Yglesias Persists in Misunderstanding Drug Policy

This has little to do with economics but it popped up on Moneybox and I wanted to comment about it , so here goes. 

Yglesias bloviates a bit today about drug policy and decides that:

One plausible story is that marijuana would substitute for alcohol use, and since marijuana has fewer health risks than booze that would militate in favor of policies designed to make pot at least as easy to get as beer. Another also possible story is that legal marijuana will complement drinking, and therefore exacerbate existing alcohol-related problems. That would indicate that we should try to make pot less widely available than beer currently is (though still more available than under the status quo) along with higher taxes on alcohol.

Like much drug policy writing, this idea suffers from several fairly coarse assumptions but most importantly the failure to make a distinction between overall drug use and "problem use" that carries a significant social cost.  It's as if people were trying to reduce car accidents by making it harder to get a car. Yes, it may have some effect, but you're sort of missing the point.

Efforts to prevent the population at large from smoking pot (or really, doing any illicit drug) are doomed to be very ineffective. If you commit a burglary your chances of getting caught are something like four hundred times higher than if you consume illegal drugs (and your chances of getting caught for committing a burglary are not that high.)

There's good news there, though, because the really harmful problem use in the US is drug use by people who commit crimes. For many years it was believed that drug use actually turned people into criminals, but this was studied in the 1980's (check your university library for the excellent work of James Inciardi among others) and found to be incorrect.  

It is actually very easy to lower the drug use of convicted criminals by drug testing them several times a week and imposing a mildly painful penalty like a small amount of community service. Those who are addicted and truly cannot stop will have to be provided with treatment (or, if you prefer, stiffer penalties like incarceration), but it is known that most drug users are very responsive to the costs - both monetary and other costs - of their drug use and if those costs go up significantly and predictably, they will use less. 

This approach is known as "Coerced Abstinence" and with a google search you can read all kinds of stuff about it including a lot of scholarly research.  It has been discussed since at least the late 1990's and has been implemented many places and its effects studied.  

Long story short, it works very well, is cheap, and reduces the strain on the justice system.  It also lowers drug use among criminals, which is a population whom EVERYONE, from prohibitionists to outright legalizers, agrees should not be using mind-altering chemicals recreationally.

This is not just an approach we should be trying.  It is THE approach we should be trying.  It makes sense.  It works.  It doesn't cost billions of dollars.  What's the holdup?

Bitcoin - Currency? Bubble? Both? Neither?

Interesting post by Yves Smith over at Naked Capitalism today regarding the phenomenon of Bitcoin.  Smith's post is very long and I'm not going to take on all the points therein, but I did want to attempt a quick summary of my take on Bitcoin.

The title of Smith's post is "Bitcoin:  Bubble or New Virtual Currency?"

The first thing I notice about this headline is that it's a false dichotomy.  Of course it could be that Bitcoin is a genuine new virtual currency AND in a bubble.  I imagine this is mostly pithy headline writing as I trust Yves Smith understands this fact quite well, but I feel it's important to be clear about these things.

The second thing is that you can answer this question pretty easily.  A currency in the modern context requires two things - a monopoly issuer and a taxation authority.

Bitcoin has the first - there is a cryptography algorithm that issues Bitcoin, and that's the only source of net  Bitcoin.  So we're good there.  The problem is with the second part of the life cycle - the taxation authority.  Currently no entity exists that can levy Bitcoin-denominated taxes on real assets.

Now, according to circuitist theory this is OK, as long as you have a legally recognized banking system that trades in Bitcoin-denominated debts, Bitcoin can still have value as a currency because the banks can levy a claim on other assets if the Bitcoin-denominated liabilities are not fulfilled.

Unfortunately for Bitcoin triumphalists, that doesn't exist either.  So, long story short:  No, Bitcoin is not a currency.  It may have some intrinsic or extrinsic value that does not arise from its value as a currency, but to the degree that its owners' expectations of value are connected to its future as a currency, those expectations are not reasonable.

Which answers that first question about the bubble.  Bitcoins are in a bubble, and indeed the bubble must inevitably pop.  But remember always "inevitable" and "soon" are not synonyms.

The Myth of Expectations

Yglesias today has a post titled "
FOMC Adopts Game-Changing Conditional Inflation Targeting Rule."If you've read his site much you can probably guess the rule - as Matt puts it the Fed "has stopped screwing around and started doing real expectations-based monetary easing.".

I've had beef with Matt about this expectations business for years, and I'm glad to see that Matt is enthusiastic about this change and not saying "well, true NGDP targeting would be better."  He's recognizing that this is the idea Matt has been flogging and if it doesn't spur economic growth by easing monetary conditions, that's a bust to the idea.

The thing Matt - and many others - fail to understand about the so-called "expectations channel" is that it's something that occurs as a result of other consequences of a policy, not as something unique unto itself.  The Fed makes a policy change, the policy change makes an impact, and then there is additional impact because people's expectations about economic performance change.

The idea that economic conditions today are being impacted by expectations about Fed action in 2014 is completely unfounded.  The new Fed targeting model may well be a great idea!  It could lead to better policy!  Hooray!

What the new model doesn't do is give the Fed new policy tools.  Fed policy is the same as it was yesterday - as expansionary as possible for as far as the eye can see.  Expectations don't change conditions, conditions change expectations.  THEN expectations can theoretically have an accelerating effect.  

A Balance Sheet Recession in a Nutshell

The Financial Times is occasionally refreshingly good.  Yesterday Martin Wolf put the essential problem of a balance sheet recession very succinctly:

[T]hose who are creditworthy do not wish to borrow; those who want to borrow are not creditworthy...

This is the problem in a balance sheet recession.  Policymakers, who overwhelmingly have banking backgrounds, want to solve these problems through the banking system - by setting interest rates and letting banks create money by lending.

However, banks cannot create net financial assets - every time a bank makes a loan, it creates an equivalent liability for each asset it creates.  So if private sector balance sheets are strained, banks don't lend, no matter what the interest rate is and no matter how much the government might want them to.

The solution to this problem is fairly simple; unfortunately ideological orthodoxy tends to assume it away.  From a different part of the same article:

Mr Osborne repeated the orthodoxies of the government’s approach to fiscal policy (it needs to be tight), monetary policy (it needs to be loose) and debt (it needs to be reduced).

The problem is, in a balance sheet recession, if fiscal policy is tight, balance sheets stay strained because no net financial assets are being transferred to the private sector, and thus no amount of "loosening" of monetary policy (which really just means low interest rates) can actually produce an expansion of private credit.

The most crucial part of the quote, though, is that bit at the end about debt needing to be reduced.  Whose debt?  For private balance sheets to "deleverage" (that is, to pay off debt) government debt must be increased.  There is no other source for the money needed to pay private debt off - that's what it means to be a monopoly issuer of a currency.

The simplest way for the UK and US to jumpstart their economies would be to target the people whose balance sheets are in the worst shape - the unemployed.  The government could hire the unemployed to perform useful work in their communities for $8/hr until such time as the private economy was ready to hire those people again.

It really is quite simple, but orthodoxy has a way of blinding people to obvious solutions that don't fit their prejudices.

Are Liberals Ignoring Monetary Policy?

One accusation that's been flying around a lot over at Yglesias' place is that liberals are ignoring monetary policy.  Matt makes the assertion today in a post called Job Creation is the Fed's Job.  The story, basically, is that liberals know that the Fed could easily create millions of jobs by changing its policies, but we're fixated on fiscal policy.

Of course this is not the case.  The problem is that lots of us, myself included, don't believe that the Fed can do much right now.  One thing that's been suggested is that the Fed could increase its inflation target from 2% to something higher.  I favor that but don't think it will help the current situation.  Another is that the Fed should target NGDP growth instead of inflation.  I think that's an interesting idea but don't think it will help the current situation.

Yglesias keeps hammering on two ideas to justify his fixation with monetary policy - one, that Bernanke himself says that the Fed has tools that could help the economy but isn't using them for some reason.  This isn't true - Bernanke says the Fed has things it might try if conditions warrant.  That's not the same as saying there are things that would help now that he's refusing to do.

The second idea is that there are central banks around the world that are succeeding with the monetary policy ideas he's hawking.  Matt's first obsession was Sweden - he linked to an article about Sweden setting its policy rate negative.  Unfortunately Sweden never set a negative policy rate - it was an apparent misunderstanding by a reporter that had been debunked before Yglesias ever got involved.

Yglesias continues to claim that Sweden did what they did not do, and has never addressed the Economix piece to my knowledge.  And now he's got a new dead horse to flog:  Bank of Israel's alleged targeting of NGDP growth.  Evan Soltas started a rumor that Bank of Israel was NGDP targeting and that this policy had led to Israel's impressive growth path since the 2008 financial collapse.

Once again, though, Matt has simply catapulted a myth into the mainstream.  Bank of Israel is not NGDP targeting.  Sweden never had a negative policy rate.  All these little mistakes add up to a big imaginary set of data that monetarists seems to have agreed to pretend is actual data.  This is no way to discuss the finance policy of the most important nation in the world.

Proving that Bank of Israel is Using an Inflation Target

Eric, one of the more rabid market monetarist commenters at Yglesias' place, is still insisting that I prove that Bank of Israel is not using NGDP targeting.  So, here goes.

1.  Bank of Israel's published policy is a 1-3% inflation target.
2.  Bank of Israel publishes a report every quarter explaining how it arrived at its policy by targeting 1-3% inflation.
3.  Bank of Israel's policy changes are consistent with a 1-3% inflation target (their stated policy) and inconsistent with an NGDP target (their alleged secret policy that a prep student invented by writing a blog post.)  We know this because in late 2009 Bank of Israel tightened rates to curb inflation  despite the fact that NGDP growth was below the alleged target rate of 6.5%.

I really, really hope that does it.  But somehow I think that it won't.

The Bank of Israel is not using NGDP Targeting

A couple days back Scott Sumner approvingly linked to a piece by a little-known blogger named Evan Soltas in which Soltas alleged that the Bank of Israel is using NGDP targeting.

Then Matthew Yglesias approvingly linked to the Scott Sumner article, and now around the web you're seeing market monetarists in comment threads bringing up how wonderful NGDP targeting is and wouldn't it be nice if all central bankers were as smart as the ones at Bank of Israel.

Well, there's a problem.  The Bank of Israel is not using NGDP targeting.  Soltas' "evidence" that the Bank of Israel was using a 6.5% NGDP target is that Israel's NGDP growth rate has hovered around 6.5% the past few years.  Seriously, that's the evidence.  

Sumner, who despite being by all accounts a nice guy traffics in these kinds of flimsy free-associations all the time, took Soltas' post at face value, and Yglesias, who is not known for his rigor, catapulted the whole myth into what passes for the blogosphere's "mainstream."  

This is the same thing that happened with Sweden's fictional negative interest rate policy - Yglesias linked to an old article that had since been corrected and now the myth keeps popping up because Yglesias never, ever corrects anything.  

I defend Matt a lot to people who think he's a real nuisance, but this sort of thing makes it hard.  Correct the record, Matt.  Bank of Israel is not using NGDP targeting - they're using a 1-3% inflation target.  Full stop.

The Television Addiction Situation

Once upon a time there were two children who were very smart and very obedient but whose parents had made a very serious miscalculation.  The parents had allowed the children to become addicted to television.

Every morning upon awakening the children would demand television.  They would demand to have it before breakfast, and when they were told they could not have it before breakfast, they would demand to have breakfast WITH television, and when they were told they could not have breakfast with television, they would collapse on the floor in tears and refuse to do anything at all for the rest of the day.

The parents were beset by offers from friends and neighbors to break the children of their unhealthy reliance on the glowing storybox, but the parents, being an odd sort of parents, saw in their kids' affliction an opportunity.

One morning when the children awakened they were greeted not with the normal trip to the breakfast table but to a strange room that they had never noticed in the house before.  Inside were stacks of cards, each identical to the next, with a drawing of a snake wrapped around a staff, and the signature of the mother and father in the bottom left and right corners, respectively.

The children were told that from now on in order to watch one television program each child must remit one card to either the father or the mother.  The cards were acquired by doing chores - one card for sweeping the kitchen, two for cleaning out the shed, and three for planting a berry bush or suchlike improvements to the home.

At first the children worked only for the television they wanted to watch each day, but soon Ruby, who was older, said to her little brother "Luke," for that was her brother's name, "we should spend a day doing chores so that the next day we can spend the ENTIRE DAY watching television."

The prospect of an entire day of doing nothing but watching television so inspired the little one that he did twice his normal work - though it was still a fraction of what his sister could do - and the two saved enough cards to make their dream come true.  They could hardly contain their excitement as they lay their heads down to sleep.

When they awakened they did not demand television before breakfast but ate their fill, knowing that a glorious day of television watching lay ahead of them.  After finishing their meal they sat down and watched all their favorite movies, and all the best episodes of the very funniest shows.

At lunchtime they ate thoughtfully and talked about their cards.  They loved television but they loved the power of the cards as well, and they didn't want to be without television the next day.  In the end it was decided that they would go to a friend's house for the afternoon, and use their cards to watch television the next day.

As time went on the children began to acquire so many cards that they could not imagine ever using them all.  It was then that things began to get complicated.

Yglesias Comment Mirroring

I've been unable to force myself to post here enough to get the blog going, so for at least a while I'm going to try cross-posting my substantive comments from Yglesias' blog.  Perhaps after a while this will get me in a good enough posting habit that I can do something a bit more reader-friendly.  For now, here goes:

Today Yglesias links to a Mike Konczal interview of former Fed staffer Joe Gagnon.

Yglesias:

After all, right now the European Central Bank is refusing to engage in the volume of monetary activism that the European Union needs and the Fed is refusing to engage in the volume of activism that the United States needs. 

This is quite a triple bank shot, but the reasoning is more or less sound. More than anything it points up how ludicrous our self-induced paralysis is - it can't be the case that a currency war between the two most important economies in the world would maximize human welfare. There MUST be better policies available. 


As for the linked post, I appreciate learning that the Fed is currently authoritzed to buy FCR in large quantities as I wasn't sure that was the case.  


I hope that people read the full interview, especially the part where Gagnon makes it ABSOLUTELY CLEAR that the only impact of Fed asset purchases of bonds is through the interest rate channel: 

In the Treasury market, yields on three-year notes are only 0.3 percent, so the Fed must buy five-year to 30-year bonds to have any effect. With the 10-year yield at 1.5 percent, the scope for further effects is modest. Even if the Fed bought every 10-year Treasury, it would be hard to get the yield much below 1 percent, because the risks on such a bond become tremendously skewed toward future losses. 

Gagnon is exactly right - since Fed policy operates through the interest rate channel, when rates are as low as they go Fed policy doesn't do anything. The point of "unconventional" monetary policy is NOT to stimulate the economy directly but to lower long rates. Once long rates hit bottom Fed asset purchases no longer have any effect. 


So, if the Fed bought every MBS in the economy Gagnon believes we could lower the mortgage rate for prime borrowers to somewhere a shade under three percent. Would that impact lending? Of course! It would mean that people who are not creditworthy at 3.75 percent but are creditworthy at, say, 2.75 percent could get a loan. That would be stimulative.  


So, I will direct to this post anyone who accuses me in the future of saying the Fed is powerless. The Fed has the power to set interest rates, and could lower long rates a bit more by buying up mortgage backed securities. The Fed could also theoretically buy foreign currency. It has no other powers. 


For the record I don't at all share Gagnon's belief that it would be a good idea to authorize the Fed to intervene in the stock market.

A Place for The Yglesias Banking System Discussion

My wife's out of town so I'm hanging out a lot over at Yglesias' place discussing the banking system.  It's getting a little tedious to use the comments over there for such a long discussion, so here's a place we can discuss it.  Hopefully I can get Adam to come over here and continue our session, and perhaps some others will follow as well.

Russ Roberts Interviews William Black

Really good interview via New Economic Perspectives.

I especially like the explanation of the type of fraud that allows banks to continue to report good earnings while they're actually going under.

Basically, as Black explains it, let's say I'm a bank that made a dumb $60m commercial real estate loan to a developer. The developer never makes any money, so he never pays back any part of the loan. Thus I, the bank, am the new owner of a $60m development that's almost certainly not worth $60m.

However, I don't want to eat the loan because it will hurt my profits and I might not get my bonus. So the next time someone darkens the door of the bank, I talk him into taking out an $80m loan to buy my worthless development for $78m and then have $2m "walking away money." Now, I've kicked the can down the road because 1) I sold the property at a profit and 2) the new owner of the development can use some part of his $2m to service the debt for a little while.

During this time, of course the bank is in even worse objective shape (since it's now loaned $80m against the same property we know wasn't even worth $60m) but I can continue to collect bonuses and possibly even stave off regulators if they don't stick their noses too far up into my business.

Unvanishing the Vanishing Dollar

Lots of good stuff going on right now making it difficult for me to blog. However, I wanted to highlight this conversation I had with the Internets about private sector savings and federal deficits.

Yglesias: ""A path to an increased national savings rate over the long-term that opens with a gigantic increase in public sector debt doesn't make any sense.""

ApeMan: Actually, it does! I don't favor a cut in the capital gains rate for fairness reasons, but in fact public sector deficits are the ONLY source of net financial savings by the private sector.

Private sector saving equals, to the penny, public sector deficit. The only source for net financial saving is money creation by the currency issuer.

This is the piece of information that is preventing you from understanding economics, Matt. You MUST think about it and try to understand it. If you don't the confusion you sow will continue to offset the good work you do. It's really critical.

This is why it's misleading to think of deficit spending as "borrowing." It isn't - not really. It's the creation of net financial assets.

Here's a simple way to think about it in lay terms. The federal government creates a certain number of dollars in a given year. Some of those dollars are accumulated by foreigners - that's the trade deficit. Thus for savings by Americans just to get to zero, the government has to create dollars (deficit spend) equal to the level of the trade deficit. For Americans to actually accumulate net dollars (save money) the government must create a number of dollars GREATER THAN the level of the trade deficit.

The government does not, of course, borrow these dollars from anyone. It just creates them. If it creates fewer net dollars than are sent overseas, Americans wind up with less savings. If it creates more than are sent overseas, Americans wind up with more savings. It's so simple, as I think Galbraith wrote, that the mind recoils from it.

Steve: I don't understand, ApeMan. I thought money is created by people and corporations who borrow from banks.

ApeMan: Money is indeed created by bank loans. However, when a bank loan creates money it also creates a corresponding private sector liability (the note itself), so the total operation nets to zero. Total private savings are unaffected.

When the currency issuer creates a dollar, no corresponding private sector liability is created, so the total operation has a net positive impact on private sector savings.

This sounds complicated but in fact it's quite simple - when you borrow money from your bank, you wind up with two accounts, a deposit account (positive) and a loan account (negative). When you get a check from the federal government, you wind up with one account, a deposit account (positive.)

The government's account with the Fed is debited, of course, but the government's account with the Fed is purely notional - the federal government doesn't have "savings."

In a way it's actually easier to understand if you look at the way it used to work. Banks used to create their own money, such that when you took money out of your bank it would say "Bank of America Note" on it instead of "Federal Reserve Note." Banks had various agreements about honoring each other's notes.

Eventually everything was standardized when the Fed declared that notes issued by legitimate banks would clear "at par" with federal reserve notes, at which point there was no longer any need for individual banks to issue their own notes. That's why now we just use nothing but federal reserve notes.

The only downside is that it's harder to demonstrate conceptually that some money is "bank money" and some money is "state money" since now it all looks and acts the same, regardless of where it originated.

The one key is: bank reserves - and thus savings - are still always state money. That's why deficits are the norm for modern governments. It's a feature of the system, not a bug, and present deficits do not necessitate future tax increases. It's a misconception.

LD: Why would 'net private sector savings' be zero?

ApeMan: Imagine I'm the currency issuer. I issue $100 in notes. Now people have $100 in savings. Then at the end of the quarter I tax them back again. Now people have $0 in savings.

LD: That would only be if the tax equaled the entire money supply, but maybe I'm not understanding your argument.

ApeMan: No, the money supply is the total amount of money in existence, not the NET money in existence. Savings is net money. The private sector can't create savings by borrowing, obviously.

To extend the example, I'm the currency issuer and I issue $100 of state money. Bank A now has $100 of reserves and a deposit account in the amount of $100. Now Bank A makes loans in the amount of $100, so now Bank A still has $100 of reserves but it has $200 in deposits ($100 in bank money, $100 in state money) and $100 in loans.

The total NET savings in the economy is still $100, no matter how much money Bank A creates by lending.

LD: If I might adjust your example?

Currency issuer issues $1000 at $100 each to 10 banks.

Banks loan out with 10% reserve, implying a total money supply of $9000. Let's say the banks make 5%, for a total profit of $450.

On tax day, Gov'mint takes 10%, $45, and spends $45.

First, you assume money supply=tax rate or government expenditure. Second, even if the net savings is '$100', or $1000 in my scenario, this is not dramatically affected by the tax imposition such that "money injected into the economy by the federal treasury would be taxed back out again"

ApeMan: Right but you're confusing yourself by equating "savings" with "money." Savings is NET money, not total money. Total money is only slightly affected by taxation because most money is bank money. But ALL net money is state money.

The easiest way to see it is to look at the POV of the customer of the bank. He can take out loans in any amount the bank will allow, but his net position will still be zero unless and until he gets a check from some outside entity. if you aggregate the entire private sector together, obviously the only remaining outside entity is the currency issuer.

More on Debt Ceiling Fight From MSNBC

MSNBC's First Read has this tonight:

"In addition, McConnell said the hope is to also include spending cuts agreed upon by the White House and House Republicans. He said that is the key. Will the White House agree to enough cuts to pass the House."

So this is the key bit I was mistaken about. In addition to creating another catfood commission, the plan will include actual spending cuts that have already been agreed to in principle by the White House and the House Republicans.

So the main questions are whether those cuts will in fact be included in the Senate bill, and if so whether it can pass the House. I'm still hoping No on the first and Doesn't Matter on the second, but it seems we just don't know yet.

Wait A Minute, Is This Thing Over?

Is this debt ceiling fight over and nobody told me?

I'm hearing from Republican contacts that the current state of play is that the GOP has essentially punted after a falling out between Boehner and Cantor about whether or not the GOP could marshal the votes in time for a passage of a Grand Bargain-type legislative package.

Harry Reid and Mitch McConnell then stepped in and fashioned a compromise, which compromise involves Obama submitting a bill full of cuts at some point in the future which will almost definitely not be passed by Congress. In exchange for this "concession" Obama gets control over the debt ceiling until the end of FY2012, a provision that will presumably be extended in an election year without much fuss.

Is that right? I don't get the sense at all from liberal blogs and commentators that the Democrats have won, but I get that sense from the Republicans I'm talking to. What gives?

***UPDATE***

So, here's the bare bones of the Reid/McConnell plan, via The Hill:

The proposal McConnell introduced would authorize President Obama to raise the debt limit by $2.5 trillion in three requests.

Under the plan, Obama would have to make three requests to Congress which lawmakers could block only through a resolution of disapproval. It gives Obama nearly unilateral authority to raise the debt limit because it would require only 34 votes in the Senate or 146 votes in the House to sustain a veto of a disapproval resolution.

Reid is talking with McConnell about adding $1 trillion to $1.5 trillion in spending cuts to the authorizing legislation.

Now what I heard, which I'm still trying to find evidence for, is that the cuts aren't even part of the actual legislation, that they are a sort of floater that requires an up or down vote on a slate of Obama cuts. That's not what this piece says so that bit may be wrong. I'll continue to update as I have more information.

ECB Could Just Print the Money

I admit I got this via Atrios, but he didn't really add much so I'll just cheekily link to the original post at CEPR pointing out that the European Central Bank can solve the debt crisis any time it wants to by creating money and granting it to member states to pay their bills.

The European Central Bank (ECB) can just print euros which can be used to address any potential default risk among its member countries. There would be little obvious economic downside to this policy since most European counties have large amounts of unemployment and excess capacity due to inadequate demand.

If this were done as a per capita grant to all Eurozone members, it wouldn't cause a race to the bottom - in fact it could be contingent upon following certain budgeting guidelines, if you're into that sort of thing.

There's no technical reason it can't happen, only political reasons.

Yglesias At It Again

After I praise a post of Matt's he usually turns around and posts something that's wildly mistaken. Today is no exception":

Banks penalized for holding excess reserves will presumably lend to someone. Make the penalty large enough, and banks may even lend money at negative rates. Alternatively, they’ll just go out and get fancier office furniture. Either way, money gets spent.

This exposes Matt's fundamental misunderstanding of how banking works. Banks cannot use their reserve accounts to go out and buy office furniture. They park those dollars in Fed deposits, Treasury securities, and other more complicated financial instruments as a way of maximizing their interest income. They cannot spend it on office furniture or ANY real goods and services.

Also, for the millionth time, BANKS DO NOT LEND THEIR RESERVES TO THE PUBLIC.

And of course Sweden did not do what Matt says they did. I really wish I could get him to pay attention on this, it's just really embarrassing.

Balance Sheet Recession

Everybody's talking about the balance sheet recession today, as we find Paul Krugman, Brad DeLong and Matthew Yglesias discussing William Galston's piece for The New Republic.

Delong and Krugman are both ticked off that Galston seems to have called out liberal economists for not saying something that both of them in fact said several times, starting a good while ago - that the US and the world are suffering from a "Balance Sheet Recession."

So what is a balance sheet recession? In plain English, a balance sheet recession is when households suddenly become unable to continue spending money because they owe too much money against too few assets.

The reason I want to highlight this is because this is intimately connected with the discussion we've been having at Yglesias' place about monetary policy. As I've noted before, banks always lend when they can find creditworthy borrowers at prevailing interest rates and never otherwise. You can increase the supply of creditworthy borrowers by lowering the interest rate, but you can't increase it beyond a certain point because households that have strained balance sheets aren't creditworthy at ANY positive interest rate.

To fix a balance sheet recesssion, you have to fix household balance sheets. You can do that in a lot of ways. One way is directly, via mortgage modification which would work immediately, another is by deficit spending which operates on a bit of a lag.

At current rates, as Galston notes, at the current rate of deleveraging it's going to be a LONG time before we're back to normal levels of household indebtedness. That means a long recession. If you want to jumpstart the recovery you have to repair those balance sheets faster. Regardless of who said what when, maybe now we can all agree that this is the current situation and start discussing how to approach it.

Matt actually gets us started:

[T]he best resolution would be to set a higher Nominal GDP growth target and clarify that the Fed is willing to accommodate Reagan-era levels of inflation if that’s what’s necessary to achieve it.

I don't actually think that would work (the Fed can set whatever target inflation rate it wants, but it can't actually cause that inflation to happen), but bravo to Matt for pointing us in the right direction - toward solving the problem instead of arguing over who diagnosed it first.

In my view the best resolution would be to send everyone a $500 check every month until we get back to a normal level of household indebtedness. This program would cost 150 billion dollars a month. That's a lot! It wouldn't pay for itself. It would increase the deficit! It might even cause INFLATION!!!!!!one!1! It would also repair the balance sheets, and the economy.

Not the best sales pitch, I know. But it has the advantage of being completely accurate.

Sweden Again

So, the otherwise good Matt Yglesias is at it again, hyping Sweden's famous "negative interest rate" experiment.

As I've noted before, this entire story is the result of a misunderstanding and nothing that Matt has said on the subject is true.

To recap:

1) Sweden never paid a negative interest rate on overnight reserves, and in fact they never stopped paying positive interest rates on overnight reserves.

2) Paying interest on reserves does not cause banks to "hoard reserves" and refuse to loan them out because banks do not loan their reserves to the public. Ever.

Austerity and Household Debt

Economics as a discipline has a lot of problems owing to its relative newness, but one thing that's nice about it is that it's backed by another discipline where all the science is known - accounting.

Dig deep enough into the accounting side of a bad economic policy and you'll always find something alarming. In the case of the UK's disastrous plan to cut government deficits during a deep recession, the accounting problem comes in the form of household debt projections, which Krugman brings us today via Yves Smith (whose charts are always awesome).

Because the only way the economy can avoid taking a hit from government cuts is if private spending rises to fill the gap — and although you rarely hear the austerians admitting this, the only way that can happen is if people take on more debt.

Why is that? Can't households theoretically make more money? No. Since US deficit spending is the only source of net US dollars, households as a class cannot gain dollars unless the government provides them via deficit spending. The only way they can increase their spending power in the face of falling deficits is to borrow.

We don't need more consumer debt - we need less.

Schumpeter and Clean Energy Research

There's a bit of an off-topic debate over at Yglesias' place - the post itself is about Martians but commenter njorl had a very good comment about so-called Cap and Trade:

People don't like carbon emissions, rather, they like energy which has a byproduct of carbon emissions. By taxing carbon emissions, you squeeze energy production from CO2-producing fuels to non-CO2-producing fuels.

This is a good description of what cap and trade COULD accomplish. However, we need to be realistic about the fact that what makes Cap and Trade necessary is that we have underprioritized clean energy research as a nation for far too long.

If we had known in advance that fossil fuels would damage the ecology of the planet, which of course we didn't for most of the 20th century, we could have chosen to put research dollars into clean energy and possibly develop those technologies to the point where they could compete with fossil fuels now, in 2011.

We didn't do that. Too bad! So now we need to intervene in the market to slow the environmental damage from overconsumption of fossil fuels. As economic conservatives will always (correctly!) point out, such interventions often have unforeseen and chaotic effects.

These interventions are necessary in the short and probably even the medium term. But long-term the task remains the same - we MUST prioritize clean energy research much more highly than we currently do, and undertake the long-term, serious and difficult process of finding the technologies that will provide for the energy needs of the 21st century.

The bit of cap n trade/carbon tax triumphalism I object to is the idea that it will somehow magically force the nation to develop clean energy technology. It won't. It will incent the use of existing clean energy technology. It's tempting to think that this would increase the basic research being done in that field, but in fact there is no market mechanism by which that can happen. Basic research in clean energy, like ALL basic research, must necessarily be a policy choice.

As Schumpeter pointed out many decades ago, capitalist markets chronically underinvest in basic research because its commercial benefits are too far in the future. A dynamic actor such as the state is able to correct this over the long term, but for the last 50 years we have focused almost all of our significant nonmedical high-tech research efforts on developing weapons, and we are now reaping the whilwind of that disastrous miscalculation in the form of an antiquated energy production system.