John Howard’s interest rate lies
Posted by Christopher Sheil on Sunday, August 5, 2007
Elementary economics says there’s no direct correlation between public borrowing and interest rates. If governments borrow to relieve capacity constraints for, say, ports, they may increase production and improve productivity, taking pressure off demand, inflation and rates. On the other hand, if they borrow for, say, aged pensions, they may deprive the economy of more productive private investment, add to demand and tend to push rates up. If they borrow for recurrent spending and fail to relieve constraints, the punishment can redouble.
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It is a Howard government lie to allege that the states are responsible for interest rate pressure, without a good supporting case. I have heard no case; only a generalised political slur. It remains true, moreover, that the states did not promise to keep interest rates down; the Howard government did. In blaming the states, the Prime Minister is also implicitly conceding that he lied when he promised, as this is an admission of him not having had the power to do so.
Then again, he didn’t promise to keep rates down, did he? He only promised to keep them lower than a Labor government would. As this was a promise for which there could be no counterfactual to test its keeping, he actually promised nothing. Thus, the whole story is one big lie from beginning to end. And so it goes, on.
Update: So, the Liberal Party did positively promise to keep “interest rates at record lows”. In fact, the promise was made zillions of times in media adverts. This presents the PM with the problem that, while he may have personally promised a non-promise, the Liberal Party trumped him with a real promise, live on television, featuring Ratty the Megastar, zillions of times. How will this unfold? Will the PM retell a version of the famous lie about how he, as a leader of the Coalition of the Willing, APEC, his country, the government, his party and the television adverts, was not advised; and had he known he was making a real promise, zillions of times, he would have “never ever” dreamed of so doing, honestly? Will the Liberals reinvent the famous lie about non-core promises, and admit they were just joking? Will this government be laughed out of office?
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Preferred economic managers clueless on economics…
Last weekend, I wrote about why I thought the lead the Coalition has on economic management in the polls doesn’t necessarily reflect an actual advantage. This weekend, I’m stunned at their chutzpah.
Posted on 05-Aug-07 at 10:48 pm | PermalinkIn a new ad, the Libs blame Labor states&…
I gather that by ‘relieve capacity constraints’ you mean invest in infrastructure. You’re right that this will reduce inflationary pressure for a given level of demand in the future, but that doesn’t mean it won’t be inflationary now.
When you say ‘if they borrow to spend on, say, old age pensions, they can deprive the economy of more productive private investment, which will tend to push rates up’, this gets the causal sequence wrong. Higher consumption, adding to total demand, aggravates inflation and obliges the RBA to raise the interest rate, which in turn curtails investment. Furthermore, whether the government is borrowing to finance the expenditure is neither here nor there.
You are actually making the argument more complicated than it needs to be. The real message that Labor should hammer is that interest rates have nothing to do with government borrowing per se. They are set by the central bank, which is concerned with the overall balance of supply and demand. To see this, all you have to do is imagine an export boom. This raises tax receipts, so that even if the government simultaneously raises its spending, as long it’s by less than the tax windfall, its net borrowing requirement has decreased. Nonetheless, the government has added to the overall level of demand; and if the economy is already at the inflation threshold on account of the export boom itself, the government’s contribution can be deemed irresponsible.
Posted on 05-Aug-07 at 11:18 pm | PermalinkWhen you say if they borrow to spend on, say, old age pensions, they can deprive the economy of more productive private investment, which will tend to push rates up, this gets the causal sequence wrong. Higher consumption, adding to total demand, aggravates inflation and obliges the RBA to raise the interest rate, which in turn curtails investment. Furthermore, whether the government is borrowing to finance the expenditure is neither here nor there.
The conventional assumption is an ultimately finite pool of borrowable funds. Borrowing for recurrent expenditure depletes the pool without supplying any extra capacity, thus possibly putting pressure on rates. Borrowing for productive investment expands the capacity, thus reducing pressure on rates. Whether the higher spending comes from recurrent consumption or productive investment is the key, for either way it is still increased spending. It is the type of spending that matters, not spending per se. So, I’m sorry James, but it is you who has the causal sequence wrong.
The real message that Labor should hammer is …
… not my problem; but the suggestion that government borrowing has no relationship whatsoever to interest rates (good or bad) is Voodoo economics.
I can supply a mathematical rendition, if you were interested, James.
Posted on 05-Aug-07 at 11:26 pm | Permalink… which is wrong according to Peter Martin.
http://petermartin.blogspot.com/2007/08/labor-cant-manage-money.html
Posted on 05-Aug-07 at 11:35 pm | PermalinkPeter is clearly wrong, in his own words:
Governments, as well as individuals, have been able to freely borrow from abroad. There is no longer a limited stock of available funds.
Borrowing abroad does not change the assumption, it merely widens its application. To save his proposition, he should insert “domestic” between “limited” and “stock”. In any event, markets price government and country risk.
Posted on 05-Aug-07 at 11:37 pm | PermalinkCS
Can you elaborate on this point please. Maybe it’s me that I can’t quite get it.
“If governments borrow to relieve capacity constraints, they can increase production and productivity, taking pressure off demand, inflation and interest rates.”
Posted on 06-Aug-07 at 12:07 am | PermalinkI’m not going to give free lessons in economics to an Austrian troglodyte, JC.
But, heck, I’m in a good mood, so I’ll give you one hand-out.
Imagine that a government borrowed to widen a port in a way that doubled its capacity without – say, for the sake of making this an easily understood argument, even by Austrian troglodytes – also requiring any wharves to be added. Such a case might occur, conceivably, if the restraint on port usage was due to an unfortunately placed headland, that Public Works could contract for removal. There would, as a consequence, be more port capacity, facilitating an increase in production and an improvement in productivity from the other already existing capital assets (wharves, portainer cranes, straddles, computer equipment, etc); which would generate more income from export sales to, say, China and India, and thus more savings to be loaned, leading to a lowering of pressure on interest rates from government borrowing to remove the headland.
OK, that’s the first and last free lesson. Get with the speed or drop off.
Posted on 06-Aug-07 at 12:23 am | PermalinkLet me explain: I disagree with Howard that interest rates are being pushed up by the states seeing the feds are running a healthy surplus. The states are borrowing like say any large borrower. It would only have an effect on the part of the yield curve they drawing funds from if it were significant. In other words it has next to no real impact other than a yield curve “bend”.
However I think Howard is making a strategic error here. It would be far better to present the argument that despite the thundering/ booming conditions in the country, leading to enormous gains through state returned GST and other things like property transfer taxes and the like. Despite all that these 6/7 entities still find themselves in a hole. Case in point, last year WA grew at the astoundingly fast rate of about 14% but even then labor managed to get themselves in debt. Where’s the money gone, he ought ask? The obvious inference is that the Feds in combination will bring us ruin especially if bad times hit. That’s how he should have approached it. Despite the Feds/Howards best efforts. But this government deserves to lose because they’re so silly and uncreative.
Posted on 06-Aug-07 at 12:26 am | PermalinkChris, it’s obvious he means ‘limited for practical purposes’, which is the whole point of the concept of a price taker. If you don’t take Martin’s word for it, there’s a chapter in Andrew Charltons book that sets out the issues very simply.
(In any, I suppose you know that the ‘fixed pool of funds’ notion — in the context of an economy with limited financial integration like Australia 20 years ago — was only ever the ‘conventional assumption’ in what might loosely be termed pre-Keynesian macroeconomics.)
And I didn’t know algebra was your thing but, yes, I’d love to see your equation.
Posted on 06-Aug-07 at 12:27 am | PermalinkHey CS, no reason to get defensive or anything like that. i was just trying to understand the point. But thanks. No comments required.
Posted on 06-Aug-07 at 12:29 am | PermalinkCase in point, last year WA grew at the astoundingly fast rate of about 14% but even then labor managed to get themselves in debt. Wheres the money gone, he ought ask?
JC, if you knew anything at all about WA, you would know that it is bigger than most of Europe and virtually the entire population lives in Perth; which automatically means that the government faces enormous public capital spending to liberate the wealth from place.
James, it may be obvious to you and me, but he did not actually say it, which is why Mark B was led astray. Economists should write carefully. The so-called “fixed pool assumption” is the basis of the so-called “crowding out thesis” which is the ruling othodoxy today. What it overlooks is the crowding-in thesis using its own terms.
I will rescue the maths.
Posted on 06-Aug-07 at 12:34 am | PermalinkI know it late, but you seem to be in one of your better moods to shoot the breeze with a trog like me.
ok fine, I understand how say dredging a channel etc. can lead to faster movements of shipping. That’s easy to understand and I should have said so and not wasted your time. It’s other points that have me a little stumped. Say the govt. did borrow money (at better than sub prime) dredged the channel and that allowed in bigger ships. Fine, lets say they did that and the shipping was moving up and down the channel faster than Katrina. How would that specific borrowing ease up on interest rates, inflation?
It’s this part that has me stumped. Again I know it’s me that’s making the mistake, but seeing youre in a good mood I’ll take my chances with a second question
Posted on 06-Aug-07 at 12:40 am | PermalinkRe WA>
Maybe so, CS, I know WA hasn’t shrunk since the last bout of rising sea level, but it’s a bit odd, no? I mean it grew at a faster clip than China did and they’re out there with red stained fingers.
What infrastructure do they need exactly that the miners can’t provide themselves?
Posted on 06-Aug-07 at 12:43 am | PermalinkFixed pool assumption is bogus. Borrowings can only effect the yield curve. the level of interest rate though shouldn’t change. In other words absolute interest rate levels cannot possibly change…. especially with a fixed pool of cash.
Borrower A goes to market, borrows 1 million dolls for 10 years. He then spends it and ends up in supplier B’s account who places the money in a 3 months bank bill.
Net effect zero, except the hole in the 10 year gap on someone’s lending book and the surplus in another banks liability side of the balance sheet. It causes a bend on the yleid curve that it. There’s no crowding out.
Posted on 06-Aug-07 at 12:51 am | PermalinkHow would that specific borrowing ease up on interest rates, inflation?
Boy, JC, you sure need to brush up on the basics. Don’t they teach supply and demand in Austria anymore? Increased supply reduces demand which reduces inflationary and therefore interest rate pressure.
Net effect zero, except the hole in the 10 year gap on someones lending book and the surplus in another banks liability side of the balance sheet. It causes a bend on the yleid curve that it. Theres no crowding out.
Sure JC, and money grows on trees. You forget there is a real economy, not just entry books for the financial system. Voodoo.
Posted on 06-Aug-07 at 1:05 am | PermalinkWhat infrastructure do they need exactly that the miners cant provide themselves?
What do you think this is? A blog or the WA Department of Industrial Development? Do your own research, chum.
Posted on 06-Aug-07 at 1:35 am | PermalinkCS
I hope your still in a great mood there, CS . So lets take this down Keynes Cul de sac, shall we?
So you’ve built the deeper channel……..If your importing like crazy now with the faster boats/ ships (all things being equal) the exchange rate would drop. How can you assume that the increased supply will lead to increased demand. Under the Keynesian economics we have now, the fall in the exchange rate could lead to higher import prices thereby (all things being equal) leading to a possible rate hike by the central bank due to these “inflationary pressures” from the external account. In other words the dredging could lead to a recession under Keynesian economics. Am i bad for thinking this way, CS.
“Sure JC, and money grows on trees.”
Not in a fixed pool. It can’t by definition, which was how my exmple was predicated.
Posted on 06-Aug-07 at 1:38 am | Permalink“What infrastructure do they need exactly that the miners cant provide themselves?”
Great question. Who asked that? Oh it was me!
CS
“What do you think this is? A blog or the WA Department of Industrial Development? Do your own research, chum.”
Course not CS. I don’t want our academics overworked. There’s more to life than 14 hours weeks….. just kidding I do know how hard you guys work., I married one, so I ought to know.
But on a serious note…. you make it sound as though this infrastructure spending and additional state workers head count during a time of really truly historic growth rates makes it necessary to go out and borrow like crazy and move into an operating deficit. WA last year experienced the highest ever-recorded growth for a small but decent part of the developed world is my bet. Isn’t it the time a govt ought to be running at least a square budget balance? In other words if you can’t run square during a 14% growth rate period what chance have you got at other times.
Big risk, CS Id hate to see the weekly salary bill over there. Lets hope this keeps going.
Posted on 06-Aug-07 at 1:54 am | PermalinkYou’re completely nuts, JC. For a start, I am not a Keynesian economist, I am a post-Keynesian economist. For seconds, if you haven’t read Alfred Marshall, there is no point discussing Keynes. I didn’t say increased supply would lead to increased demand, but the reverse – as a starting premise, increasing supply leads to less demand, nutso, which leads to falling prices, which is why inflationary pressure eases, and therefore also interest rate pressure. This is one the most basic theorems in all economics, and I am not going to talk to anyone in the terms of the discipline who doesn’t understand it, let alone move onto exchange rates; full stop. Stop clogging up this thread with mad ravings. Please go away.
Posted on 06-Aug-07 at 1:57 am | PermalinkDear James, and other hard-core fans of economics only (with tks to Tony Aspromourgos, who helped me with this many years ago). Turn down the lights and come in close. You don’t often see something like this on blogs.
Now, starting, as one does, with a steady state, consider the financial mathematics of ‘sustainable’ debt and deficits:
d = (g-i)D*
This simplified fundamental equation gives configurations of long-run or ‘steady state’ debt and deficit ratios – where d is the trend primary budget deficit as a percentage of GDP; D* is the chosen trend in the ratio of public debt to GDP, g is the trend GDP growth rate of the economy, and i is the average interest rate on public debt, which sets the bench for private debt products the subject which we are here analysing via mathematical pedagogy. (The ‘primary’ budget deficit, by the way, refers to the budget deficit net of interest payments on government debt. The budget deficit as a whole, as a percentage of GDP, is d+iD*.)
To give the equation operational significance, it can be read like this: given the trend growth rate of the economy (g), and given the trend in the real interest rate paid on government debt (i), governments can choose a desired trend in the ratio of debt to GDP (D*). This then determines the required trend in the primary budget balance, d.
But how is the choice of D* made? This is what John Howard is in effect arguing about. Certainly if zero is the chosen value of D*, as he says it must be, then clearly d must be zero – and of course the overall deficit will be zero as well. The overall deficit, as a percentage of GDP, is just:
d+iD* = (g-i)D*+iD* = gD*
Only under the complete fluke that g = i will the desirable steady state value of d be zero, other than in Howard’s case of enforcing D* = 0. And note that with D* positive, and assuming trend positive g, the overall public budget balance (gD*) is necessarily positive.
In a sense, this is merely an expression of the proposition that the private sector needs public debt (pdf): in a growing system there automatically is a growing demand for government securities, and the only way the supply can be augmented is by the government running an overall deficit. In any event, given these basics, we must now be careful in interpreting the logic to define the effects of debt on interest rates. Our starting equation has been all about outcomes along the steady state path, or long-run trends, not change, as Howard proposes.
Hence, if a government starts with a value of D it thinks too high, and wants to move to a lower value of D, as Howard says that the states now should, then in the transition the government would obviously have to run budget deficits smaller than steady state size, and possibly budget surpluses, and/or sell assets, as the Howard government has done in following a pathway that it now implicitly urges upon the states.
In other words, this fundamental equation describes long-run financial ratios not transition paths between different values of D*, whether to zero or any other value. The crux is that the feasible values of D* will finally be conditioned by private sector portfolio preferences. Our whole question thus is: what D* are acceptable to the private sector, and on what terms?
In a market economy, public debt must be willingly held by the private sector, and the readily observable fact is that ‘sustainable’ public budget balances are consistent with a spectrum of D* values, of which Howard’s zero is merely one possibility.
Is zero debt optimal in the particular case of Australia, as Howard argues, to keep interest rates low or any other reason? At its heart, the essential issue is defining, as I have said in my post, the trade-off between the benefits of increasing the trend value D* (and therefore increasing the trend overall budget deficit, gD*), and the costs and benefits of doing that.
One cost might be a tighter primary budget balance, depending on the relationship between g and I, squeezing hospital and other essential and already way over-stretched state services. Unless you live in Voodoo Land, it is also important to notice that higher D* can feed back upon and raise i, raising the bench for private debt and ultimately Australian interest rates overall.
This is to say, as my post does much more succinctly, that i is ultimately determined by the economically relevant characteristics of the debt asset. These asset characteristics, or at least the market perception of them – e.g. a heightened perception of exchange rate risk – might well change as D* gets higher, although, crucially, there are not any smooth continuous functions linking D and i (for they are not directly correlated, depending on the type of spending, or debt asset; as I have effectively said in my post, “crowding in” is as logical as “crowding out”).
As I say, many issues could feed into a consideration of the costs and benefits of increasing the debt/GDP ratio. The appropriateness of using more or less long-lived debt to finance long run public capital expenditures is well understood and appreciated by all mainstream economists, the international credit rating agencies and distinguished commentators, such as Troppo‘s very own Fred Argy. Using debt to finance non-productive recurrent payments, and the classic case is old age pensions, is not supported by anything within the entire discipline of economics.
On the other hand, given the historic character of the Australian economy as a capital importer, and the associated high exposure to foreign liabilities, conceivably low public debt could be justified as a counterbalance to high private foreign liabilities – as Australia now has: this is “country risk” (see also, the “Pitchford thesis”).
In sum, this is a complex matter, on which no glib John Howard-type lies work. On the contrary, it can be said, for sure, that it is extremely unlikely, if not completely impossible, that the correct answer to what is the optimal value of D would ever turn out to be John Howard’s zero.
With Australian public debt now so low relative to GDP, it’s impossible to imagine any real benefits in arguing that the states should take debt lower – for interest rates or anything else – other than for the current low level to be framed up as a political excuse for John Howard’s lies.
Economics lesson over. Comments are welcome. Questions are not encouraged, and only those that demonstrate the effort of comprehension will stand a chance of getting a response, as time may permit. Vexatious contributions may be deleted, without notice or discussion.
Turn the lights back up and resume normal transmission. Cheers.
Posted on 06-Aug-07 at 2:07 am | PermalinkChris
You might have been a little more generous in your acknowledgement to Tony Aspromourgos than thanking him for helping you out many years ago, since most of your above essay is taken verbatim from his Evatt Foundation paper (or some other version of it) here: http://evatt.labor.net.au/publications/papers/64.html
There is nothing wrong with his arguments: they are basically what we teach our third-year public finance students. But the only thing in Tony’s paper itself that’s relevant to your dispute with me is the proposition that once the public debt gets sufficiently large, we may incur a risk premium in the interest we pay. This is true, but it’s not likely to be factor worthy of practical consideration at the moderate debt-to-GDP ratios we have experienced in Australia in the last forty years. Tony was just itemising all the relevant considerations. Furthermore, this premium has nothing to do with a ‘fixed pool of funds’; indeed Tony would be surpriseded to see you rehearsing the loanable funds theory while describing yourself as a post-Keynesian.
The only point of substance which you inserted yourself into the extended quote from Aspromourgos is the one about capital expenditure versus outlays on pensions. I have no quarrel with this as a general point, but it’s worth pointing out that Tony never says that governments should only allow their deficits to deteriorate when it’s to finance capital expenditure. If we wanted to increase D, ie. move from one steady state level to another (not that we ever really in one) in order to satisfy portfolio demand for CGSs, this would justify raising public consumption expenditure, or cutting net taxes on households or businesses.
Posted on 06-Aug-07 at 10:57 am | PermalinkJames,
I think you should be careful what you assumptions. Tony is a friend of mine who prepared the paper to which you refer five years ago at my invitation, following his discussions with me three years earlier in connection with my book Water’s Fall, where his contribution is formally acknowledged. I have also acknowledged my debt to Tony in the comment, as is proper. Nothing more is required.
You might teach it in third year. I teach it to Master’s students, which is difficult enough for me. More to the point, Tony is the toughest disciplinarian in the country, which is why I like talking to him and seek his advice from time to time, sometimes inviting him to prepare papers for the Evatt Foundation, such as the one to which you refer. Historically, it might be reasonably suggested that the paper to which you refer is the fruit of a dialogue between the two of us, not only prompted but also in fact (painstakingly) edited by me. My comment by no means reproduces Tony’s paper verbatim, even though some of Tony’s words are in fact my words. The basic logic is of course repeated, as it is an accurate and timeless statement of what you say is “itemising all the relevant considerations”, in this case in mathematical form, as I undertook.
This is true, but its not likely to be factor worthy of practical consideration at the moderate debt-to-GDP ratios we have experienced in Australia in the last forty years.
That’s what I would argue for the present. We are in furious agreement (except in that the Cain/Kirner period in Victoria may prove awkward for your larger generalisation).
Furthermore, this premium has nothing to do with a fixed pool of funds
This relates to the “crowding out” argument. See earlier comments, or any neo-liberal orthodoxy. I have not supported it, but have in fact argued directly against it, positing the “crowding in” opposite, as any decent post-Keynesian would. “Abra goes up, and cadabra comes down”, as Keynes himself heckled this (neo)liberal proposition.
I don’t quibble with the rest of what you say, except in that it is rather fatuous to accuse me of taking Tony and then suppose to correct me because I haven’t taken Tony. Cheers.
Posted on 06-Aug-07 at 11:49 am | PermalinkIt’s not clear what you mean by ‘crowding in’ here. If it’s simply the converse of crowding out, I don’t know how you can say that orthodoxy ‘overlooks’ it. They think higher government spending (or tax cuts) crowd out private investment via the interest rate mechanism; the obvious corollary is that, if you reduce spending or increase tax rates, this will crowd investment in.
Sometimes ‘crowding in’ refers to the phenomenon whereby an increrase in government spending actually stimulates private investment spending, due to complementarities between public and private capital. This is the ‘opposite’ of crowdin out not in the sense of an alternative, incompatible hypthesis, but rather a different channell of causation. There’s no reason why crowding in (in this sense) can’t happen at the same time as crowding out – which of the two is stronger would be an empirical hypthesis.
In any case, Mark’s initial point was the main one to be made about all this. Economists don’t think that the budget balance in this day and age affects intererest rates, except through its effect on overall activity
and in turn the RBA’s expectation that inflation pressure is building.
I’ll repeat my very first point on this thread, in case it’s been forgotten by now: contrary to what you seem to be asserting, as far as the effect of the budget on the interest rate is concerned, the difference between current and capital public expenditure is irrelevant. The effect of infrastructure spending on long run productivity is not relevant to the RBA’s judgement about inflationary pressure right now, which is what determines current intertest rates and in turn private capital accumulation. Nor would does it influence, for any practical purpose, the credit rating we as a reliable wealthy industrial nation get from foreigners, or the interest rate they charge us.
Posted on 06-Aug-07 at 1:04 pm | PermalinkSometimes crowding in refers to the phenomenon whereby an increrase in government spending actually stimulates private investment spending, due to complementarities between public and private capital. This is the opposite of crowdin out not in the sense of an alternative, incompatible hypthesis, but rather a different channell of causation. Theres no reason why crowding in (in this sense) cant happen at the same time as crowding out – which of the two is stronger would be an empirical hypthesis.
It’s not meant to be an incompatible hypothesis. It is meant to take the conventional neoliberal assumption and turn the result on its head, something Keynes specialised in. If you wish to be relevant in contemporary economic debates, you have to speak in a compatible language to the orthodoxy.
In any case, Marks initial point was the main one to be made about all this. Economists dont think that the budget balance in this day and age affects interest rates, except through its effect on overall activity and in turn the RBAs expectation that inflation pressure is building.
Suit yourself, James. It obviously depends on which economist you ask. I don’t buy the Voodoo economics that says government spending (including debt spending) has no relationship whatsover to interest rates; and my point is, and always has been from the very first sentence in my original post, precisely that it depends on what activity it stimulates. The abdication of any relationship between government debt and interest rates is what I usually think of as woolly-headed leftism, and I feel sure I would be supported in this by my colleague and friend Fred Argy.
The irony here is that you are in effect supporting the “loanable funds” theory, as do Peter/Mark, for their suggestion finally boils down to the Australian government debt market being so small in the international context that its small shifts cannot affect rates – implicitly conceding that large shifts will, implicitly assuming a fixed fund. This is your price-taker point resurfacing, which ignores both government and country risk; even though, as you say, and I would also say, public debt is so low in Australia today that it is virtually insignificant in relation to interest rates.
As far as I can see, there is not much point in arguing this any further.
Posted on 06-Aug-07 at 2:10 pm | PermalinkI’m neither an economist nor an expert in finance, so not in a position to make an informed judgement, and was just passing on what Peter said. However, I’m following the debate between Chris and James with interest.
Posted on 06-Aug-07 at 2:14 pm | PermalinkAs an act of kindness, could you tell me what you mean by (a) the conventional neoliberal assumption, and (b) turning that result on its head. Please don’t refer me back to the post or one of your earlier comments, since I have read those and still do not get your meaning.
To sum up my point: A discretionary increase in government spending or a reduction in tax rates adds to domestic demand and, in an overheated economy, may contribute to inflationary pressure, in turn prompting the RBA to raise the interest rate. It does not do so by bidding up the price of some fixed supply of funds. Even if that was the case in a financially closed economy (which I, along with every post-Keynesian I know of, consider debatable), it doesn’t apply to a small country with easy access to global capital markets, (which is Peter Martin’s point).
Which part of this is Voodoo economics?
Posted on 06-Aug-07 at 2:49 pm | PermalinkThe conventional neoliberal assumption is that there is an ultimately fixed pool of loanable funds and any participation in the market by the government will increase demand, forcing the price (interest) up; this is called the “crowding out thesis” because government borrowing is said to displace more productive private borrowing, which is priced out. To the extent that the thesis has validity, it will be at full employment when a government borrows for non-productive purposes (as in, for example, borrowing for old age pensions – older people do not produce, broadly speaking, as they have retired: to an economist, it might be better if they died as soon as they retired).
The assumption fails (gets turned on its head), when the government borrows in ways that stimulate private production, and at full employment it also fails when the investment increases productivity. I have explained this in my original post and several other ways since, and am not going to explain it again. This was an act of kindness. There will be plenty of googling oportunities for more info.
To sum up my point: A discretionary increase in government spending or a reduction in tax rates adds to domestic demand and, in an overheated economy, may contribute to inflationary pressure, in turn prompting the RBA to raise the interest rate.
This is 101.
It does not do so by bidding up the price of some fixed supply of funds.
This is debateable, particularly by neoliberals. The point falls away to the extent that the government investment stimulates production and productivity.
Even if that was the case in a financially closed economy (which I, along with every post-Keynesian I know of, consider debatable), it doesnt apply to a small country with easy access to global capital markets, (which is Peter Martins point).
So, as a last resort, you still cling to “loanable finds”, or otherwise you would have no need to hold onto Peter’s small country/ large market thesis that you have just tried to reject. Have it everyway you like, I don’t mind. I’m thoroughly bored with the argument, which I only got into in the first place because John Howard’s lies get up my nose.
Bye James, until another post or something new and interesting is said. Cheers.
Posted on 06-Aug-07 at 3:52 pm | PermalinkMark
Since Chris has retired from the discussion, I won’t bother asking him to decipher that incomprehensible last paragraph. But since you expressed an interest, let me summarise the position as I see it.
Chris appears to believe that the orthodox crowding out argument applies to public expenditure and tax cuts, but not to capital expenditure. I think that:
1. It is not conventional wisdom, or neoliberal wisdom, or any wisdom at all, that private investment is constrained by loanable funds in Australia in the 21st Century.
2. There is no critique by Keynes, Keynesians, or post-Keynesians, according to which interest rate crowding out is caused by increases in government consumption and net tax cuts, but not infrastructure spending.
3. Nothing in Tony Aspromourgos’s essay, which is basically concerned with the logic of optimal public debt, contradicts or is indeed particularly relevant to (1) or (2), except — as I mentioned — the bit about the effect on our international credit rating of a hypothetical unsustainable public debt.
4. Infrastructure spending adds to productive capacity in the long run and thereby raises the threshold level of production that would trigger inflation and necessitate an interest rate rate. But that’s further down the track when the new infrastructure is up and running: it doesn’t make the actual investment expenditure now any less inflationary, and I sincerely doubt it has any effect on the interest rate we pay for longer run loans.
5. Both parties talk nonsense about deficits and interest rates. Their policy on deficits should be governed by a long term view of the role of government liabilities in the financial system (as Aspromourgos explained), and that of the public sector in national saving. Interest rates are the province of the central bank, and the public should be trained to expect them to rise when the economy is booming.
Posted on 06-Aug-07 at 10:57 pm | PermalinkJC
You seem a little confused between government debt and the budget position. The WA government budget is in surplus it is raising debt to fund infrastructure, this is a separate issue.
Borrowing to invest in infrastructure, public or private, is good policy. The cash rate is going up regardless of what the state governments do, as it should.
The RBA has already been far too slow.
Posted on 06-Aug-07 at 11:30 pm | PermalinkIt’s an accounting gimmick, SDFC. It’s like saying I have $1,000 in the bank and a mortgage of $100,000. Seeing the mortgage is owed 10 years from now my presnet net worth is $1000.
The states have a total debt committment of about $50-70 billion through present and forward committments. They are ignoring the forward dated obligations in annual budgets and presenting the operating balance as a surplus. It’s a tragi comedy.
Posted on 07-Aug-07 at 12:53 am | PermalinkChris appears to believe that the orthodox crowding out argument applies to public expenditure and tax cuts, but not to capital expenditure.
To the extent that crowding out can occur (for the sake of Howard’s argument), I have merely posited the easiest case where it doesnt, or cant, which is in the case of public expenditures that both increase production and raise productivity (whatever these may be – my two opposite and extreme examples were borrowing for old age pensions vs doubling a port’s capacity by merely removing a headland). This is my post. Full stop. End of my story. Make no more assumptions. Go no further or, if you do, please leave me out.
I only wished to show why Howard is wrong on the easiest case, with the starting assumption on his side. This mode of discourse is known as reductio ad absurdum and was famously loved by Keynes. I was not aiming to write an essay on crowding out and the various possible effects of the varities of public expenditure per se. I have not addressed these issues or aimed to address them, and nor do I intend to address them; however more interesting James may find them.
1. It is not conventional wisdom, or neoliberal wisdom, or any wisdom at all, that private investment is constrained by loanable funds in Australia in the 21st Century.
No one has suggested this, with the exception of John Howard (and an available reading of Peter Martins point, regardless of him leaving a word out). If James and Peter are only suggesting that this is not so because the pie of funds available to Australia in the 21st Century is bigger, they are not critiquing the loanable funds argument, merely ignoring it or implicitly supporting it.
The concept of bidding up the price of money by governments competing for loanable funds is, moreover, so conventional that it can be found in the Wikipedia entry for “crowding out” (second paragraph, first sentence) – and every textbook on public finance I’ve ever read. The issue is commonly debated – so common that John Howard feels he can deploy it with impunity.
2. There is no critique by Keynes, Keynesians, or post-Keynesians, according to which interest rate crowding out is caused by increases in government consumption and net tax cuts, but not infrastructure spending.
This misses my point, or makes a point that I don’t. Firstly, to describe an economist as a post-Keynesian is not to subscribe them to a rigid body of finite economic doctrine, for there is none that has settled as “post-Keynesian – “post” means both going beyond and also maintaining continuity; in this case with Keynes many insights, and the subsequent development of many of his insights. To suggest that public investment may lay outside the question of interest rates, or even take pressure off them, is not inconsistent with the line of thought of the man who wrote:
Finally there is a growing class of investments entered upon by, or at the risk of, public authorities, which are frankly influenced in making the investment by a general presumption of there being prospective social advantages from the investment without seeking to be satisfied that the mathematical expectation of the yield is at least equal to the current rate of interest Only experience, however, can show how far management of the rate of interest is capable of stimulating the appropriate volume of investment. For my own part I am now somewhat sceptical of the success of merely monetary policy directed towards influencing the rate of interest. – JMK
3. Nothing in Tony Aspromourgoss essay, which is basically concerned with the logic of optimal public debt, contradicts or is indeed particularly relevant to (1) or (2), except as I mentioned the bit about the effect on our international credit rating of a hypothetical unsustainable public debt.
I did not introduce Tonys essay. James did, and somewhat rudely. He may profit from reading it more closely in relation to his (2). I also suggest he reads my point with the same logic in my mathematical rendition of my post. The crux is (for my modest point, in my modest post) that there is not a continuous function linking interest rates to public debt, for it depends on the asset, as I said in the first line of my post – the only economics argument I have sought to make or will make (and which is, incidentally, supported by Tony, but not of course John Howard).
As for the rest, James is, in my view, limited to restating over and over the effects of spending on demand, which no-one has argued against. Inflationary effects in transition under my modest post largely depend on employment levels, with policy subject to costs and benefits.
I suggest that James writes a post on what he wants to talk about, which is demand management by monetary policy, and leave this one on interest rates, public debt and John Howard’s lies alone. Alternatively, I hope James will be be kind enough to leave me out of his comments altogether. All he is doing is persistently reinterpreting or misinterpreting what I have written so that it will sit, or not, within his own rigid categories and relations to remake his same preferred points. I have neither the time nor the inclination to keep going around in stubborn circles. I hold to my modest point. He is welcome to hold his own.
Posted on 07-Aug-07 at 12:57 am | PermalinkWhat happened to your house?
Posted on 07-Aug-07 at 2:54 pm | Permalink“Borrowing to invest in infrastructure, public or private, is good policy.”
No its not. And it cannot neutralise monetary debauch.
Posted on 07-Aug-07 at 7:26 pm | Permalink“To the extent that crowding out can occur….”
Crowding out always ALWAYS occurs. There is no magic something-for-nothing. They mysticism here comes from looking at interest rates.. Fixating on interest rates… And failing to look at producer-goods-prices…. the volumes of monetary expenditure on different aggregates…. And most funamentally the intellectual flaw comes from disregarding REAL RESOURCES.
Now I could explain further.
Posted on 07-Aug-07 at 7:32 pm | PermalinkCrowding out is a ONE-TO-ONE thing. The ISLM curves bear no relation to reality.
This is just the recognition that humans must buy/sell/create real resources. They cannot be conjured by Macromancy.
Posted on 07-Aug-07 at 7:38 pm | Permalink“Sometimes crowding in refers to the phenomenon whereby an increrase in government spending actually stimulates private investment spending, due to complementarities between public and private capital.”
This is analytical failure and sleight-of-hand. Because this analysis fails to go through the basic intermediate analytical process of imagining a change in the context of invariant Gross Domestic Expenditure.
Ultimately there is one outfit and one outfit only that exercises control over total nominal Gross Domestic Expenditure. These blokes call themselves the reserve bank.
There is no problem of inadequate spending that we need to worry about under fiat-central-banking if the policies are administered with some competence.
So its unforgiveable error to start talking about spending-this spending-that on a FISCAL level….. as if all our nominal-spending is totally autonomous from monetary policy.
In order to analyse what the real deal is…..the process goes like this:
1. Start from a fixed Gross domestic revenue and consider the implications of change you are talking about.
2. Then imagine GDR expanding at constant rate with the same change.
3. Then go back to invariant GDR and imagine what the policy-under-analysis will do in the context of an open economy that trades with others.
4. Then put it all together.
“Sometimes crowding in refers to the phenomenon whereby an increrase in government spending actually stimulates private investment spending, due to complementarities between public and private capital.”
Its more then clear that this statement reveals that its creator has failed to go through this process.
Posted on 07-Aug-07 at 7:51 pm | Permalinksdfc said:
What happened to your house?
—————————–
True SDFC, but I presumed we understood that a mortgage underlines a “house”.
That is how government accounting works. they have revenues/ expenditures and in the case of the states lots of forward loan committments. Governmnts dont carry “assets” on their books in the same way a business does.
Posted on 07-Aug-07 at 8:27 pm | PermalinkIt would [raise rates] if the borrowing by Australian state government was huge on an international scale. But guess what? Its not. Australia is a price-taker, not a price maker when it comes to international interest rates.
As an ancillary comment on Peter M’s take, about which I don’t wish to argue, much less answer interrogative questions (an attitude that is always to be distinguished from my interest in reading other peoples comments addressing the issue – rather than the author – for the benefit of readers in general), his above statement obviously relies on competition theory.
His assumption, i.e. that price-takers face a horizontal demand curve, can, however, only hold in a single market period. As the demand curve for the entire market is downward sloping (by definition – as implied by Peter’s “huge”), additional demand, however infinitesimal, really must mean that global demand increases and the demand curve must move outwards (if not until the next market period), meaning that the price (interest rate) will rise (unless all other demand is reduced by the exact same amount of the additional demand, however infinitesimal).
This is merely to say that the horizontal demand curve of the price-taker is ultimately only a useful (theoretical and practical) heuristic device. A more convincing theoretical case for low or no constraints, to my mind anyhow, would find a compensating supply-side adjustment mechanism (such as the exchange rate, however infinitesimal the compensation).
People more expert than me in international financial and currency markets may shed more light on this point, which – I add for reasons of personal safety against bumptious bloggers – is not related to the argument in my post (except, perhaps, in transition under certain conditions).
Posted on 08-Aug-07 at 7:59 am | PermalinkJC
You are tying yourself in knots. Budget surplus / deficit refers to operating expenses and revenue. Long-term borrowing to invest in long term assets is good policy, which is why business, households and yes even governments do it. It is not that difficult to grasp surely.
As far as I know governments do carry assets on their balance sheets though I find discussion of the accounting treatment of government assets quite irrelevant to the general point of this discussion. Which as far as Im concerned relates to whether what the Feds are saying about the states is just blame shifting? The answer to which is yes.
Posted on 08-Aug-07 at 3:09 pm | PermalinkAt the beginning of July I posted about John Howard’s Interest Rate Lies. I took a different slant from yours. I was considering his veracity, not his economic learning.
Posted on 08-Aug-07 at 7:08 pm | Permalink