Stimulus

by Russ Roberts on January 17, 2008

in The Economy

Here is my commentary from NPR’s All Things Considered on why a stimulus package is unlikely to stimulate. The link will take you to my newly designed site where I am archiving all my essays and related material.

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mcwop January 17, 2008 at 2:02 pm

Let the bidding start:

Hillary: $70 billion
Bush: $100 billion
Bernanke: $100 billion
Obama: ?
Romney: ?

Martin Brock January 17, 2008 at 2:06 pm

I accept the gist of this piece, but Roberts uses a generic, zero sum argument to make the point, and he knows better. Handing every American a few hundred dollars doesn't much stimulate the economy, but state spending is not automatically "robbing Peter to pay Paul." How the money is spent obviously matters. Does it employ idle factors or reorganize factors more productively? That's the question.

States may print money and routinely do. In the U.S., the Federal government prints money and spends it when it sells Treasury notes while the Federal Reserve is buying them. The Federal Reserve is buying them when it "lowers interest rates". The Treasury pays no interest on notes held by the Fed, and it routinely recycles the notes by selling new notes to pay off the notes sold earlier.

All Federal borrowing doesn't follow this pattern, but some of it does. Individual U.S. citizens, the U.S. banking system and others in the U.S. also buy the notes. The Treasury does pay interest on these notes, but it also taxes the note holders, so recycling occurs in this process as well.

If I inherit lots of Treasury notes and pay my way on the interest, taxing all of the notes away from me can increase my productivity. The state needn't do anything with the revenue. A bonfire might help more than any expenditure. This taxation is roughly equivalent to terminating unemployment benefits.

If we could limit the expenditures somehow, we might as well entitle the state to create a little money and spend it without the pretense of "borrowing". It happens already, but people don't understand it properly, because we pretend it isn't happening. I don't see how this pretense helps anyone outside of the money distribution game.

Finally, we often need credit to employ idle factors, and this credit doesn't fundamentally require the wealth of anyone else. Typically, credit does involve the wealth of others, but it needn't involve the wealth of others. In principle, we only need to get idle factors producing for each other. People more generally can benefit and presumably want to benefit from the extension of credit, but if others will not extend the credit, monetary authorities can and should extend it.

I still love the podcast though.

diz January 17, 2008 at 2:06 pm

I was flipping through the channels and heard if from about the second paragraph, and thought:

"Hey, there's a guy talking economic sense on NPR."

Well done. I really enjoyed the swimming pool analogy.

Jon January 17, 2008 at 4:43 pm

I was under the impression that the economic stimulus represented an inter-temporal transfer (that is, the government doesn't raise taxes in the short-run).

Ricardian Equivalence should in theory render such a transfer inconsequential. However, in practice this does not fully apply, either for psychological reasons (people aren't perfectly rational, and spend a portion of windfall income even if they expect a future tax hike) or credit constraints.

Furthermore, if the economic downturn is caused in part by a cooperative failure, then an increase in consumption has a chance to jump-start the economy into a higher equilibrium.

muirgeo January 17, 2008 at 5:34 pm

"The standard stimulus package doesn't change incentives. It's a check from the government. The hope is that the receiver will spend it. But when you just send out checks from the government, whoever gets stimulated is likely to be offset by someone who gets unstimulated."

Would this reasoning apply to the Feds recent actions pumping billions of new dollars into the economy?

Sam Grove January 17, 2008 at 5:50 pm

Keynes is a vampire, visiting us from the grave, prodding the government to stimulate the economy that is has dragged down with its spending.

The Albatross January 17, 2008 at 6:19 pm

"Would this reasoning apply to the Feds recent actions pumping billions of new dollars into the economy?"

Not quite, fiscal stimulus is a transfer of existing resources in the hope that whoever receives the money will spend it better than whoever you took it away from. Monetary stimulus (what the Fed did) is pretty much just printing more money, which creates signals that trick people into spending more money. This eventually produces inflation and distortions in the price system leading to misallocations of resources that eventually have to be liquefied. Whether the future adjustment results in a recession, depression, or just slower economic growth depends on the extent of the distortions, productivity, demand for money, ect.

I think it is safe to say that monetary stimulus is the preferred form of stimulus in the world today. When I say preferred I do not mean “good,” just that it is the most popular. My first economics professor, Alan Blinder, taught me that monetary expansion was the best horse to bet on, but I approve of neither method—fiscal stimulus being inefficient and inflationary monetary system potentially being catastrophic.

mark seery January 17, 2008 at 6:56 pm

Albatross,

Curious about something. If the Fed was not intervening in the first place, would monetary stimulus be required, i.e. would the markets adjust automatically to levels that would stimulate activity?

foxmarks January 17, 2008 at 6:57 pm

Recognizing this battle is already lost, I ask: Where in the Constitution do we find the President (or Congress) charged with managing economic outcomes?

…state spending is not automatically "robbing Peter to pay Paul." How the money is spent obviously matters.

This assertion is self-evidently false. However Paul spends the *gift*, Peter was still a victim of theft. One might argue that Paul will use the money better by some arbitrary measure. Yet, if the amount was only one penny, and Peter ended all death and suffering with that single penny, it was still stolen.

Discussion of the best way to spend prospective Federal plunder is rationalizing a moral failure.

Martin Brock January 17, 2008 at 7:01 pm

Ricardian Equivalence should in theory render such a transfer inconsequential.

You lost me here, but I'd simply say that handing everyone a few hundred dollars makes no difference, because it extends no credit to reorganize idle factors. If I'm unemployed in Toledo, giving a hundred bucks to a hundred million people across the country doesn't help me much, especially if they're all buying laptops from China. I'm probably idle for this reason in the first place.

If we really have a credit crisis, we must write off bad debts, dissolve unprofitable organizations and extend credit as best we can to new organizations with a smile and best wishes. If lots of people in Toledo are unemployed, particularly if they're recently unemployed and not chronically unemployed, we need to extend more credit there.

So why do Bernanke and others want a "stimulus package"? They must want bets they've already made to succeed despite of looming failure. I'm sitting here trying to figure out how the hundred dollar checks could possibly help, but I'm drawing a blank. They must be cover for something else. We're talking about the hundred dollar checks so we won't talk about something else in the package.

Martin Brock January 17, 2008 at 7:16 pm

"…state spending is not automatically "robbing Peter to pay Paul." How the money is spent obviously matters."

This assertion is self-evidently false. However Paul spends the *gift*, Peter was still a victim of theft.

It's not a gift. It's credit. It needn't come from Peter at all. If Paul and Luke can work together productively, we want to entitle them to do it. If they ultimately produce more than they need, Paul might buy their surplus. That's a win/win situation. The organization might not be profitable ultimately, but we'll never know until we give Paul and Luke a little credit.

Maybe you didn't know that the U.S. economy was built this way.

One might argue that Paul will use the money better by some arbitrary measure. Yet, if the amount was only one penny, and Peter ended all death and suffering with that single penny, it was still stolen.

The mindless moralizing doesn't interest me. If I could end all death and suffering by stealing a penny from you, I'd happily do it, but I don't believe states can do it, and I've advocated no such thing. Trying listening to some nice music. It might drown out the straw man.

Sam Grove January 17, 2008 at 7:41 pm

The reason for morality isn't to judge any particular situation, although it allows one to do so, but to prevent the cascade that happens when immoral actions are seen as justified/justifiable.

Allowing as how the state is not a moral actor, one may discuss the efficacy or efficiency of this or that policy.

The question of morality is important for the long run effects, the gradual erosion of society that occurs when morality is tossed aside in favor of short term pragmatism.

Thus the problems produced by amoral collective action elicit calls for further amoral actions amidst the recognition that, in the name of the group, very little is off the table as long as sufficient numbers can be persuaded that the morality of an action is irrelevant in the face of collective opinion.

The main characteristic that distinguishes man from animal is not intelligence, but rather the choice to act rationally in accordance with moral principles, rather than to react fearfully to perceived crises.

We can see that the skill of a politician lies in his ability to arouse passion in people rather than to counsel wisdom.

The whole failing of collective action is that morality, which is an individual characteristic, is subsumed to the demands of the collective, and in the end, no one is in control, and the fate of a people is as a house built on sand.

Randy January 17, 2008 at 7:47 pm

Boiled down, government is the theory that its okay to steal as long as nobody can stop you, and it helps to keep people from stopping you if you express an intention to do something good with the loot.

Honestly, I can't argue with the logic. It is completely rational and completely in alignment with human nature.

mark seery January 17, 2008 at 8:10 pm

"….and it helps to keep people from stopping you if you express an intention to do something good with the loot."

Yes it is amazing how often those that don't want to be bothered with discussions about morality so often make arguments based on morality.

Jon January 17, 2008 at 8:11 pm

Martin,

Sorry for the confusion.

Ricardian equivalence refers to the fact that, in theory, consumer spending decisions depend only on the level of government spending, not on taxes. So a tax cut without any change in gov't spending would make no difference: people would just save that money to pay back expected future taxes.

Consumption smoothing is the idea that people expect to have periods of high and low income during their lives, and so they will on balance borrow money during periods of low earnings and save money during periods of high earnings.

Credit constraints are usually advanced to explain the lack of observed consumption smoothing: people can't always get credit for loans when they're in a low-income period. This is generally due to market failures in the credit market due to information assymetries: borrowers generally have a better idea of what their future earnings will be than lenders.

Due to credit constraints, as well as other weaknesses in the model of Ricardian equivalence (people aren't all identical and immortal), we observed some spending of windfall tax rebates.

The second point is the concept of a stimulus. One model of recessions is that the economy is a coordination game, and changes in peoples' views can effect a drop from a higher nash equilibrium to a lower one.

Because of the high degree of cooperation in an economy, a firm or individual's optimal investment and spending decisions are highly dependent on the decisions of others. Trivially, when a firm expects high demand for its products, it will hire more workers, thus increasing employment and leading to more consumption, leading to more demand for its products. When a firm expects less demand for its products it will layoff workers, leading to unemployment and less consumption, leading to lower demand for its products.

Of course this is simplistic, since most of the a firm's sales are to employees of other firms.

No firm wants to be the one left with massive inventories during a recession, or empty warehouses during a boom, so its decisions are based on what others will do (i.e. where the economy is headed).

When the economy is heading into a recession, people would like to spend more if they could guarantee that other people would as well. If others aren't going to spend, people would rather save.

By giving everyone a windfall tax rebate, we increase spending everywhere. As everyone knows that everyone else is getting the same windfall, people expect that others will spend more as well. This can effectively nudge the economy into a higher nash equilibrium than it would otherwise attain.

There are limits to how much such a plan can accomplish (given that credit constraints are not ubiquitous and Ricardian equivalence still has teeth – see Bush stimulus attempt in early '90s), but the plan is still in line with Economic theory.

As to the analogy of the blood transfusion – a more apt analogy would be that a person sets aside blood when he is healthy so that he can receive a transfusion of his own blood when he is unhealthy. It's an inter-temporal shift in blood, rather than simply piping blood from the leg to the arm.

Jon January 17, 2008 at 8:18 pm

As an addendum: Just to be explicitly clear, the justification for a tax rebate is not to facilitate consumption smoothing (otherwise you'd be constantly giving them), but rather to affect peoples' expectations of spending.

Also, to the extent that recessions are caused by structural considerations rather than coordination failures, fiscal stimuli are ineffective. At best, a stimulus can seek to mitigate some of the negative effects of coordination failures, and land the economy in a higher nash equilibrium than otherwise.

To use the blood analogy: we're better off if we save blood when we're healthy to use when we're sick; but if the reason we're anemic is that we have an open wound, then we're still in for a rough time even with the transfusion.

muirgeo January 17, 2008 at 8:36 pm

You guys continue to amaze me in your complete irrational distain for government. How the hell do all of you get through your day with out using any government services.

Either you are complete anaracist or you approve of at least some robbing of peter to pay Paul. Which is it? If you're not complete anarcist which government program are you in favor of so I can question where the hell you think you have the moral authority to make me pay for your program.

You think we should have a treasury? Where the hell do you get off taking my money to run a treasury?…yes it's absurd isn't it?

The Albatross January 17, 2008 at 8:40 pm

Albatross,
"Curious about something. If the Fed was not intervening in the first place, would monetary stimulus be required, i.e. would the markets adjust automatically to levels that would stimulate activity?"

Mark Seely,
That is probably the most important question in monetary policy. We hear a lot about the “business cycle” in the old days the business cycle depended on the crops. Good harvest = boom. Bad harvest = bust. As agriculture became a smaller part of the economy, then the business cycle (depending on the size and diversity of the economy, potential for shocks, nuclear war, etc.) becomes less erratic—businesses will continue to be created and destroyed, but the creation should outpace the destruction as long as the price system is functioning properly. Money, like everything else has a price (the interest rate), and when this rate is artificially set two low (rate cuts), then people start making bad investment, production, and consumption decisions. I always think of expansionary monetary policy as the equivalent of drinking a bottle of tequila—it will stimulate the bejesus out of you, before you have to pass out and deal with all your bad decisions the next day (unless you die in the process). All that being said, if the Fed managed to mirror the natural market price for money, then the price system would not be confused as much and people would make fewer poor decisions leading to an economic slowdown. So to answer in one sense your question, I think a strong history of responsible monetary policy would minimize the problems that would necessitate a “stimulatory” rate cut that did not mirror the demand for money. Note Milton Freidman argued that such a rate cut during the Great Depression would have cured the rampant deflation, but this was not for the sake of stimulation; but, rather because of the effect of rampant deflation on the price system. FDR and the New Deal decided that it would be better to raise prices by forcing people to make less stuff and then pay more for it, the wisdom and goodness of which still confuses me. However, if we were to have responsible monetary policy and still manage to enter recession or period of slow growth, then it probably best just to take our lumps and accept the purge of bad investment. The market will flush out the bad economic decisions and resources will flow to those who create the most value with them, which ensures a more resilient economy in the future. “Stimulus” only trades shorter pain for longer term pain.
Hope this helps—if not, then please call me on it. Also, the answer is only caged in terms of Federal Reserve-esq monetary system. A far more fascinating issue is whether a completely private market for money, ala free banking, would better present the price of money and therefore more stable long-term economic growth.

Sam Grove January 17, 2008 at 8:42 pm

Muirgeo, you make an argument equivalent to the one that 'drugs' are bad because they are illegal and therefore they should be illegal because they are bad.

Sam Grove January 17, 2008 at 8:47 pm

IOW, just because the ubiquity of monopoly governments requires that we use its services does not mean that that is the way it should be.

So if we are going to compromise between no government and all government, then I am willing, for pragmatic rather than moral reason, to allow for only those government services that provide for the GENERAL welfare:

1 Defense against foreign invasion.
2 Courts of last resort.
3 Maybe police. Maybe.

If you give me the choice between a government that tries to be all things to all people, or no 'political' government, then I will take the latter.

mark seery January 17, 2008 at 8:52 pm

Albatross,

Thanks, so a couple of points.

Firstly people who don't believe in government are always getting called hypocrites for calling for fed intervention. However the other side of this argument is that they may believe they are only calling for action to compensate for other action they did not believe in, in the first place (for example keeping the interest rates low or high too long). Kind of like people who take money from government because they feel they are entitled to it since it was stolen from them in the first place..

Secondly I am interested in your comment about Friedman. I thought his view was that you should just keep increasing the money supply by a fixed amount every year. Would he have broken from that view during an event like the Great Depression and increased it more? Or would have simply said if it had been increasing at a fixed amount every year the Great Depression would not have occured in the first place?

With your point about historical agricultural societies you in infer that not all shocks are caused by monetary policy as Friedman seems to infer. Did you mean to indicate that?

ethan January 17, 2008 at 9:22 pm

I have a question I'd love someone to answer. My undergrad econ courses talked about how it was necessary for economic growth to go off of the gold standard so that the money supply could increase which would allow for economic growth which was being stifled. This seems like bullshit to me. I don't understand the reasoning behind this and can someone explain why some poeple believe this to be the case?

Sam Grove January 17, 2008 at 9:41 pm

If the money supply is held stable during economic growth, then the prices must fall to accommodate. However, there must be enough money to allow everyone to transact business.
If the growth of the money supply matches the growth of the economy, then prices should remain stable, in general.

Understand that this is gross simplification.

Money has great value as a function, much as chemicals are used in an ant colony to transmit information throughout the colony.

The problem with politicians is that, for the most part, they have little respect for, or comprehension of, this function.

The Albatross January 17, 2008 at 9:55 pm

Mark Seely—sorry, long and addressing your comment middle, last, then first.
Wow, deep questions, I will start with Freidman, but I will admit my Freidman is a little rusty. As you pointed out correctly Friedman was an advocate monetarism—which is primarily concerned with making sure that the supply and demand of money are in equilibrium. I am a little unsure (and I am sure there is Freidman scholar in the Café somewhere), but I think the idea of increasing the money supply by X a year came a little later. I think the reason for the binding target was because central banks (with perhaps the exception of the Bundesbank) had consistently proven that they were incapable of resisting government pressures to inflate the money supply, so it became impossible to think it practical for a central bank to coordinate monetary policy with price stability. I think that most economists in the 70s would agree with this and it is a problem we see in many countries today. The beauty of Greenspan (heavily influenced by Freidman) was that he was able to more or less (or at least better than anyone else previously) to match money supply with money demand. Freidman had thought this impossible (in the context of political pressure), and I remember a Wall Street Journal article about a year or so before he died when Freidman praised Greenspan for this. I think the exact words he used were “you were right and I was wrong.” Anyway, it has been a while since I read Freidman’s Monetary History of the United States, but I think his argument was that the supply of money did not meet demand in the Depression. Interestingly as the economy deflated and prices crashed, the Fed got the bright idea to raise interest rates, which did not go well with the other poor government decisions—raising taxes and erecting the Smoot-Hawley Tariff. I think the X percent of monetary growth is a little overstated when people talk about monetarism, when price stability is really its core, and its theory would dictate that the deflationary aspects of the Great Depression would merit rate cuts. (I would welcome a correction on this).
Can shocks be non-monetary? I am not sure if Friedman meant that all shocks are monetary. However, I think it would be fair to say that most shocks are monetary in nature, but considering that non-monetary shocks would still affect the price level and the demand for money, then I could definitely see some interaction between the two. Anyway, I am sure someone who knows better is kicking around here somewhere.
As to the first part of your comment, to tell you the truth I am not sure. I think the appeal to small government types of fed action over fiscal stimulus is that they believe it the lesser of two evils. If the government spends money to stimulate then it gets bigger and taxes or borrows more. Also, I think there is a qualitative argument, fed action will probably stimulate more than fiscal stimulus (Blinder's view), and if the economy does well enough with strong productivity growth, then it might be enough to sop up the Fed’s action. So there is an element of dice rolling. Lastly, the Fed has established itself as more independent (at least since Arthur Burns), so perhaps small government (or public choice types) can take some solace that it is less likely to succumb to political pressure. My favourite example of the former was when Barney Frank asked Greenspan “well, what about the poor.” I think Greenspan replied with something like “that’s not my job.” Lastly, there is the contention (again turning a little bit to Blinder) that the price level will adjust quickly enough to minimize the disruption to the price system. Anyway, sorry not much insight with this last (first one).

ethan January 17, 2008 at 9:59 pm

*Long Post

Martin, I was reading another thread of your on this subject of credit and monetary policy that I thought was interesting. I haven't had a chance to read anything by Proudhon yet. You gave an example about some dudes building houses:

"The process ends with three laborers, a smaller forest, three houses and no money. No more money exists at the end than existed at the beginning. We could add a blacksmith and a farmer and a tailor to this illustration as well, all credited at the outset, all providing their goods and services to the organization, all ending the process with a house and no money.”

Yes and no. No one need possess the actually money, that is true. However, the three houses represent money. The credit provided by the banker does not have to be in form of money(wood coins) but it still has to correctly represent the value of the houses and labor/skills required to build them. Credit extended by the banker was not to required to build these houses what was, was communication between the logger and carpenter who determine what each of his skills are worth and then they enter a voluntary agreement. Money I believe is a just a market of information that makes this communication and exchange easier.

“The banker doesn't "lend" anything in the sense of providing something of intrinsic value at the moment he extends the credit. He provides an accounting service by requiring you to build my house in a timely manner (to obtain the money required to repay the loan) and requiring me to provide your lumber in a timely manner.”

For this example to work, then you must assume the banker can accurately assess the value of both the logger and carpenters labor and knowledge. And both parties must believe the banker has accurately done this. However, I think the values can only be determined as they emerge between the parties not by an all knowing banker. However, if the banker can do this, then his services should clearly be compensated because he has provided a service that was made their exchanged easier (they them time/work which is money).

“None of us want just anyone handing out money, because the tokens then don't serve their purpose. The tokens are units of account for what we already possess, but we still need someone to monopolize the token distribution.”

Why? Having a monopoly on the tokens will not ensure they are the best representation of the product of everyone’s labor. The more token producers that are involved in this process will increases the accuracy of its value. In your example the banker has to do this. If he thinks giving both the logger and carpenter 1000 is fair, but the carpenter value his work worth more than the 1000 the logger has, then he will want 2000 from the logger before he agrees. If there are 3 bankers then each will compete or maybe work together to gauge the proper value of the carpenters higher skilled labor.

Mikhail January 17, 2008 at 10:05 pm
ethan January 17, 2008 at 10:06 pm

Thanks for the reply Sam

"If the money supply is held stable during economic growth, then the prices must fall to accommodate."
- Why is this a problem?

"However, there must be enough money to allow everyone to transact business."
- Agreed. But why is increasing the money supply required for this. Wouldn't breaking down the same amount of money into smaller units accomplish the same thing?

Martin Brock January 17, 2008 at 10:37 pm

Jon:

So a tax cut without any change in gov't spending would make no difference: people would just save that money to pay back expected future taxes.

I guess I see that, but I don't think many people save tax rebates to pay future taxes. My taxes are withheld. I hardly think about them. If I didn't have to file a return, I'd never think about them. Ignorance is bliss.

Credit constraints are usually advanced to explain the lack of observed consumption smoothing: people can't always get credit for loans when they're in a low-income period.

I'm a terrible oversaver myself. At least, I keep far too much cash, because I have three kids and live in constant fear of unemployment, probably an irrational level of fear. I never borrow unless absolutely necessary, so I haven't had any debt in many years. That's probably a mistake too, since I take no advantage of leverage.

Still, I have to believe that consumption smoothing is one of those "rational actor" theories that grossly overstates the rationality of common people. Maybe, we'd be more rational hunter-gatherers, but we aren't hunter-gatherers anymore. Most of us aren't rational actors when it comes to finance.

By giving everyone a windfall tax rebate, we increase spending everywhere. As everyone knows that everyone else is getting the same windfall, people expect that others will spend more as well. This can effectively nudge the economy into a higher nash equilibrium than it would otherwise attain.

I guess I see that too, but I don't understand recession simply as a herd effect. At a given time, most organizations are profitable and grow by reinvesting profits to employ free resources appearing continuously. Some organizations are not profitable, so they shrink by freeing resources instead. Other free resources are the output of existing organizations, like new labor entering the market and new tools produced.

Recession occurs when shrinking organizations shrink faster than growing organizations grow. The shrinking organizations are shrinking, because consumers want less of what they produce. Giving everyone money to spend doesn't halt their shrinking, but it might speed reorganization if people channel the rebates toward small but growing organizations, thus providing them greater profits to invest in free resources. Now that I think of it, that seems right.

If I'm content that my organization is profitable and growing by producing valuable goods, I might spend a tax rebate. If I'm not so content, and if you give me a "recession fighting" tax rebate, then I'll more likely save it, anticipating a period of unemployment. So the worse the economic situation really is, the less effective this type of rebate is. I suppose it could have some beneficial effect but not because I spend expecting you to spend. I don't think about your spending at all. I think about my future income vs. my future costs.

mark seery January 17, 2008 at 10:49 pm

'My favourite example of the former was when Barney Frank asked Greenspan “well, what about the poor.” I think Greenspan replied with something like “that’s not my job.” '

;-)

Someone cares about the poor pressumably, but interesting the contrast there. The fed defines its role very narrowly, whereas politicians expect themselves/are expected to be an expert on everything. That's a big part of the challenge of government IMO.

On another note, interesting to review Bernanke's thoughts on the whole thing:

"To be useful, a fiscal stimulus package should be implemented quickly and structured so that its effects on aggregate spending are felt as much as possible within the next twelve months or so. Stimulus that comes too late will not help support economic activity in the near term, and it could be actively destabilizing if it comes at a time when growth is already improving. Thus, fiscal measures that involve long lead times or result in additional economic activity only over a protracted period, whatever their intrinsic merits might be, will not provide stimulus when it is most needed. Any fiscal package should also be efficient, in the sense of maximizing the amount of near-term stimulus per dollar of increased federal expenditure or lost revenue. Finally, any program should be explicitly temporary, both to avoid unwanted stimulus beyond the near-term horizon and, importantly, to preclude an increase in the federal government's structural budget deficit. As I have discussed on other occasions, the nation faces daunting long-run budget challenges associated with an aging population, rising health-care costs, and other factors. A fiscal program that increased the structural budget deficit would only make confronting those challenges more difficult."

"…the nation faces daunting long-run budget challenges…."

We probably can not hear that enough when people start talking about stimulus packages without associated spending cuts.

The Albatross January 17, 2008 at 11:06 pm

Great quote

Sounds like Ben has all the bases covered–fiscal stimulus should be timely and not too much, but at the same time to the right people and we face long term fiscal challenges. So we need a perfect fiscal stimulus, well that's insightful, but then again I will cut him some slack these are public/congressional statements, so I cannot see him saying anything else. Sorry, not trying to bag on the guy, I think few people in the world know as much about this topic as he does, and he is speaking in public. Furthermore, I think he was my professor and preceptor for econ 201 or 202–I remember very nice, quiet man with a beard.

Martin Brock January 17, 2008 at 11:27 pm

ethan:

Yes and no. No one need possess the actually money, that is true. However, the three houses represent money.

I think that's a mistake in nomenclature. Houses are valuable assets, but they aren't money. Money is a medium of exchange, a token of entitlement to purchase. Because a house is valuable, I can exchange a house for money, and I can exchange money for a house, but the money is only a unit of account. If I exchange my house for $100,000, the $100,000 itself is not a valuable property. It's a record of my entitlement to property of comparable value at current prices (thus "currency"). "$100,000" names a category of things I may possess. With my cash in hand, you know the name of real properties I may possess. If I exchange the $100,000 for your four cars, I realize my entitlement, and you then possess only the name of a category of properties to which you are entitled. My house has this name, and your four cars has the same name, currently at least.

I could also exchange my house for cars directly, but this exchange is barter and involves no money.

The credit provided by the banker does not have to be in form of money(wood coins) but it still has to correctly represent the value of the houses and labor/skills required to build them.

There is no correct value of the houses, only the values the carpenter and I agree upon. We agree that $1000 names one house worth of lumber and one house worth of carpentry services, because we agree that the two have comparable value. We could agree on other prices, like $20,000 for each or $5000 for one and $10,000 for the other. We could also name one house worth of lumber "one house worth of lumber" and agree that "one house worth of lumber" also names one house worth of carpentry services or that "one house worth of lumber" names two houses worth of carpentry services.

This sort of naming convention occurs with a gold standard. Then we name the value of everything in terms the value of gold, so a house might be worth as much as a thousand ounces of gold. Despite popular misconception, this naming convention does not at all imply that the value of gold in bank vaults equals the value of everything else or the value everything we're trading at an instant or even the denomination of all monetary tokens in circulation. It just means that gold has a standard price. Gold is the standard of value.

Credit extended by the banker was not to required to build these houses what was, was communication between the logger and carpenter who determine what each of his skills are worth and then they enter a voluntary agreement. Money I believe is a just a market of information that makes this communication and exchange easier.

Yes, that's right. Credit extended by the banker is not required, but it makes the accounting easier. Creditors are accountants providing a service. That's all. They aren't rich people lending you the use of something they have. They're accountants assisting you to account for the value of what you have.

Martin Brock January 17, 2008 at 11:53 pm

ethan:

For this example to work, then you must assume the banker can accurately assess the value of both the logger and carpenters labor and knowledge.

The banker only needs to believe that I'll return $1000 to him in a timely manner. He needn't know what you and I agree to exchange at this price, but knowing something of the transaction and the market value of things could help him rationally to assess the likelihood that I'll return the $1000.

And both parties must believe the banker has accurately done this.

The carpenter doesn't need to know how I obtained the $1000, only that he'll accept $1000 for one house worth of carpentry services. Similarly, I only need to accept $1000 for a house worth of lumber to arrange my exchange with him. I don't need to know where he gets the money.

However, I think the values can only be determined as they emerge between the parties not by an all knowing banker.

The banker is not all knowing. He needn't know anything really. He can simply hand out money and hope for the best, but we don't want him to be so cavalier with it. The critical service he performs is accountability. Ideally, he knows that when I borrow, I'm likely to repay on time. He knows the same thing about you. He knows our credit histories. He then demands that we pay on time.

Since I expect to get my money from you, and you expect to get your money from me, the banker essentially demands timely payment on our behalf. That's all that matters really. If you extend me credit directly, you also want payment on time. You don't need the banker to extend me credit, and I don't need the banker to extend you credit, but we can both use his services rather than accounting for credit ourselves.

However, if the banker can do this, then his services should clearly be compensated because he has provided a service that was made their exchanged easier (they them time/work which is money).

Of course, he should be compensated.

Martin Brock January 18, 2008 at 12:21 am

ethan:

Having a monopoly on the tokens will not ensure they are the best representation of the product of everyone’s labor.

No. We do that by negotiating prices.

The more token producers that are involved in this process will increases the accuracy of its value.

Well, there can be lots of creditors, but they're all creating the same tokens, and they're all following similar rules. "Monopoly" doesn't mean one man here. It means one set of rules, one monetary authority. When we accept these tokens, we want to know that they were created and distributed according to these rules. A central bank is just a regulator enforcing these rules.

The carpenter and the logger outsource their own credit accounting. The carpenter could use "carpentry" coupons while the logger uses "logging" coupons, but accounting for all of these coupons would be very burdensome, so they agree to use a common token and to use the banker's credit accounting service. This bank is part of a larger franchise of banks all using the same tokens. The carpenter and logger want to know that all of these accountants are honest and reliable, so they want this regulatory authority.

In your example the banker has to do this. If he thinks giving both the logger and carpenter 1000 is fair, but the carpenter value his work worth more than the 1000 the logger has, then he will want 2000 from the logger before he agrees.

The carpenter and the logger set their prices.

If there are 3 bankers then each will compete or maybe work together to gauge the proper value of the carpenters higher skilled labor.

Carpenters and their customers gauge the proper value of a carpenter's labor. Loggers are skilled too, but that's a separate issue. I'm not suggesting that everyone earns the same hourly wage or anything like that. I chose $1000 for one house worth of lumber and one house worth of carpentry services only for the sake of simplicity.

A banker might believe the risk too high and refuse to credit me if I plan to pay carpenters too much, but in the scenario we're discussing, the carpenter and the logger have already agreed on the price of a house worth of lumber and a house worth of carpentry services. $1000 is the market value of both by assumption. Different assumptions don't change the nature of the banker's service.

ethan January 18, 2008 at 2:07 am

Thanks Martin, I think we agree on what is money and what purpose it serves. I guess I'm confused why having access to credit would be the driver for growth and not a lubricant instead? And along witb that why would a govt be as good as a private bank to best deliver this service? Credit given carelessly will cuase bad investments which will trigger a recession not economic growth. If we agree govt is not the best institution to run our supermarkets then how can we exspect it to manage our currency and make sound investments?

Sam Grove January 18, 2008 at 2:59 am

"If the money supply is held stable during economic growth, then the prices must fall to accommodate."
- Why is this a problem?

It's not inherently a problem. The problem is popular misconceptions about money and wealth. People who sell stuff aren't to keen to have to lower prices, even though they will be paying less for what they buy.
IOW, psychology plays a great part in all this.

"However, there must be enough money to allow everyone to transact business."
- Agreed. But why is increasing the money supply required for this. Wouldn't breaking down the same amount of money into smaller units accomplish the same thing?

Because someone benefits from the printing of the new money. AND I tend to think so..

ethan January 18, 2008 at 4:41 am

Sam, what I was thinking is that in order for there must be enough money to allow everyone to transact business, rather than print new money, couldn't the same goal be accomplished by converting dollars into pennies and then pennies into tenths, etc. and using these smaller pieces of the existing money supply to transact business. Would this have the same inflationary effects?

Randy January 18, 2008 at 8:16 am

Muirgeo,

You're right. There's no integrity in demonizing government while using its services. Then again, there's no integrity in demonizing the free market while using its services.

Martin Brock January 18, 2008 at 9:04 am

ethan:

I guess I'm confused why having access to credit would be the driver for growth and not a lubricant instead?

I suppose you could call it a lubricant. It's just that a system of credit using standard tokens of entitlement to value works well to organize resources, and some authority must monopolize production of these tokens; otherwise, they aren't "standard tokens".

And along witb that why would a govt be as good as a private bank to best deliver this service?

"Public" and "private" are largely arbitrary distinctions. We have more central authorities and less central authorities.

Credit given carelessly will cause bad investments which will trigger a recession not economic growth.

So we don't want credit given carelessly. Right?

If we agree govt is not the best institution to run our supermarkets then how can we exspect it to manage our currency and make sound investments?

Well, we don't want credit given carelessly, so we want it governed otherwise.

Martin Brock January 18, 2008 at 9:08 am

Randy:

There's no integrity in demonizing government while using its services. Then again, there's no integrity in demonizing the free market while using its services.

The state is not one thing, but it is a monopoly of forcible propriety. One has little choice about using its services, but one may demonize particular proprieties while being subject to them, one hopes.

The market is not one thing either, and it's never "free" in any absolute sense. It's organized by countless forcible proprieties.

Martin Brock January 18, 2008 at 9:12 am

If the money supply is held stable during economic growth, then the prices must fall to accommodate."
- Why is this a problem?

It's a problem because of the effect on long term credit. If I borrow $200,000 to buy a house today, I don't want to owe $150,000 on a $140,000 house ten years from now. If I do, I'll default.

Randy January 18, 2008 at 9:53 am

Martin,

Re; "The state is not one thing…"

Of course it is. I've never seen anything on any tax form giving me any choice as to how my rent payment is to be spent.

Re; "The market is not one thing either, and it's never "free" in any absolute sense."

The free market(s) can be seen as more than one thing, but in terms of demonization it (they) can be and often is(are) seen as one thing. We know from history that free markets can be destroyed by attacking the principles that make them possible. And yes, there is a truly free market. To say otherwise is to say that we are slaves. First, from personal experience this does not seem to be the case. Second, even if it is true, I wouldn't think that is something that any good propagandist for the slave owners would want to declare openly.

muirgeo January 18, 2008 at 10:15 am

Muirgeo,

You're right. There's no integrity in demonizing government while using its services. Then again, there's no integrity in demonizing the free market while using its services.

Posted by: Randy

Absolutely! Couldn't agree more! That's why I like to shop in a democratically well regulated fair market since no such thing as a free market exist.

Those people claiming to use the free market are the same ones who steal from the government and use the government to protect themselves from fair and competitive market forces.

Randy January 18, 2008 at 10:27 am

And once again, for Muirgeo, to say that there is no such thing as a free market is to say that we are slaves. Again, I don't think that we are slaves, but even if we are, I don't see why a good propagandist for the slaveowners would want to admit it openly.

Mark January 18, 2008 at 11:06 am

Muirgeo, watch the YouTube video "Milton Friedman on Libertarianism". I believe it's part 1 of 4 where he summarizes what a typical Libertarian thinks the role of government is. He goes into more detail in parts 2, 3 and 4. I'm pretty sure most people on this blog would describe themselves as "libertarian", so it probably will give you a good idea what most people on this blog think.
For the record, I find it hard to believe that you have never purchased a good or service from an industry that is competitive and for profit. You've never bought a t-shirt?

Sam Grove January 18, 2008 at 11:14 am

The market is not one thing either, and it's never "free" in any absolute sense. It's organized by countless forcible proprieties.

Please explain "forcible propriety".

Libertarians see a difference between using force to defend/protect rights, and using force to violate rights. At least this one does.

Randy January 18, 2008 at 11:15 am

Just in case you are missing the point and not deliberately avoiding it;

When I buy a loaf of bread, I think that I really want to buy a loaf of bread, and not that the government is somehow feeding information into my brain telling me to buy a loaf of bread. I also think that the guy who sells me the bread decided on his own to sell bread and not that he is simply an undercover agent of the government who is under orders to sell me bread. This is the free market. It exists. If it didn't, the government would have nothing to tax or regulate.

mark seery January 18, 2008 at 11:54 am

"free" is an ambiguous word of course. voluntary, private, public, distributed, centralised, command-and-control, mixed, are all words/terms that may have more meaning depending on the occassion.

Randy January 18, 2008 at 12:50 pm

Voluntary markets then? Okay. That works for me.

muirgeo January 18, 2008 at 1:04 pm

You've never bought a t-shirt?

Posted by: Mark

I admitted I do. But I don't by t-shirts made from child labor. And the big companies who make the shirts have to follow the rules for corporations, banking and finance. They don't operate in a free market but a regulated one. They have to pay back some of their revenue to pay for the roads and infrastructure that allows them to have a functional business.

Anyway thanks for the Friedman reference. I'll watch those videos. Actually I'm reading Capitalism and Freedom right now.

muirgeo January 18, 2008 at 1:11 pm

And once again, for Muirgeo, to say that there is no such thing as a free market is to say that we are slaves.

Posted by: Randy

No we are not slaves. But to think that we are completely independent entities is unrealistic to. If you want complete freedom and independence then go live alone in the wilderness. You want the benifits of society then you will have to reliquish minor freedoms and recognize some debt to society.

You don't get to be in the club for free.

Your position is like some one who wants a room mate to share rent but still wants the apartment all to himself. It's a selfish and unrealistic position. It's NOT how society works.

YOU ARE NOT independent and there are NO FREE MARKETS.

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