Tuesday, September 21, 2010

Set-up for ongoing discussions

While I wait for my new friend to show up, I figured I'd take the opportunity to define a few terms that I think were causing hangups in our discussion.

The one that drove me nuts (maybe because of my background) was savings. Typically, we define savings as the residual of income after paying all expenses. This seems consistent with Keynes (Y=C+S or something) and Friedman, who had the "lifetime wealth" formulation. This makes sense to me, but then I'm trained to think in a certain way. I'm open(ish) to debate on this issue.

The other thing is aggregate demand. This is my bad. I always think AD means consumer spending. But it does include investment and government spending and net exports (I imagine). So I promise to keep that in mind.

Any suggestions as to what else to include?


  1. Hey Prof,

    Good of you to offer this place and free up Davids comment section. I agree with you that Savings and AD are two areas that are the most contentious. Not being trained as an economist I'm really starting to get a feel for the places where the various paradigms have their frictions.

    The only thing I want to add is that in discussing these things it will often times be necessary (for me anyway) to step back and go a little different direction in order to clarify the higher order identity which brought me to this point. As an example when discussing savings or govt spending it is necessary to first clarify/discuss the fact that in modern monetary systems, an entity which issues currency is NEVER in need of "savings" the way a household is. Our govt has no savings account. No rainy day fund where they can get previously unspent money from. Its a nonsensical notion when you ARE the currency issuer. The govt never runs out of money. This is not arguing that we can simply print our way to prosperity or that there can never be inflation, it simply recognizes a simple reality of our monetary system AS IT IS. So maybe we need to start here before we can move beyond otherwise we are in parallel universes.

    My entire notion of savings and AD comes from operating in this paradigm. As I've said I'm not a trained economist but the last two years I feel like Ive studied more than most of your students probably. I havent come to my views with lack of serious thought and questions. I'm in a science field so my nature is to reverse engineer things and get to the nitty gritty of things and understand things at the "cellular level" so to speak. I've explored the Austrian perspective, the monetarist perspective, the New Keynsians etc etc and TO ME, the MMT or neo chartalists make the most convincing cases with their models.

    Let me ask you to check this article by Randall Wray out. Randall along with Bill Mitchell, Warren Mosler, Marshall Auerback and Jamie Galbraith are probably the most published of this school of economic thought.

    Its his "olive branch" to Austrians and others.


    I look forward to this discussion. I just think that before continuing on the road we were on over at Davids we might first need to step back and find how the pre suppositions we bring are affecting our arguments. We can either align our suppositions or agree to disagree. Either way we will learn something and have less confusion.


  2. Greg,

    Welcome! I liked our discussion, but as you point out, we were using up a lot of David's space.

    First, we agree on the issue of government saving. There's nothing in that section I disagree with, so let's move on.

    So, I'm a finance prof, not an econ prof. Operationally, that means I think on the firm-level which I think is sometimes good and sometimes bad. I'm trained in the neoclassical method (representative households and all that) but, as you know, have been going down the Austrian path of late. The thing I don't like about Austrian econ is the method - sometimes it seems like just a series of unbacked assertions. I'm inherently an empiricist. That said, I think it's also really important to recognize the limitations of data.

    I'll take a read of what you posted here. I'm not familiar at all with MMT, so this will be interesting.

    I agree about stepping back and thinking about our suppositions, but I also think that it will be hard to clear them all away from the start. My solution is thus: when we disagree on an issue, let's first define our terms and then we can disagree about issues once we've figured out what each other is trying to say. Fair?

    Finally, should we just reboot this thing and start fresh on the topic of "what's holding back the economy" or "why is unemployment still high?" I see these as related, after all.

  3. That all sounds good Prof.

    I think the reboot is the way to go. Those two questions are at the center of my interests and all the paradigms have much to say about them.

    Personally I think its the high unemployment that is holding back the economy and its the austerity measures which are holding back employment. One cannot hire a person without spending money. I dont think thats even debatable. Now, I think all would prefer to see the private sector step in and hire but they arent and its the reasons they arent that have been the great source of debate.

    Most if not all the proposals by mainstream economists and politicians have centered around supply side measures. They seem to be arguing that if we just give the companies more money (tax cuts on their income and on their investments, cutting unemployment benefits and eliminating min wage) they will start hiring. So this amounts to a 'businesses dont have enough money' argument. This is frankly absurd in my view.

    When you go to start a business and ask for a loan or investors, they dont ask you how much money you have, they ask you how many customers will you get. The ongoing success of a business is NEVER about how much money they have NOW, that reflects the success up til that point, its about how many customers will you have over the foreseeable future. Yes if youve been successful and have saved up cash you can get through a rough time but the amount of money you have never determines the viability of a new investment. Yes, having money is necessary for a new investment but the amount of money you have doesnt influence the likelihood of success once you have the minimum necessary. My boss doesnt decide to hire a new anesthetist because he has a lot of money and his taxes are low, he decides to hire new anesthetist when a new operating room is opening and new surgeons will be bringing cases to that OR.

    The cost of labor, which we had a disagreement about, I would summarize this way. If you want to argue that labor is like an apple and that unemployment happens because the "hire-ers" cant afford the labor, you must explain to me what it is the apple does with the money you pay for it? Does it purchase a seed to regrow it self? Does it purchase a grape to eat and give it more sweetness? This is why the labor as commodity analogy breaks down because labor has TWO sides. It is a cost to one person and a source of income to another. The apple has no such property.

    The view, which I think is quite Austrian, that everything is a commodity and has a price is in sufficient to deal with the realities of life. Yes a kidney can be profitable in the market of organ transplants but ther comes a point where others might use YOU as a source of kidneys to sell. This view of labor has led to much dehumanization in our societies.

    Your turn

  4. Hey Prof

    Bill Mitchell has this blog today at his site which is germane to our discussions.


    I'd be interested in hearing what you think about it AND I would suggest you comment on his site (he has one of the best comment sections on the web). There are a couple of posts from earlier this week where the discussion was right up your alley I believe.


  5. Greg,

    "Prof" seems so stuffy. Why not "Jeff" so we're a little more comfortable in the discussion here. If we were talking in my house, it'd be weird to not use each other's first names, no?

    Thanks for the link. Will definitely check it out.

    So, let's start with the things we agree on, and there is much that we do agree on (shocking, right?)

    1) You say that to hire new employees, businesses must spend. Definitely, and I would take it a step further: to employ yourself (start a new business for example) requires investment especially as your try to generate sales. So any engagement of labor requires an upfront investment.

    2) You say (I'm paraphrasing) that future demand is what matters for business. Again, totally agree. I think I might have (on David's blog) given the impression I thought this was irrelevant, but you are 100% correct. A business won't be founded/expanded/whatever if the entrepreneurs do not foresee sufficient demand for their product in the future. An, if current businesses see demand waning, they usually take steps to trim their business now (layoffs, selling equipment, etc.)

    3) Labor income becomes consumer spending. I agree in a mechanistic sense (people can't spend if they don't earn, after all) but I think there's more going on here that we can explore (I do so below).

    4) You didn't say, but you did imply: businesses have plenty of money right now. This appears to be the case, but I don't know how it is distributed. I think (but can't prove) that the cash is concentrated at the biggest firms, and small businesses have a lower per capita share of cash. This is important for growth.

    Now, the things I disagree with and my responses:

    1) Unemployment is holding back the economy. It seems you are saying that unemployment is the cause of current problems (namely no recovery from recession). I'm more agnostic than that, and I'm leaning towards unemployment being a symptom rather than the disease.

    We agree that an investment is made when businesses hire people. The lack of investment right now coincides with a high unemployment rate. Thus, either we've got a simultaneity problem (I won't invest until unemployment goes down! I can't get a job because businesses won't invest!) or the two are symptoms of the same root disease.

    (continued in next post)

  6. Greg,

    Please call me Jeff. Prof is too stuffy for a friendly discussion.

    Also - are you trying to kill me? Bill Mitchell's post is huge! That's going to be a project. But thanks for the link though - it does look pretty interesting.

    So, we agree on many things. To summarize: hiring of employees constitute an investment on the part of the business; future demand matters for investment today; and labor income becomes consumer spending (at least in large part).

    Now, you seem to be saying that unemployment is the cause of the current lack of recovery from the recession (btw, I don't buy into the NBER's dating of the end of the recession). But, as we discussed previously, commensurate with high unemployment is low investment by the business sector. As you know, they're holding cash and long-term gov't bonds.

    Now, it may be a simultaneity problem: firms won't invest until outlook improves including more people working, but without investment the outlook won't improve. I see this as a distinct possibility, especially for more risk averse entrepreneurs.

    But, it may also be that low investment and high unemployment are symptoms of the same root cause. I believe it is in the nature of this root cause where we disagree most strongly.

    You say you don't find much margin in the supply-side explanations. Now, being a libertarian (almost a Rothbardian, really), I find taxes basically immoral. But, the marginal effect of the expected tax increases on cost of capital for firms shouldn't be all that big, especially since interest rates are so (artificially in my opinion) low right now.

    (continued in next post)

  7. (continued from above)

    Minimum wage, which we also disagree on, really only affects low-skill workers (like teenagers, for example). If you look at the break-down of unemployment rates by age group, you'll see it's worst amongst the youngest group. Similarly, the less educated people have the worst unemployment rates.

    Now, what also is included in both the unemployment and investment numbers (from Bureau of Labor Statistics (www.bls.gov) and Bureau of Economic Analysis (www.bea.gov)) is the residential construction industry collapse. During the boom, there was too much construction, drawing people away from other jobs and into the construction industry. Similarly, households and home builders were all drawn to overinvest in the residential housing industry. Now it has collapsed. Businesses likely won't build very many new homes, since there's boatloads of them available on the market (12.5 month supply, according to WSJ a few days ago), and this means people won't be employed in the construction field.

    This kind of recalculation can spell long-term unemployment. If people are geographically constrained, they will try to find work in their area - but such work may never come back. Retraining is hard and painful and takes time. Financial capital is much more liquid than labor, so the businesses can move to more fertile ground and find local employees.

    I also believe there is a great deal of uncertainty about costs because of the new regulatory burdens from the health care bill and Frank-Dodd. You pile this stuff on, along with tax rates (which I know is small, but straw & camel's back), and you get a recipe that will lead businesses to permanently exit the country if they decide that the new regulatory burdens will be too high.

  8. Alright Jeff it is.

    Ha Ha Yes Bill Mitchell writes a sermon every day, sometimes not on Fridays though (he tries to surf on Fridays he says).

    You also will need to read the links he provides to his own posts that he is branching off of. He's really giving a lecture and a course in economics. He even has weekly quizzes. Being a finance professor I'm sure you would have much to comment on. His readership has doubled over the year that Ive been following him daily, if you judge by the number of people who comment.

    MMT is very fascinating stuff. So much of it is grounded in the operational realities of our monetary system and is completely inarguable, other stuff, which Bill is quick to point out, has to do with your own ideologies about what we should do.

    One thing that all the MMT guys say is (I'm paraphrasing) never make the discussion about money, there are no monetary limits, make the discussion about resource use and distribution.

    Any way back to our discussion.

    Excellent point about employing your self and the costs of that, but let me ask you this. Would you feel better about starting a private contracting venture when you knew there were 100,000 potential (cash holding) customers or 50,000? Vibrant communities like Athens where I live has a lot of public services an infrastructure supported by our public UGA employees and a lot of private contractors doing house repairs, lawn work, computer repairs. These guys wouldnt have the same optimism if they were in a similar size town that had poor public services no public University, in other words a lot of people with stable govt jobs. These people become great customers for the private sector to feed off of. So I guess I'm arguing that a reliable stable pool of income earners makes for a great starting point for small businesses to start and grow. This is why I dont understand the vitriol being spewed about "public sector workers" from our lovely republican leaders.

    I agree that distribution of the money is important when determining the amount of funds that "business" is sitting on. But I THINK my point is even more fundamental than that. Arguing that we need to make sure small businesses have more money seems to be beside the point, they need to be able to have a market to participate in, and what is a market? Customers! It really is a catch 22

  9. Continued..

    So really I'm saying unemployment is a symptom AND a disease. Yes we precipitated the unemployment because a financial crisis was mismanaged but the persistent unemployment is now becoming the disease.
    Like a leg that dies because of poor blood flow, simply restoring flow wont help at some point and the rotting leg which was a symptom is now a disease (gangrene) that is killing the organism. There are transient reductions of blood flow all the time in our bodies, minor recessions if you will but let the flow be low enough under the right conditions and a whole new dynamic emerges. I dont think there is any doubt that our financial crisis CAUSED the unemployment. Some of it was, as you say, simply too many workers building houses instead of something else but a great many workers (like at our hospital) got laid off because we were running out of money (?????) not because we had fewer patients or their skill eroded. These are the result, in my view, of a flawed notion of our financial system, a broken govt that has one side pathologically opposed to public spending (except on their pet projects and military) and value system which has become rotted with a short term gain rather than a long term view of wealth.

    When I, as you say, "say you don't find much margin in the supply-side explanations" I must add that different problems call for different answers. I have seen Bruce Bartlett make the point that when the supply siders had their revolution in the late 70s early 80s the supply side prescription were warranted. They arent now. We have a group of people who are masquerading as economists who are simply the vehement anti tax crowd. Thats fine but dont make up bullshit arguments to try and prove your tax cuts solve everything mantra. My view on taxation has changed a lot over the last year after studying MMT. I actually think we are overtaxed but....................................

    I got to go and pound a couple brewskis down (someones got to!)

    We'll talk more about taxes later.

  10. Alright, I'm a little buzzed (okay more than a little) but I'm ready to finish my thoughts on taxes.

    Taxes immoral? Okay but so is unemployment. When someone wishes to have a job (so they can meet their obligations) and the society doesnt have enough? Thats immoral as well. Taxation is taking something youve earned and unemployment is denying you something you need.

    Now, while I do think there are moral issues here, a man laying off a worker is NOT an immoral act and a govt requiring citizens to pay for services with taxes is not immoral either.

    The problem I now have with taxation is the fact that its tied to govt spending instead of simply inflation control. Taxation simply extinguishes money and thusly should only be used when money needs to be extinguished. The conditions under which money should be extinguished are what should be discussed. Taxation is what gives our currency value. Without needing them to pay taxes there is no need to seek our green pieces of paper. This is one of the realities of sovereign currency.

    So, I do think we need tax cuts in general, however until our system is ready to "untie" taxes and govt spending I cannot support cutting taxes in the way they are being presented. The plan of those calling for the tax cuts is to also cut teachers and other needed public employees to "pay" for the tax cuts. Until we get off the notion that tax cuts need to be paid for I wont support them.

  11. About minimum wage, there is no evidence that cutting wages will actually lead to more employment, unless we adopt a European job sharing type mentality (fat chance). What has usually happened, according to those who have studied it, is that the 12$/hr employees are replaced with 6$/hr employees. The whole "lowering wages will lead to more employment" argument rests on the notion that businesses simply dont have enough money to pay labor. Which as I discussed above seems completely counter to the way an employer actually makes a hiring decision.

    My boss, when we are at full staff, wouldnt hire another employee even if he offered to do what I do for half my cost, he might hire him to replace me though, which would NOT be a net new job. I'm not arguing that there are no situations where a lower wage might lead to some new hiring but IN AGGREGATE the net affect would likely be simply lower aggregate demand because average wages would fall.

  12. Greg,

    I've got some catching up to do, so at this point I'm just going to add a bit to your first two posts re: customers.

    Of course it's true that one would prefer to start a business that will generate more revenue than less. Many small customers or a few big ones can do this. Either way, a bigger pool of potential customers is certainly desirable.

    The issue that I think people have with highly-paid public employees is as follows. They are being paid from the pool of taxes collected by the government. Tax revenues would not be available if not for a productive private sector. So, people tend to think that public workers have jobs at private expense. Further, it has gotten worse as public wages have gone up because that is combined with much stronger job security than private workers. Historically, the balance was that public workers got paid less but also typically had the job for life.

    The one thing I disagree with that is commonly said is that public workers are overpaid. While I might think this is the case, it is actually unprovable since there is generally no market for the stuff produced by public workers. So without some basis for comparison, we can't say one way or the other if public workers are overpaid. The only way to know is if the cost of the worker is greater than the value generated by the worker.

    I'll address more points later.

  13. Jeff

    There were some recent publications (I'll try to locate them) that analyzed the public/private employee pay issue. As I recall, most of the cited comparisons took all private and all public employees, meaning the lowest wage jobs in the country (all private sector) were dragging the average down for the private sector. The public sector has more educated workers and when you compare a private sector job with equivalent skill level in the public sector the private sector in fact pays more, as it should.

    You are right that people tend to "think" that pubic workers are at the expense of private workers, but this is part of what I referenced above regarding how we view taxes. We have to get away from thinking they "fund" anything in the public sector. This is not to say we should not consider whats proper compensation for public employees (or any employee for that matter) but its important to break the link between my taxes and some public employees salary.

    One last thought/comment. It is quite proper for us to examine the pay structure of public employees, its equally proper to examine those of the private sector. One reality that is never discussed is that in addition to any tax increases on a business being passed on to customers so are bonuses. ALL expenses of a company are paid by customers. Taxes, salaries, bonuses, business expenses etc etc etc all come out of its revenues from customers. There is no other place to get them.


  14. Greg,

    It seems that the MMT position on the value of currency is because it gives us some method of cancelling our tax bill. Is this the argument that any currency exists, or the argument for why a fiat currency exists?

    On the supply-side/demand-side arguments. I think you are getting a little too close to saying that economic laws are situation dependent. On the other hand, you might be saying that the marginal value of a change in the marginal tax rate right now is probably small. Please tell me it's the latter, and not the former.

    A final comment for now (I feel bad not holding up my end of the conversation, but students have exams and homeworks these days). The argument against minimum wage isn't that businesses don't have enough money to pay people that amount. The argument is that minimum wage is above the value-added of the employee to the business. If you cost $10/hr but only generate $7/hr in value, I lose economic value by employing you.


  15. Sorry for the delay in commenting here. Between working and some comments at Davids (he has a lot of interesting topics) I've been failing to hold up my end here.

    Your summation of MMT is accurate but incomplete. The truth is whatever the govt required as payment for taxes would immediately become of value. One could argue that the more of it that is required for taxation the harder one will work to acquire that thing. Now in order to be an effective currency it must also be cheap and easy to exchange.

    One thing to be noted here I think is that ALL currency is fiat currency, even those "backed" by gold. Why? Because some authority determines the exchange rate, the value of gold if you will. This is a decree and not a market operation. Many people seem to ignore this fact when advocating for a gold standard currency.

    How does one determine the value added by an employee? I would argue that its a post facto description AND that as more customers with money come a'callin' there will be more value.

    Let me argue a minimum wage this way; Its clear that there is a maximum tax rate that will be tolerated before people refuse to work, is not the minimum wage the other side of that coin? There certainly should be a maximum tax AND a minimum wage.


  16. Greg,

    No worries.

    MMT seems to me to be a story of the world as it appears right now in developed worlds with stable currencies, rather than a story of how currency came to exist or how it would exist without taxation. Given taxation is a friction, it seems important to have an idea or theory as to how market exchange would function without taxation.

    In order to have some form of currency, you just need people who have wants unsatisfied by their own production and who do not have the geographic/temporal meetings necessary for barter to work.

    Now, let's say there was a situation with private money production (free banking). The state could impose its will and declare only the money it produces as suitable for canceling one's tax bill. If the state produces otherwise sounds money, then this would have the effect of crowding out all private money (I presume). If the state didn't produce good money, then private money would exist in black markets. One can see this is countries that had (or still have) hyperinflation. The people trade using U.S. dollars or some such, rather than the local currency, and the tax bill can't be cancelled in U.S. dollars.

    Thus I don't think MMT can tell us why currency generally exists, but it can have an explanation as to how government can choose a currency to have primacy.

    Also, I'm no gold standard guy. I agree with you on this issue and pegging to a gold standard is just as artificial as any other currency. I'm mostly in the free banking camp (which has its own internal squabbles).

  17. Now, regarding value of an employee.

    I've been thinking about this issue, and here's what I've come up with.

    Let's separate the issue into two kinds of hires: replacement and new. Hopefully this delineation is clear.

    In all cases of a replacement hire, the job description is well known, and the decision maker(s) know what the value of the job description, properly executed, is to the business. Thus, when they look for the replacement hire, they look for someone who can competently execute the job description. If they can find that someone and hire that person for a wage at or below the value of the job, then they will do so. If not, then it is possible the job will go unfilled.

    In the case of new hires, if it is for a job similar to one already existing then the case will be similar to the replacement hire. This would be the situation for a firm expanding in the same business line, for example.

    If the new hire is for a job that has never been done before (very rare) then value determination will be very uncertain and will have to be reassessed frequently as the job and hire mature with the firm. But, then again, this is very likely to be a job done by the entrepreneur him/herself.

    The concern with a minimum wage, from the libertarian point of view, is that it makes it illegal for a worker to sell his/her labor for less than that amount. If the value the person can contribute to the firm is below the minimum the person can't be legally hired. This is a huge concern for youngsters because it keeps them out of the labor market. Without developing professional skills, the youngsters cannot climb the ladder of wages.

  18. Hey Jeff

    Well yes, MMT is an accurate description of modern monetary systems which, given the state of understanding of most people, is a HUGE need. However it also informs us as to how ANY monetary system MUST work.
    Someone or some entity MUST issue the currency, it doesnt grow on trees or sprout from the ground. IF you are the currency issuer you IN FACT
    have no limits to how much you can issue, you are in affect a scorekeeper. This is the starting point that must be acknowledged by all discussing monetary operations.

    I agree that"some" form of currency arises in many situations. The question is when does it become "money"?. In order to act as money, everything must be able to be priced in that unit of measure ........everything. I am very leery of a system (free banking) that would promote more currencies to be circulating. If we, the United States, consider ourselves one, we should have one currency. Europe is having trouble because the different cultures dont consider themselves one yet. They are trying to get there but having a single currency only works when the people consider them selves one. This is why the Euro will likely fail.

  19. I disagree with why you think the Euro will fail, but I agree that it currently doesn't look too good for the future of the Euro. But that's another discussion.

    The point of free banking is that it in fact does limit how much currency can be issued by any individual bank because of the clearing mechanism. I'm reading George Selgin's "Theory of Free Banking" (available for free here: http://oll.libertyfund.org/index.php?option=com_staticxt&staticfile=show.php%3Ftitle=2307&Itemid=99999999) which is very illuminating on this topic.

    The state doesn't have to obey note issue limits, provided it doesn't care about price inflation. But if it does, then that may be a limiting factor. Right now is a strange time because much of the money that has been created is not circulating so that money inflation has not yet led to price inflation.

  20. Currency is simply a "common" way to settle debts and obligations. If you dont trust MY currency you will not accept it. The Euro is suffering form a clash of cultures who have tried to be tied together by a currency for all. The Germans think the Greeks are lazy, the Italians are suspected by everyone else as being corrupt, England has kept its OWN currrency and the French are just plain smarter than all the rest. Unless these people start to see them selves as one, there will be NO common currency. Thats the issue in the US too. We are suffering from political crises that are REFLECTED in our currency issues. It really is that simple. Money is a man made, politically influenced entity. Its NOT a hard asset.

  21. I think you are correct about the current regime of currency across most countries (I won't say all just to cover my bases.) However, that is only because the federal government, or super-national entity (ECB for example) is the currency monopolist. So the behavior of the Euro is schizophrenic, partially (at least) because of the cultural differences you point out. Although, I hope your joking when you say the French are smarter than everyone ;). But there's also significant differences in government capital structure and political risk which, on net, affect the Euro's behavior relative to all other currencies. So I can see where Germany wants to stop co-insuring other countries. The more specific the currency, the better the information it will carry.

  22. It seems you are arguing for a lot more domestic currencies to be running side by side. I cant say I'm opposed to the idea, because anything that moves us away from an IMF "one currency for all" system is a winner in my book, but I do think one must be careful that the number of currencies doesnt get too large. How to control this?? I'm not sure it can be done with "market" mechanisms. There would end up being a currency police aka the govt, so not sure we're really in a different world form today in that regard.

    To me the question is not how many currencies but how does ANY currency serve the most people.

    Back on our employment discussion though, I'd be interested in your point by point critique of this article, which I think pretty much sums up the paradigm from which I am operating. Yes its a little long but I know you have the time ;-)


  23. The optimal number of currencies is a priori unknown. It would be a function of competitive pressure by banks to issue sound currency. The "currency police" would really be the other banks. Again, I recommend reading some of the free banking material, or a review of Scottish banking in the 19th century, for a sense of how this works.

    I'll get back to you on the article you linked. All my extra time seems to have departed from me :)