Arnold Kling  

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Why does National Review Online embarrass itself with this sort of economic commentary?


Budget deficits are only too large if they usurp the private economy’s need for physical capital and labor, thereby precipitating an inflationary surge.

So, as long as there is are any unused resources in the economy, the government should increase spending?

...tax payments simply reduce account balances in the private sector. Nothing “goes” anywhere; the government doesn’t “get anything.” To reinforce this point, if you pay your taxes in actual cash, or buy Treasury securities (government bonds) with actual cash, the Fed shreds the cash. Likewise, if you donate cash to the federal government for Katrina, it shreds it. In fact, if you take a $100 bill and burn it, you’ve donated that $100 to Katrina!

I'm sorry, but I've read the preceding paragraph several times, and it makes less sense each time. Same with the following:

Will private borrowers be crowded out [by increased government deficits]? Impossible. The causation is “loans create deposits,” as taught on day one of every traditional money and banking class. The act of borrowing itself creates exactly that same amount of new liabilities (deposits). The process is “self funding” and circular, as a matter of accounting. The concept of a “pool of savings” that somehow gets “used up” by borrowers is a throwback to the time of fixed exchange rates and gold standards, and has no application in today’s floating-exchange-rate world.

When I was in grad school, I somehow missed the lecture where they said that government deficits are self-funding in a flexible exchange-rate regime.

I would suggest that NRO clean out its stable of economics writers and instead choose from some of the other bloggers around. James Hamilton or Andrew Samwick or Russ Roberts or Don Boudreaux or Tyler Cowen or Alex Tabarrok.

The incoherent babble that is NRO economics today simply will not do.


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CATEGORIES: Fiscal Policy



TRACKBACKS (6 to date)
TrackBack URL: http://econlog.econlib.org/mt/mt-tb.cgi/370
The author at MaxSpeak, You Listen! in a related article titled DON'T TAKE MY WORD FOR IT writes:
    Brad DeLong isn't the only one who thinks National Review Online economics writers are idiots. Here's the very, very conservative economist Arnold Kling: Why does National Review Online embarrass itself with this sort of economic commentary? . . . I... [Tracked on September 28, 2005 10:42 AM]
The author at William J. Polley in a related article titled Government finance is more than scorekeeping writes:
    So I spent much of the last couple days working on a research question. I'm catching up on blog reading and I find PGL (Angry Bear) and Arnold Kling (EconLog) discussing Thomas Nugent's column at the NRO. Obviously, I sat... [Tracked on September 28, 2005 2:06 PM]
COMMENTS (26 to date)
David Thomson writes:

I agree completely. The National Review must not fall into the trap of becoming an excuse maker for the Republican Party. Yes, the GOP is still the lesser of evils compared to the Democratics---but is that good enough? I don't think so.

James Erlandson writes:

They screwed up the byline. It was written by Ted Nugent, not Tom Nugent.

http://www.tnugent.com/

Timothy writes:

It didn't talk nearl enough about girls, guns, and not doing drugs to have been written by the Motor City Madman.

I missed the part in undergrad where they explained that there isn't dead-weight loss associated with taxation. I guess everything they taught me in those 400-level micro and macro courses is wrong.

james writes:

Nice excerpts, Arnold, but I reckon this was the best part of all...

Bottom line: Operationally, virtually all of the federal government’s spending per se consists of the Fed crediting an account — that’s all. The federal government doesn’t have any “box of money” that gets “filled” from tax collections and the proceeds from new Treasury securities and then gets “used up” by spending or lending.

See, the government can just print money to pay for everything. I wonder why we even have taxes.

Radford Neal writes:

In reference to this quote of Nugent's:

... if you pay your taxes in actual cash, or buy Treasury securities (government bonds) with actual cash, the Fed shreds the cash. Likewise, if you donate cash to the federal government for Katrina, it shreds it. In fact, if you take a $100 bill and burn it, you’ve donated that $100 to Katrina!

You say

I've read the preceding paragraph several times, and it makes less sense each time.

Frankly, I'm shocked. Can you really be so ignorant of how the current monetary system works? Nugent's description is entirely correct.

The actually dubious part of Nugent's piece is the following:

The true economic cost of Katrina is the real, physical resources committed to repairing the damage that otherwise could have been used elsewhere to expand productivity or improve overall standards of living. But with today’s excess capacity in everything but energy, there is not going to be much of an opportunity-cost to rebuilding...

He's right about where the true economic cost comes from, but why he thinks that there is such "excess capacity" is baffling. And if there actually is capacity being wasted, and deficit spending could actually harness this capacity, then without Katrina it could have been harnessed to some other good purpose, which will now have to be foregone.

spencer writes:

YES, YES, YES.

Timothy writes:

Yes the Fed shreds the physical cash, but they put it down someplace as an asset. On a balance sheet, in a computer, etc. If I withdraw $100 from my bank account, then light it on fire, I've just given up the purchasing power of $100. Gone, poof, off of my assets and into pretty smoke. So the whole "burn your money and you've donated to Katrina" thing really is crazy talk.

And, "tax payments simply reduce balances"....yeah, because we live in a world of electronics where we don't have to phyiscally move things around. We don't even have to move negotiable instruments around physically anymore. I honestly can't figure out what he's trying to say here, I think he's desperately trying to disbelieve dead-weight loss, but I can't be certain.

Radford Neal writes:

James comments (mockingly):

See, the government can just print money to pay for everything. I wonder why we even have taxes.

The government can just print money. The reason they (sometimes) refrain from doing so to excess, preferring taxes, is that printing money tends to cause inflation. A whole area of economics deals with this concept of "seigniorage", discussing how much wealth a government can appropriate by printing money without disaster striking.

Timothy comments:

Yes the Fed shreds the physical cash, but they put it down someplace as an asset. On a balance sheet, in a computer, etc. If I withdraw $100 from my bank account, then light it on fire, I've just given up the purchasing power of $100. Gone, poof, off of my assets and into pretty smoke. So the whole "burn your money and you've donated to Katrina" thing really is crazy talk.

If you burn a $100 bill, then you do indeed give up purchasing power. But no real assets are destroyed, and because of your voluntary relinquishment of purchasing power, the government can print another $100 bill, and spend it on Katrina relief, without increasing inflation.

These are elementary points about how the current financial system works. If you don't understand them, you can't possibly understand what goes on in the world today. You will regularly fall prey to ridiculous propaganda about the causes of inflation and deflation, which throughout history has periodically led to massive economic and political damage.

pgl writes:

Well said. We also took exception to Nugent's nonsense over at Angrybear

Mark writes:

Arnold, when you're right, you're right. National Review's economics reporting/analysis, whether in print or online, has been disgraceful for a very long time.

knzn writes:

I think Radford Neal has this almost right. If there is excess capacity, as Nugent believes, then we can monetize the debt and reconstruct at little or no real cost. Unlike Radford Neal, I agree with Nugent that we have excess capacity, but I still disagree with Nugent’s conclusion. The problem is, we need to be not only able, but also willing, to monetize the debt. The Fed is not willing. The issue is not whether we have excess capacity, but whether the Fed believes we have excess capacity.

Arnold Kling writes:

There has been an outbreak of nonsense on this comment thread, concerning "monetizing the debt."

Let's simplify things by considering an economy that does not use money. A barter economy. People pay their taxes in grain. When the government borrows, it borrows grain.

So when the government wants to allocate additional resources for hurricane relief, it has to take in more grain. It can raise taxes now, or it can borrow now and raise taxes later.

And it's totally wrong to say that "nothing goes anywhere and the government doesn't get anything." Grain goes from the private sector to the government, and the government gets grain (until they use it for hurricane relief).

And don't tell me that this is a misleading illustration because it doesn't use fiat money. The descriptions of fiat money by the Nugentoids are way more misleading.

Sheesh.

Barkley Rosser writes:

There is one more point that was hinted at in the original comment on NRO, but not commented on, the aspect of international borrowing. The last number I saw was that something like 43% of our national debt is now owed abroad. That is rising rapidly. Given the low savings rate in the US, increasing the deficit increases that percentage and aggregate amount.

It is a textbook argument that interest "we owe to ourselves" is just an internal transfer, but interest paid abroad is a drain on national income. That presumably will increase in the future with larger current deficits and no increase in domestic savings.

Nimish Adhia writes:

Tom/Ted Nugent and some readers on this post confuse monetary policy with fiscal policy. When the govt. writes checks for Katrina related reconstruction (fiscal policy), its account at the Fed does get debited. On the other hand, the process of merely "crediting a bank's account," that Nugent talks at length about, is an how monetary policy is enacted by the Fed. It's not how the government pays for bridges.

Radford Neal writes:

Arnold Kling writes:

The descriptions of fiat money by the Nugentoids are way more misleading.

I hadn't know there was any group of "Nugentoids", but I'll assume this is a reference to something in my earlier comments. So would you like to explain what, for example, is misleading about equating burning a $100 bill with donating $100 to the government?

Radford Neal writes:

Nimish Adhia writes:

When the govt. writes checks for Katrina related reconstruction (fiscal policy), its account at the Fed does get debited. On the other hand, the process of merely "crediting a bank's account," that Nugent talks at length about, is an how monetary policy is enacted by the Fed. It's not how the government pays for bridges.

In a fiat money system, the balance of the account of the central government with the central bank is a totally meaningless quantity, since the central bank is effectively owned by the central government. If the government wants to increase its "balance" with the central bank, all it has to do is tell it to purchase a bond, and - presto! - its balance is increased. Of course, it needn't pay back this bond, since it owes it to itself anyway. Now, you might say that buying the bond is monetary policy, not fiscal policy, but this is just playing with words.

(Actually, I vaguely recall that in the case of the US, there is some trace of private ownership of the federal reserve banks, but my impression is that this is no longer of any real significance.)

Similarly, in a hangover from the old days, I believe that when a central bank issues cash, it carries this as a liability on its books, as if it might have to redeem the cash for gold someday. This too is utterly meaningless.

The simplest way to unwind all these misleading layers of meaningless numbers is to simply consider that any money collected by the central government just disappears, and that any spending by the central government is paid for by printing new money. If this sounds crazy, it's because you don't understand the system.

Barkley Rosser writes:

Radford Neal,

The Fed is privately owned, technically, although it is a creature of laws passed by the Congress, which created it, and its Board of Governors is appointed by presidents with the approval of the US Senate. Otherwise it is independent. The "government" cannot order it to do anything, although various figures such as the president or the Secretary of the Treasury can request it to do things. But it does not have to respond to any of these requests.

So, does the money the US Treasury borrows from the central banks of Japan, China, and Taiwan simply "disappear"? Do our obligations to pay interest on this borrowed money disappear? Does it not bother you that continuance of the housing bubble in this country depends on the forebearance of the Standing Committee of the Political Bureau of the Central Committee of the Communist Party of the Peoples' Republic of China and that increasing current budget deficits will only increase our dependence on the forebearance of this particular group of worthy gentlemen?

Radford Neal writes:

Barkley Rosser writes:

The "government" cannot order [ the fed ] to do anything, although various figures such as the president or the Secretary of the Treasury can request it to do things. But it does not have to respond to any of these requests.

Sorry, I don't believe this. I'm sure that the "government", meaning the congress+executive, can indeed order the fed to buy government bonds. It may choose not to order it to do so, and this may be wise, but that doesn't mean that it can't.

So, does the money the US Treasury borrows from the central banks of Japan, China, and Taiwan simply "disappear"?

Yes, effectively, if the money is US dollars. That's the easiest way to think about what happens.

Do our obligations to pay interest on this borrowed money disappear?

Of course not. Borrowing from another country's central bank is totally different from borrowing from your own. Now, if the debt is in US dollars, then the US government could pay it off by just printing money, but since these dollars would be devalued by the consequent inflation, the other countries might get upset. Whether the US government would be disturbed by this is a political question.

Does it not bother you that continuance of the housing bubble in this country depends on the forebearance of the Standing Committee of the Political Bureau of the Central Committee of the Communist Party of the Peoples' Republic of China...

Whether this bothers me or not has absolutely nothing to do with this discussion. I'm not saying that the US government should run deficts. I'm saying it can run deficits, of any magnitude it may desire. This is simply a fact. It's truth is amply demonstrated by the numerous countries that have done so, and suffered hyperinflation as a result.

Nimish Adhia writes:

Radford Neal,

This is what is wrong with equating burning a $100 bill with donating a $100 to the government: when to you donate to the Government, you transfer your claim on resources to the government. When you burn a $100 bill, your claim to resources gets distributed among everyone in the economy. How so? Because you have just decreased the money supply, which would lead to a proportional decrease in prices, enabling all people to buy more.

In India, where I come from, there is a common practice among Hindus of tossing coins into the river whenever they cross one (as an offering to the river Goddess.) I don't know if the Goddess receives the bounty, but I definitely know that the government of India is not richer for it.

Nimish Adhia writes:

The government (congress+executive) cannot order the Fed to buy govt. bonds any more than it can order the supreme court Chief Justice to declare abortion unconsitutional. The whole point of having an independent Central Bank is to prevent this. Countries where the govt. can order the central bank to print money invariably run into problems with inflation.

You may take the view that the Govt. and the Fed are in bed together, and so the Fed would always monetizes govt. debt, but that would just be a conspiracy theory, not a standard government operating procedure.

A point about the burning bills: in most countries, including the US, destroying currency is prohibited by the law. Do you think that it would be so if burning $100 was equal to donating $100 to the Govt.?

knzn writes:

AK: Perhaps Keynesian economics is indeed nonsense, but let’s assume for a moment that it isn’t. Let’s also assume that Nugent is correct in stating that the US economy has substantial excess capacity. In that case his (and mine and Radford Neal’s) descriptions of fiat money are only mildly misleading, and your example is (almost) irrelevant. (See my second comment in William Polley’s blog, where I acknowledge certain points.) It makes no logical or rhetorical sense to counter an argument about the effect of fiat money by assuming that it doesn’t exist.

(If I say, “I have a can opener. I’m going to open this can of tuna,” you might say, “It won’t work. The blade isn’t sharp enough.” But instead you say, “Let’s simplify things by considering a world in which you don’t have a can opener…”)

Nimish Adhia: Technically, I believe the US government can order the Fed to buy bonds. If Congress can pass the Humphrey-Hawkins act mandating the Fed’s objectives, why can’t it pass a new act that mandates the new objective of buying bonds to fund hurricane reconstruction? This is really an academic point, since that’s not going to happen. More realistically, the Fed might on its own follow a passive interest rate policy which would have the same effect as if the government mandated it to buy bonds. Your argument about burning money assumes flexible prices, which we Keynesians don’t believe in. When you burn money, you give up your claim on resources. Theoretically, anyone could claim those newly available resources, but only the government can sell bonds to the Fed, so only the government will exercise that claim. Prices may be flexible in the long run, but before the long run gets here, the government will figure out that there are new resources available and grab them. (And in this example, the Fed would choose to buy those bonds, since it has a policy of accommodating currency held by the public.)

Barkley Rosser writes:

knzn,

Yes, the Congress could pass a law ordering the Fed to do something and it would have to do it. However, it has not done so. The Fed currently remains very independent of both the president and the Congress, although it clearly keeps a watchful eye over its shoulder to keep them from passing such restrictive laws.

Also, the Fed does not buy bonds from the US Treasury. It buys them on the repo secondary market from specified brokers. Of course, the effect is essentially the same as if it did buy regular bonds straight from the Treasury.

knzn writes:

Barkley Rosser: The real question is not whether the Fed is independent but whether it has a passive interest rate policy. If so, it will automatically accommodate increases in the deficit, even though Congress doesn’t ask for the help. In the very short run, the Fed’s policy is obviously passive. In the very long run, it certainly isn’t passive, because we know the Fed would react to dramatic changes in the inflation rate. In the intermediate run, it’s not so clear. I don’t really think they are being passive, but over the past 14 months, there is no evidence that they have reacted to any new information.

Barkley Rosser writes:

knzn,

This will be my last post on this thread.

The Fed has been steadily increasing its target fed funds rate over a long period now, doing so again after the last FOMC meeting. You call this a "passive policy"?

knzn writes:

Raising the target federal funds rate at regular intervals, without ever speeding or slowing the rate of increase, is indeed a passive policy. Over the past 14 months, the FOMC could have been replaced by a computer program that takes no economic data as inputs. It will become an active policy if their decision of when to stop raising rates is determined by something other than just the level of the rate itself. I suspect that will be the case, but I’m not 100% convinced.

Even if it is the Fed’s policy is not passive, the effect of deficit-financed Katrina reconstruction may be too small to affect the Fed’s decision. I think there is a case to be made that, compared to variation in private sector behavior, year-to-year variation in the federal deficit is too small to worry about. So that temporary deficit spending such as hurricane reconstruction is mostly financed by seignorage whether the Fed intends to do so or not.

Taxman writes:

This blog is very hard to take seriously. There is no way a former federal reserve economist with a PhD from MIT could have such a fundamental misunderstanding about the way a fiat currency system works.

Radford Neal is completely correct.

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