dimelab dimelab: shrinking the gap between talk and action.

confront Topic in The Credit Debacle Catalog

incredulous beliefs confronting contrary evidence (1).

billy blog Wed 2010-09-29 10:15 EDT

Budget deficits do not cause higher interest rates

...An often-cited paper outlining the ways in which budget deficits allegedly push up interest rates is -- Government Debt -- by Elmendorf and Mankiw (1998 -- subsequently published in a book in 1999). This paper was somewhat influential in perpetuating the mainstream myths about government debt and interest rates...Their depiction of...Ricardian equivalence...alleges that: ``the choice between debt and tax finance of government expenditure is irrelevant...[because]...a budget deficit today...[requires]...higher taxes in the future...'' ...I have dealt with this view extensively...Ignoring the fact that the description of a government raising taxes to pay back a deficit is nonsensical when applied to a fiat currency issuing government, the Ricardian Equivalence models rest [on] several key and extreme assumptions about behaviour and knowledge. Should any of these assumptions fail to hold (at any point in time), then the predictions of the models are meaningless. The other point is that the models have failed badly to predict or explain key policy changes in the past. That is no surprise given the assumptions they make about human behaviour. There are no Ricardian economies. It was always an intellectual ploy without any credibility to bolster the anti-government case that was being fought then (late 1970s, early 1980s) just as hard as it is being fought now...So where do the mainstream economists go wrong? At the heart of this conception is the [pre-Keynesian] theory of loanable funds...where perfectly flexible prices delivered self-adjusting, market-clearing aggregate markets at all times...Mankiw claims that this ``market works much like other markets in the economy''...[assuming] that savings are finite and the government spending is financially constrained which means it has to seek ``funding'' in order to progress their fiscal plans. The result competition for the ``finite'' saving pool drives interest rates up and damages private spending. This is what is taught under the heading ``financial crowding out''...Virtually none of the assumptions that underpin the key mainstream models relating to the conduct of government and the monetary system hold in the real world...When confronted with increasing empirical failures, the mainstream economists introduce these ad hoc amendments to the specifications to make them more realistic...The Australian Treasury Paper [used advanced econometric analysis to find that] domestic budget deficits do not drive up interest rates. The long-run effect...is virtually zero. The short-run effect is zero!...toss out your Mankiw textbooks...

Billy Blog; budgets deficit; caused higher Interest rate.

Sun 2009-10-11 18:07 EDT

Cassandra Does Tokyo: Mourning Rally

...it is most curious that I should find myself experiencing very visceral negative reactions to the upward movements in the gold price...the rallying Gold price signifies more monumental failures at multiple levels for society, in politics, for nations, for our individual and collective ability to measure our wants and desires with our means. So despite my skeptical exoskeleton about most things (financial innovation perhaps first and foremost), the aforementioned bothers me intensely, for I am, at heart, both an idealist, and a closet optimist about humanity...So when I see Gold rally, my visceral reaction is the result of my incredulous beliefs confronting contrary evidence, and the mourning for said failures (both real and imagined) that it represents.

Cassandra; Mourning Rally; Tokyo.

Thu 2009-10-08 17:04 EDT

After subverting bank insolvency, our leaders are now about to make a mess of liquidity

Unless there is a major change of direction among global economic and financial officialdom, we are at risk of ending up with a world in which liquidity provision is privatised and insolvency risk for banks is socialised. This would be the exact opposite of what makes sense: solvency is (or should be) a private good and liquidity is (or should be) a public good...The authorities should not waste their limited organisational capital to force banks to provide inefficiently the public good of liquidity when confidence and trust are low. They should instead focus on ways of enforcing hard budget constraints on banks - to confront them with the realities of insolvency in a way that separates shareholders, unsecured creditors, boards and managers from their investments while leaving the bank as a functioning organisation capable of continued intermediation.

leaders; liquidity; makes; Mess; subverting bank insolvency.