Stopping Deflation with Government Stimulus

Credit NY Fed

This post was inspired by a comment over at The Big Picture. Barry Ritholtz posted some interesting chart pr0n from the NY Fed's report on Household Debt & Credit and a commentator by the name of "HelicopterBen" brought up Richard Koo, whom I've written about before, and whose book I reviewed.

I feel like a broken record, but I'll say it again: Koo's GIGANTIC assumption is that the government will spend the money in projects with a NPV greater than zero. I quote myself below:

I'm just not comfortable leaving that decision up to the guys that decided to try to reflate the bubble by pulling-forward demand, subsidizing toy arrows and foreign liquor and build useless airports. Just sayin.

As I said in my response in TBP (I comment there as "X on the MTA"), trying to return to the good times by maintaining the money supply inflated is like trying to--ignore the negative connotation of disease for a second--infect a patient by inducing the symptoms. Or, if you prefer, curing the symptoms instead of the disease, either analogy works for me. I'm not going to rant about malinvestment, because I've already done so--although Pettis said it better  and then what Steve Waldman said it best. instead, I'm going to make a quick point about the money supply.

One of the Fed's goals is to maintain relative price stability. When Paul Volcker was first appointed Chairman of the FRB, he changed how things work and decided to try to control inflation by targeting the size of the money supply. Little '84 hiccups aside, it is in my opinion he did a good job navigating this new, uncharted territory. At the time this "monetarist" thing was fairly new, but it makes sense to control inflation by controlling the growth of the money supply. This works well because the Fed can act in the markets via the FOMC, and they can release accommodate expansion when it's needed and tighten when things are heating up too fast.

Koo--correctly, in my opinion--argues that during a large-scale deleveraging, when rates are already pushing zero, monetary policy becomes impotent. He argues that no matter how much money a central bank puts out, it won't create inflation if businesses and households are all focused on paying down debt. I think he is totally correct. Where I disagree with him is where he argues that the government should become the borrower of last resort to keep the money supply from shrinking. Yeah, the government can soak-up funds when there's an excess, but can we trust them to release them when the private sector needs them? More so, can the government allocate capital in anything but a wasteful manner? Which brings me to my main point: why do we need to keep the money supply inflated, and businesses and households leveraged? I am not saying we should allow a violent deflationary crisis to take place, or the government shouldn't stimulate when it makes sense, I'm just saying there is nothing wrong with having excess reserves when there's nothing to invest them in. Americans are simply not going to halt spending because of small price declines are expected. I'll put money on that.

Borrowing is contracting and there is excess reserves because people want to save and pay-down debts. Some may need to save the money for future expenses, others may want to pay down the underwater component of a mortgage so they can refinance at a lower rate or sell and move. CC debtors may need to lower their debt-service so they can start spend that money elsewhere. Some may want to lower DTI ratios so they can borrow in the future. Slack in the system is a good thing, just like cash in an investment account. There is nothing wrong with not being fully leveraged or fully invested. Businesses and households are preparing and keeping their powder dry so that once a suitable investment comes, they can act on it. That is healthy and rational.

Businesses and households may be paying down debt because they have ugly balance-sheets as a result of the decline in asset values. Fixing balance sheets is not a bad thing, it leads to strong businesses that can grow once their internal problems are fixed. Trying to keep businesses and households in their current, insolvent and over-leveraged state to prevent a few bankruptcies is like locking up junkies and keeping them high so that they don't have to go through withdrawals: ultimately counterproductive.

I would favor going through a painful deflationary cycle and dealing with the bankruptcies of weak businesses and households, but if the Koo sympathizers really want to transfer debt from businesses and households to the government aka "the borrower of last resort", maybe we could do it by having the government borrow large amounts at record-low rates and sending checks to tax-payers instead of poorly investing it. Tax payers could then use that money to pay-down debts, get out of homes they can't afford, or consume and invest if they are so inclined. If nothing else, it would speed-up the process of getting consumers back to a healthy place where they can start spending again so businesses have an incentive to start investing again. Of course we'd have to deal with higher taxes to serve that debt, but something tells me Uncle Sam has a better rate than Joe the Plumber's Capital One card.

Must read from Interfluidity

 Even in a depression, cutting expenditures to entrenched interests that make poor use of real resources can be beneficial. Even in a boom, high value public goods can be worth their cost in whatever private activity is crowded out to purchase them. Rather than focusing on “how much to spend”, we should be thinking about “what to do”. ... If we do smart things, we will do well. If we do stupid things, or if we hope for markets to figure things out while nothing much gets done, the world will unravel beneath us. We have intellectual work to do that goes beyond choosing a deficit level. The austerity/stimulus debate is make-work for the chattering classes. It’s conspicuous cogitation that avoids the hard, simple questions. What, precisely, should we do that we are not yet doing? What are the things we do now that we should stop doing? And how can we make those changes without undermining the deep social infrastructure of our society, resources like legitimacy, fairness, and trust?

Ummm, yeah, what he said. I've been trying to make that point for six months now, but Stever just blew me away with how well he presented the argument.

Previously:
"My biggest criticism is the assumption that the fiscal stimulus will be spent in value-creating projects / activities--I simply don't think politicians can be trusted to do this." -- From my review of The Holy Grail of Macroeconomics

"Sometimes I really wonder if policymakers understand that the best and most sustainable path to increasing your wealth is not to take someone else's, it's to create your own." -- China, bubbles trade-wars and balance of payments

"For example, if RMB 100 is borrowed to build a railroad, the debt is sustainable if the railroad creates net economic value to China of RMB 100 or more. If it doesn’t, the difference must be considered net debt that one way or another must be paid for by Chinese households." -- Pettis on debt-fueled stimulus

On Healthcare Pt. 1: Economic, Ethical and Political Decisions

Health-care reform has been a BigDeal(tm) lately, and I wanted to express some thoughts about it, the way it works and my general gripes about what is decidedly not real progress in my mind. In this series I will explore the benefits and failures of the current path of health-care reform in the United States. I will talk about insurance companies and risk pools; the difference between moral, political and economic decisions; and (in)efficiencies of scale in different levels of the industry.

I'd like to begin this series by explaining that I am decidedly not a fan of large government. I also do not think that health-care is a right. I think that as a wealthy nation, it behooves us to share this cost to improve the life of the collective and improve our collective experience at a small cost to the privilege. If it all works well, we will collectively be more efficient, create more value and ultimately all be better off. To me, denying health-coverage to someone because of a socio-economic disadvantage that they may not be at fault for is tantamount to denying a child a polio vaccine until they can pay for it out of their wages. An investment in health-care is an investment in our labor force and our future, and I like to think it will have a positive return. That being said, that is an economic decision, not an ethical or political one.

My personal ethical inclination toward universal health-care lies in the fact that  we all get sick. Children in Nigeria, children in the United States, children in Sweden and children in China all get sick. The Queen of England gets sick, the Pope gets sick, Socrates got sick, the Dalai Lama got sick and even the seemingly invincible Dr Gregory House gets sick. Getting sick is as much a part of being a human as is being born, getting hungry and dying. Denying someone the right to live because of something they can't control seems a little backwards. We've spent so many thousands of years innovating, working towards advancement and creating this thing we call society. Fighting this just seems like spitting in the face of thousands of years of human ingenuity and progress over, as Frances McDormand once said, "just a little bit of money," which as I will explain later in the series, may not be as much as you think.

Finally, it is important to plainly state that this system implies a redistribution of wealth, which is a political decision I happen to favor, but many are opposed to *ahem*libertarians*ahem*. It is important to understand that the reasons people support, or oppose, universal health-care are varied in many different dimensions. Calling someone names over their ultimate answer is, in my opinion, unwarranted and a sign of ignorance since, ultimately, these decisions are all deeply personal. Right, wrong and truth are all subjective in this context and calling names because someone refuses to accept our truth as their own is not only intolerant, but ultimately totalitarian. This democracy thing we have going, after all, rests in the idea that we all get to have a say so we can influence, not dictate, what happens. 

This is not progress: Move Your Politician’s Money?

 From The Baseline Scenario:

what happens when the location of political candidates'own money starts to matter. As early as this fall's primaries, expect to hear people ask politicians in debates and through various kinds of interactions: (1) where do you, personally, keep and borrow money, and (2), in all relevant cases, where did you put public money when it was up to you?

Make them put the money where their mouth is? Seems plausible for demand deposits, notes and revolvers; however, who you gonna call when you need to place $3B of callable notes in the muni mkt? Hopefully not your friendly neighborhood credit union. Investment Banking: somebody gotta do it.

Don't government agencies have to use the service provider of least-cost that meets all of the stated deliverables? What happens when Mayor Joe Corrupto decides to do all the town banking through the local Bank that his biggest campaign donor is heading?

Don't get me wrong, I think the idea makes a tiny bit of sense. But only if local banks can provide the same or better service for equal or lesser cost than TBTF banks. Any other way is just begging for favoritism and corruption.