Thursday, January 20, 2011

The "Credit Impulse"

Selected paragraphs from Steve Keen, A Fork in the Road?:

Private debt has gone from rising by US$4.5 trillion in the USA—thus adding $4.5 trillion to aggregate demand—to falling by $2.5 trillion, and thus subtracting from aggregate demand there. This was the factor that drove the US from boom to near-Depression.

But though Australia began the deleveraging process, it stalled it just as the change in debt approached zero. The increase in debt since then has been a major factor in why our unemployment rate stopped increasing, and has since fallen.

The common factors driving the two economies (and therefore the difference in their economic outcomes to date) is starkly evident when one considers the “credit impulse”—or the rate of acceleration of debt.

[Australia] got out of the crisis before we really got into it by reversing the private sector’s trend to deleveraging, and encouraging borrowing once more.

Can we keep on borrowing our way to prosperity? Here’s where I turn cynic once more: we could, if we didn’t already have an unprecedented level of private debt

This implies a limit to the credit impulse (both in Australia and overseas). For the credit impulse to remain positive, then ultimately the debt to GDP ratio must start rising, and keep rising. But with the economy so heavily indebted already, the credit impulse is likely to peter out and give way to decelerating debt once more—with a negative impact upon aggregate demand.

This returns me to the bottom line of my credit-oriented analysis. Sustained recoveries from recessions in Australia and the whole OECD in the last 40 years have all been accompanied by rising levels of private debt to GDP. I simply don’t believe that’s possible now.

And Keen from a comment on that post, regarding the reliance on credit:

At an extreme, if you owe 1% of your annual disposable income and a loan shark is charging you 100% interest p.a., then you can get out of that trap in a few days: servicing the debt takes 1% of each paypacket, so increase the payment to 2% and after slightly more than 1% of the year is over, you’re out of debt.

If you owe 100% of your annual disposable income and an ultra-friendly building society is changing you 1% interest, it still takes 1% of each paypacket to service the debt. But it would take you more than a year to pay the debt down via the same manoeuvre.

This is, I'm quite certain, only the third Keen post I've ever read. Every time I do read one, I have to praise it. I agree more with Keen's analysis than with any other.

Given Keen's analysis of the problem presented here, I can only add that the obvious solution is to use policy to help reduce the accumulation of private-sector debt.


Greg said...

Steve Keen is outstanding. I actually found him before I found Bill Mitchell.

What Keen leaves out of his analysis is the vertical portion of money creation. The conduit between govt and non govt. Keen does his outstanding work on the horizontal relationships within the non govt sector. This vertical and horizontal distinction is crucial to the MMT paradigm.

Greg said...

Oh I meant to add

As a result of his looking only at the horizontal relationships, Keen sees the only solution to our problem as debt jubilee. Mitchell, while agreeing that some jubilee is desirable or likely, adds that a govt willing to run high enough deficits can support the additional spending requirements of a highly indebted private sector.

The Arthurian said...

To me, the problems of our economy are not the result of inadequate government spending. They are the result of an excessive accumulation of debt (or so my graphs tell me).

That being the case, I am more likely to see "jubilee" as a solution -- that's like "forgiveness," right? -- rather than additional govt spending.

But I think MMT has the "operational" stuff figured out, and understands what will work and what won't.

Greg said...

You are correct when you say that the (underlying) problems of our economy are not the result of too little govt spending, and Im quite sure that all MMTers would agree, however, at this point, with debt jubilee or forgiveness likely to be even less popular than a tax hike ( at least with the crowd who mostly drives policy), govt spending is the only other option along with tax cuts.

Now, the form this spending takes can be many things. A Job Guarantee like Bill and Warren advocate, a huge public infrastructure program or earlier age to collect SS benefits are a few things out there.

The Arthurian said...

[Hesitantly] Okay... Let's say the only option is to increase government spending and cut taxes.

I still say they should use the money to pay off private-sector debt.

If everybody suddenly had their debt cut in half, we'd have a lot more disposable income left over. It's the same principle as Mosler's plan to eliminate the payroll tax.

The 300+ million Americans who oppose the growth of government might go along with a government plan to pay down their debt, especially if this program expired when its task was done.

And I still say you can just print money and use it to pay off debt, because paying off debt destroys the money. So I think the Fed can do it, and Congress need not even get involved.

Greg said...

No disagreement from me regarding where the spending should be directed (at private debt reduction)

I'm not sure the fed can do it though. The fed, as I understand it, only gives out loans or swaps assets. They cannot issue debt free money, I dont think, that is a fiscal operation. I might be confused on this but I think Scott Fullwiler has dealt with that before.

The Arthurian said...

Yeah. Tschaff also said something like that a few months back, I believe, and it shut me up for a while. Still... In the Kucinich bill we find:

"(24) Reclaiming the power of the Federal Government to create money, and to spend or lend money into circulation as needed, eliminates the need to treat money as a Federal liability or to pay interest charges on the Nation’s money supply to financial institutions..."

So all that's needed is a little Congressional approval for the Fed to fix past mistakes. Congress wouldn't have to approve any "spending" so they would be off the hook. And if the money that gets printed is destroyed by paying off debt, then the whole thing is copacetic.

Not sure, but the Kucinich excerpt sounds a lot like MMT to me.

Greg said...

Mosler had a dissection of Kucinichs proposal a few weeks back. He said it was a step in the right direction (parts of it anyway) but still not MMT. I'll see if I can find it and link to it for you.

He had a more recent post about coin minting that I think addresses what you are talking about here. He is talking about ways to get around the debt ceiling and it doesnt use the central bank but the "mint" (which I think is an arm of the treasury)

The Arthurian said...

Oh, I see Mosler's post on the debt ceiling. Interesting.