-production. This leads to unsustainable private debt, and ultimately meltdown; the fear here is Quantitative Easing has simply kicked the can down the road, with the risk of meltdown appearing later.    

Tax on the wealthy can be part of the solution (as in the opening of the final chapter of General Theory), but to restore the balance to labour requires wholesale macroeconomic change that operates on a global basis. Hence my recent argument that ‘internationalism begins at home’.  

We were convened in the first instance as a group inspired by Keynes, so I hope colleagues engage with this argument. On my view, it’s how Attlee, Dalton, Gaitskell, Bevin, Blum and FDR understood the world, helped them successfully to win office, and to begin to make real change.    

Jan Toporowski

The real con trick in the government’s proposals is the claim that this is a solution to the social care crisis, when the funding for that is being explicitly postponed until the difficulties in the NHS have been overcome. So the social care funding is conditional on that same funding being enough to overcome NHS difficulties, a most unlikely prospect. The electoral con is the message that the residual of working people on proper contracts will get in their payslips that their money is going to be spent by the government not once but twice to solve both health crises.

Guy Standing

One cannot sensibly discuss how to pay for social care without a systematic view of what care entails, which encompasses its messy definition, who should receive it, who should receive money being spent on it, how they should receive it, and so on. Once one opens the Pandora’s box one should realise that any hypothecated approach, as implied in what the Tories are doing, makes no sense whatsoever. Hypothecated taxation opens the door to the worst features of utilitarianism, 

The Government’s tax and NI rise is doubly regressive, since it lowers the earning of most paid carers at a time when their income and morale are abysmally low. If a government does not alter the structure of the so-called ‘social care industry’, the primary beneficiaries of pouring more money into it will be the private equity interests (mostly foreign capital) which are plundering money being spent on social care. Removing private equity should be a top priority. And any funding scheme that relies on means-testing will accentuate what is a highly regressive scheme, not reduce it.

More generally, there must be a huge shift in taxation from earned incomes to wealth of all kinds and to incursions into the commons, which means much increased eco-taxation. Ironically, incomes are nowadays the least taxable, with the UK being a rank outlier in the very high extent of tax evasion by high-income earners. But changing the incidence of taxation should be the secondary concern to the need to restructure the care sector. The social care crisis is a structural one, not primarily a fiscal one. Perhaps a Royal Commission should be set up to devise a proper plan for an integrated, universally-based system.

Sue Himmelweit

I agree strongly with Danny about not muddling up comments on taxing and with those on spending. But I don’t think that means that Labour should comment soley on alternative forms of taxation.

The first thing that has to be said about the so-called plan for social care is that it isn’t one, that it won’t be doing anything to improve provision nor even get back to the already failing system that we had in 2010. As the party that stands for protecting the vulnerable by collective provision this must be Labour’s first call. If they are commenting on a policy on social care, their first comment should be on social care and the need for it to be adequately funded (in the sense of enough spent on it), not on different forms of taxation. This should be true of PEF too!

Labour should also make clear that we could benefit from an overhaul of the tax system, so that it taxes, at the very least, gains in wealth. Reforming CGT so that is charged at the same rates as income tax with no specific tax allowance (except to exempt gains too small to count) would be a first step. And I would also like to see inheritance tax replaced by a receipts tax covering all ways of receiving wealth, also taxed at income tax rates (with some allowance for spreading a windfall over a few years). This way all ways of gaining wealth would be taxed at a reasonably high rate. This to me seems easier and more logical than taxing wealth itself at a low rate.

The post Should we tax wealth to fund social care? appeared first on The Progressive Economy Forum.

The bloc québécois’ housing platform

Published by Anonymous (not verified) on Mon, 13/09/2021 - 7:23am in

With Canadians heading to the polls in a federal election this month, I’ve written a 600-word overview of the Bloc Québécois’ housing platform.

It’s available here: https://nickfalvo.ca/ten-things-to-know-about-the-bloc-quebecois-housing...

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