The logic of what I have to say is simple. Getting people to accept is not. People want to believe that government is their rich uncle. Uncle Sam just walks up to the attic, dusts off some of his fabulous wealth, and gives it to us. Try to erase that notion from your mind and pay attention.
A friend of mine does marketing for major events at Capital One Arena. Well, there is not much demand for that these days. Meanwhile, there is excess demand for Personal Protective Equipment (PPE). The economy’s job is to shift resources from producing events at Capital One Arena to producing PPE. Maybe we’ll reach a point in a year or two where resources should shift back.
Meanwhile, we have the government supposedly giving us $2 trillion. Let us see how that works in three scenarios. In the first scenario, the government can neither borrow nor print money. In the second scenario, it can borrow but not print money. In the third scenario, it can print money.
1. Must use real resources
Suppose we feel sorry for the folks who used to work for Capital One Arena, and we want to make sure that they can eat. We could form a charity, and the charity could collect food donations from other people, perhaps people who are earning income producing PPE. We could redistribute these food donations to the ex-workers from Capital One Arena.
With no ability to borrow or print money, Congress would have to act like a sort of forced version of this charity. Congress cannot create more food by magic. If it wants to feed the unemployed, it has to take food from the employed.
Apart from being nice to the unemployed, how would this help the overall economy? The Keynesian way to think about it is that the PPE producers will just hoard their incomes and not spend it on anything that would create jobs. But the unemployed workers would spend income on stuff that would create jobs. So if you take food from the employed and give it to the unemployed, their will be more spending and less unemployment.
But this Keynesian view is not necessarily correct. Even if the employed workers are savers, their saving can be put to work by firms to obtain machinery, by households to buy houses, and by students to invest in their human capital. The Keynesian world is one in which savings just disappear down a black hole. They call this the Paradox of Thrift. I call it a far-fetched story.
2. Government Borrowing
Suppose that the government does not have to take food from the PPE workers to give to the unemployed. The government can instead borrow from the PPE workers and pay them for food to give to the unemployed. This works out the same as the first case, except that some of the savings of the PPE workers now goes into government bonds. Maybe they continue to put as much as they did before into the market for machinery, houses, and human capital, or maybe they decide to put in less. If they decide that they don’t want to raise saving by the amount that the government is borrowing, then they will try to buy some of their food back. This will cause prices to rise.
3. Printing money
Suppose that the government prints money to buy food from the PPE workers to give to the unemployed. But there is nothing more being produced than before. If there is 10 percent more money for the same amount of stuff, prices will go up 10 percent.
Describing an economy in which there is a fixed amount of stuff that can be produced makes Keynesian economics seem really stupid, which I believe it is. But I can be more charitable. The Keynesian idea is that borrowing or printing will actually lead to more production. The belief is that demand creates its own supply, as it were. When the unemployed get their food (or their money), they go out and buy stuff, and other unemployed people get hired to make that stuff, giving them incomes to buy other stuff, and so on, absorbing more and more unemployed resources.
But remember how I see the economic problem here. We have resources that are in the wrong place, like workers waiting to get jobs back at Capital One Arena when what we need is help producing PPE. More borrowing or money-printing isn’t going to make the Capital One Arena jobs come back–that depends on what happens with the virus. To the extent that more stuff isn’t produced, the borrowing or printing is just going to raise demand for what is produced.
My main point is that it is more accurate to think of government spending as taking, not as giving. You can only give if you have something to give in the first place. The government does not have valuable production to give. What the government does is take.
Back in the mid 1970s, I used to argue that the reason we were experiencing higher unemployment rates AND higher rates of inflation (contra the Phillips Curve) was what I termed “secular shifts in demand”, in that era having to do with trying to shift manufacturing employees into the oil patch. Arnold Kling’s analysis here says similar things are going on now, and I think he’s right. Furthermore, if he (and I) are right, a so-called stimulus programme will do little to increase real production. It will however add to cronyism, suspicion of gubmnt, suspicion of market capitalism (sadly), and inflationary pressures.
The point is not to increase production above the 2019 level. The point is to prevent the level of production from decreasing by more than it would without intervention. I don’t think “stimulus” is the appropriate word. Perhaps “maintenance” plan is more accurate.
Great point.
Indulge a question from an econ amateur. I thought $2 trillion rationale was a) forestall panic and b) create more buy-in for shutting down society.
Then virus passes, mostly, sort of.
Then much more tax revenue is available than if we allowed panic.
So the rationale is: gov’t is indeed Taking Money but as a result, has a bigger economic pie to tax vs Not Taking and panic?
For now, the government wants the economic pie to be smaller to reduce virus spreading. When the virus passes, the economy should rebound, and tax revenue should rebound. But whether at that point the economic pie is higher because of the “gift” we hand out today is questionable. If the pie is indeed bigger, because fewer small businesses have shut down, then the legislation will have accomplished something. But I think that the same thing could have been accomplished with loans.
“the government” has goals including both economic rebound AND re-election of “the government”. “The same thing could have been accomplished with loans.”
Yes to the economic rebound goal – loans would have been even better. By far!
But, thanks partly to silly socialists in most colleges, and an elite which hates Reps, it’s not at all clear that any loan would be as electorially (?) popular as “free” gov’t cash.
Trump, in particular, can’t fight the Dem majority in the House for anything other than bigger, or Bigger, or BIGGER spending.
Any who believe such deficits are unsustainable, and I’m fairly sure they are, should be outraged at elitist college professors. And I am.
Is this a falsifiable belief? (That there IS a limit) I don’t see how. Assume there is no limit … use the Central Bank to borrow as long as any loan you cash … and see if there is global economic crash, depression, and resulting revolution. I fear no limit belief will be tested, with this terrible result, and don’t want to see it.
The economy is highly levered; most people and companies have made binding commitments based on projected future income.
A shrinking economic pie either means a large wave of bankruptcies cascading through the economy or a de-facto partial, general default through inflation. Inflation may be the best choice here.
Taking? Yes, but not sure from today, but more so from tomorrow. The Virus has caused what i will call a liquidity or cash flow crisis experienced by households and various business entities. The goal: avoid as much economic damage today as possible, recognizing that there will be losses but with bridging this liquidity/cash flow event of whatever duration it to be, the losses on a PV basis will be less than if all taken today.
Arnold,
Thank you for this very lucid analysis. My intuition is that the 1st scenario is defensible in a vast public-health emergency — Government must use real resources to provide public “charity” through taxation-and-transfer, because private charity won’t suffice.
Fundamental problems:
(a) Public charity gets very distorted in the sausage factory;
(b) Ideologues, interest groups, and mainstream macro-economists use public charity to advance the other, more massive scenarios (which you show are indefensible);
(c) The welfare state tends to crowd out private charity for the worthy in the long run.
Question about scenario 2 from an undergraduate economics student:
You seem to imply that the PPE workers are not Ricardian because they don’t raise savings to anticipate future taxation due to the debt issuance. Wouldn’t it be the case that if every dollar borrowed from the PPE workers is then used to give the PPE workers money in exchange for their food this has not changed net wealth of PPE workers. Even though it has not changed their wealth (in a Ricardian word) are you asserting that their consumption of food would increase relative to before the government got involved, or rather because they have less food now to consume the same amount of food they would have to spend more and save less. I hope this makes sense!
Normally I would be very sympathetic to this line of argument but it doesn’t seem correct here.
First, under panic conditions, the paradox of thrift, normally nonsense, becomes closer to true. Savings is channeled to investment by the financial system, which is in the process of seizing up. Most firms are not borrowing to invest right now, and 0% interest is insufficient to motivate them to do so.
Second, not all the important things we want unemployed workers to be able to pay for involve real resources. Rent payments and health insurance premiums being the most obvious examples.
Third, as I’m sure you’d agree our economy is no longer dynamic enough to rapidly shift resources from e.g. entertainment services to PPE goods. The unemployed workers from Capital One Arena will not be able to find jobs producing masks or ventilators, at ANY wage.
I wish there was a better way to coordinate funneling resources to the tens of millions of Americans that now cannot afford rent or food, but I don’t think there is one. Centuries of accumulated red tape prevent civil society and the market from solving this problem quickly enough to count. We have made ourselves dependent on the state.
“Second, not all the important things we want unemployed workers to be able to pay for involve real resources. Rent payments and health insurance premiums being the most obvious examples.”
Huh? Rent pays for a place to live, a real resource. Health insurance premiums pay for health insurance, which pays for the work of doctors, nurses, ventilator manufacturers, etc.
If you are paying rent on a building, the building continues to exist whether the rent is paid or not. No *production* is taking place and no real resources are consumed. It’s true that if _you_ are not renting that place then _someone else_ could be, but how relevant is that to the discussion at hand?
With health insurance premiums you are paying for an option to consume real resources. Again no production takes place in response to the presence or absence of those payments. While having insurance is known to affect health care consumption, that fact pattern does not currently apply due to the crisis (e.g. my doctor is only doing “telemedicine”). Put simply, discretionary health care consumption has been halted, so virus aside, whatever care is being consumed is likely to be emergency in nature, and therefore would be consumed regardless of whether it can be paid for.
I’m deliberately ignoring second-order effects here. Obviously your landlord and your insurer are going to use your rent check or premium payment for something, and eventually this connects to real resources somewhere. But in the short term (as in the next 2-3 months while we endure Peak Crisis), these arrangements are purely financial.
So you’re saying that no real resources are “consumed”. That’s not quite true. While you’re living there, the hot water tank is thinning, the washers in the faucets are wearing out, paint is peeling, walls are getting nicks and bumps. The place is generally wearing out, unless it is getting fixed and/or renovated, in which case it is obvious that (new) real resources are being consumed.
To the extent that “health care” workers are no longer providing health care, then certainly no resources are being consumed. But many still are, to a greater or lesser degree.
See also this piece about the toilet paper shortage https://marker.medium.com/what-everyones-getting-wrong-about-the-toilet-paper-shortage-c812e1358fe0
Re-directing commercial toilet paper to the retail market would be trivially easy compared with re-directing labor and other real resources from entertainment to PPE, and yet it is happening very slowly.
One problem is that services people never thought that they would become assembly labor.
Forty states have laws requiring balanced budgets: consistent with Dr Kling’ s observations above, they are operating in situation 1 more or less. Many have rainy day funds and some have unfunded pension liabilities, but nevertheless, the more functions of government transferred to the states with a corresponding reduction in the size of the national government, the better off we all will be.
Unfunded pension liabilities at both the federal and state level are taxes on future growth as well. It is time now for government workers to be moved off defined benefit plans into defined contribution plans. Doing so moves pensions from a type 2 situation to a type 1 situation. Very few private businesses offer defined benefit retirement plans anymore so making the change ought to appeal to other audiences as well, for example, the inequality obsessed.
Taxing the fortunate is probably the least efficacious means of raising revenues. The fortunate are willing to conserve their wealth through economically inefficient accounting strategies, etc. Why would Jeff Bezos pay taxes when he could just build another office with a rain forest in it? Tax reform is desperately needed to increase tax revenues. The best reform would be shifting to a consumption tax like a VAT so that Bezos winds up paying taxes as well as all the other tax exempt industries like education, charities, think tanks etc as well as all the inefficient tax code preference nudging.
their saving can be put to work by firms to obtain machinery, by households to buy houses, and by students to invest in their human capital.
The interest rate is the best way to measure how ready the real economy is to put savings to work. It’s very low; we’ve had a savings glut for a long time. It seems that anyone who can use money profitably can get it and many fairly stupid investments are being funded. Accordingly, I think that (right now) the Keynesian story is basically correct. If interest rates rise, I will consider the Keynesian story correspondingly less credible.
My prediction is for no inflation — particularly not in the short term, but probably also in the medium term. Under current conditions, handing out more money will not increase demand for food, simply because population is not increasing, I’d guess we’re wasting less of it, and buying food is a hassle (possibly even somewhat dangerous). So I suspect some kinds of foods will see lower demand and lower prices. I went shopping today and fresh raspberries were on sale. I assume that’s because they can’t be stored and there aren’t enough buyers.
In the medium term (after the first shutdown is relaxed), I suspect there will be a lot of worry about job security and the demand for savings will increase. Also, for a while, doing anything that looks like splurging may be considered a bad look. Even people in secure positions may not want to put a shiny new car in the driveway when they’re surrounded by still unemployed neighbors who are worrying about making mortgage payments.
Production in the food industry and related industries haven’t stopped in any of the countries that have implemented quarantine. The same amount of food is produced as before the Coronavirus crisis. If the majority of the population have no money to buy food or let’s say eats half the amount of calories that it used to, then the surplus food they cannot buy will remain stocked and eventually some will be thrown way (fresh food or with short expiring date)
Let this sink in.
You are saying that in the Keynesian world savings disappear down a black hole and you don’t believe it.
I want to suggest this concept is not completely unbelievable. When there is economic fear the resulting low inflation and low interest rates might not adequately incentivize borrowing for consumption and borrowing for investment in production. Savings would earn very little and some savers might irrationally seek to earn nothing or find it more convenient to earn nothing. Some savers, private banks, have accounts at the Federal Reserve. Those savers might find it rational to earn 0.25% instead of lending and in fact trillions of USD were stored that way for several years since 2008. Stored money has not disappeared down a black hole but it has temporarily disappeared in the shadow of the moon.
Incremental money creation does not cause inflation because incremental money can be stored by savers. Those savers were choosing a 0.25% rate instead of a volatile but similar rate on U.S. Treasury bonds near maturity. Incremental (government) borrowing can cause inflation but if a similar increment of money is being stored by savers then the borrowing does not necessarily cause inflation.
Imagine if there were no money but for the sake of convenience all barter transactions saw canned food traded for goods and services. In other words, canned food replaced money. When there is economic fear the canned food price for goods and services will not increase and instead it might stay the same or it might decrease.