[phil_20686]

helene_t, on 2011-June-06, 05:19, said:

Not really. If a transaction gives me a before-tax profit of x and my tax rate is r then it gives me an after-tax profit of (1-r)x which has the same sign as x as long as 0<r<1.

What matters is the tax rate on one opportunity relative to the tax rate on other opportunities. If I bake my own bread I pay zero taxes on the value of my work while if I do paid work and spend my salary on paying the baker for baking bread for me then I do pay taxes, and the higher the tax rate the bigger the incitement to bake my own bread.

I have a friend who is fond of saying that the answer to every question in economics is "Its a bit more complicated than that".

Even in your case of a profit tax, you will effectively stop an activity if the profit falls below the central bank interest rate, and further, in practice the cost of taxes on businesses is nearly always borne by consumers in the form of raised prices. E.g. the "inflation" spike following the rise in VAT in the UK. And rising prices always mean that the number of units sold will fall. Ie less trades.

[phil_20686]

cherdano, on 2011-June-06, 05:40, said:

That's a bit simplistic. Let's consider a metro line. If the metro company sells tickets at the marginal cost of transportation, it will run a big deficit. However, the consumer surplus generated by all passengers using the line will probably outweigh that deficit. Yet, price discrimination for metro tickets just doesn't seem to work (selling rush hour tickets more expensively doesn't count, that's just accounting for the difference in marginal cost). So a private company won't be able to run a metro line at a profit, even though it creates a (potentially big) economic surplus.
In addition to that, a metro line will have huge indirect effects. It will spur the development in the suburb it is creating, it will decrease congestion on roads running in parallel, it will decrease the need for regulatory parking subsidies, etc. etc.
So I would argue that a government-run (or basically government-run) metro line
2a) increase GDP (via the expenditures for building and running the line)
2b) creates an economic surplus (or a net increase in quality of life, if you prefer)
2c) can indirectly spur development and growth

Of course, such beneficial opportunities are always limited, and at some point the government may run out of infrastructure investment opportunities where the costs (in the need for higher taxes, along with their negative impact on economic growth) outweighs the benefits.
The US, to put it mildly, does not seem to be at this point.

I merely meant, that since GDP amounts to the sum of all spending, an increase in spending always amounts to an increase in nominal gdp. You have merely constructed an example where the multiplier for government spending is greater than one. I.e., where it increases GDP by more than the amount spent.

If your point was really that the good done can outweigh the "badness" of having a deficit, I do not disagree, but it seems virtually certain that it would be better off to have paid for it in extra tax than by (structural) deficit. In the spirit of "its a bit more complicated than that" let me outline an alternative scenario.

Suppose I borrow money to build a motorway in 20xx. All is good and it causes decent economic return. A few years later a new technology cuts the cost of building a motorway by a factor of 5. Now with the money that I have to pay back in debt for the motorway I have already built, I could have built 5 motorways. So I have a "lost opportunity" cost.

Of course, the counter argument is that with my extra revenue from the the first motorway I can fund more debt so I can actually build all 6 motorways. I do not think that this is really a good argument as in practice the amount of debt one can have at any one time is finite, so by holding debt (even if it increases my revenue) I have probably certainly lost money if motorways became that much cheaper, as there would be many motorways i might want to build at that price....etc etc.

[Winstonm]

Opportunity cost is the value of the "next best thing" you could have done with the money.

Lost opportunity cost is the dream they sell in Las Vegas.

[helene_t]

phil_20686, on 2011-June-06, 16:37, said:

Even in your case of a profit tax, you will effectively stop an activity if the profit falls below the central bank interest rate

Assuming I have the option of receiving tax-free interests from the central bank.

[cherdano]

phil_20686, on 2011-June-06, 16:53, said:

I merely meant, that since GDP amounts to the sum of all spending, an increase in spending always amounts to an increase in nominal gdp. You have merely constructed an example where the multiplier for government spending is greater than one. I.e., where it increases GDP by more than the amount spent.

No, this is just a side point. My main point is that in the case of a metro line, a "benevolent monopolist" is able to create a huge amount of value that is not measured by the increase in GDP. That's what I meant with "consumer surplus". However, this cooperative monopolist needs to run the metro line at a deficit, and essentially only the government is in the position to be able to do that.

Quote

If your point was really that the good done can outweigh the "badness" of having a deficit, I do not disagree, but it seems virtually certain that it would be better off to have paid for it in extra tax than by (structural) deficit. In the spirit of "its a bit more complicated than that" let me outline an alternative scenario.

This is really a separate discussion. But all serious economists seem to agree that a modest structural deficit is beneficial for the economy. It increases the availability of money, which encourages economic activity. (That's why the Fed is targeting a non-zero level of inflation.) Since not running a deficit is a drag on economic growth, the logic "if the government hadn't borrowed 2 Billion in 2000, it could spend 2 Billion * (interest rate)^10 times more in 2010" does not hold.

[phil_20686]

cherdano, on 2011-June-07, 21:31, said:

No, this is just a side point. My main point is that in the case of a metro line, a "benevolent monopolist" is able to create a huge amount of value that is not measured by the increase in GDP. That's what I meant with "consumer surplus". However, this cooperative monopolist needs to run the metro line at a deficit, and essentially only the government is in the position to be able to do that.

Ah, ok, I see. Yes, a government can do this. My intuition would be that the consumer surplus will get spent else where, so the benefit will probably turn up in GDP somewhere, in the same way that a more efficient transport infrastructure tends to help economic activity.

cherdano, on 2011-June-07, 21:31, said:

This is really a separate discussion. But all serious economists seem to agree that a modest structural deficit is beneficial for the economy. It increases the availability of money, which encourages economic activity. (That's why the Fed is targeting a non-zero level of inflation.) Since not running a deficit is a drag on economic growth, the logic "if the government hadn't borrowed 2 Billion in 2000, it could spend 2 Billion * (interest rate)^10 times more in 2010" does not hold.

There seem to be several points here. I think everyone agrees about the benefits of a mildly inflationary economy. However, it does not follow that borrowing is a sensible tool to achieve this. Afterall, a government can inflate the economy easily by "printing" money. It feels like borrowing from the private sector is inflationarily neutral since, in general, the private sector will find a way to put their capital to use anyway. This means that government borrowing is (relatively) inflationary only if the private sector was planning to sit on the money. Further, by printing enough to put inflation at 3-4% the government gets the best of both worlds, since it makes it expensive to sit on capital and therefore forces the private sector to invest even without borrowing money.

Further, several well run advanced economies run surpluses routinely, eg Australia. I think if you sensibly manage a sovereign wealth fund you can achieve worth objectives while saving up money for a rainy day, eg, buying up land in cities to create parks, and prevent over development which in the future could be sold to business to raise funds. I do not see that such a scheme necessarily represents economic drag. It is true that one can sustain a small deficit forever provided that one has robust growth, but I am not at all convinced that this is a better strategy than a (cyclically) balanced budget.

[Winstonm]

IMO inflation is not so easily created with debt-backed fiat currencies, and inflation is a monetary event only with a commodity-backed currency where there actual value can be lowered by creating additional currency without proper backing.

In the U.S., the thinking error is that the Fed can "print money", but that is only part of the picture, as they must then "buy" something with that money, namely, debt. It is hard to buy U.S. debt if the budget is truly balanced.

Quantatative Easing undertaken by the Fed has been their move into the bond markets to buy long-dated US treasury bonds.

At the other end the 3-4% inflation idea is the crushing affect inflation has on fixed incomes, but I doubt a hardline Randian free-marketeer cares much about the difficulties of the lower 95% and especially when Soylent Green prices have gone up dramatically and you own that stock.

[phil_20686]

Winstonm, on 2011-June-09, 07:29, said:

In the U.S., the thinking error is that the Fed can "print money", but that is only part of the picture, as they must then "buy" something with that money, namely, debt. It is hard to buy U.S. debt if the budget is truly balanced.

The government can also pay the wages of its employees with this money, for example. Provided the amount printed does not exceed the value of the goods and services that the Government purchases is can buy `real stuff' rather than debt.

Buying debt is a strategy for helping the banks, it seems mostly irrelevant to the printing money argument.

[phil_20686]

Winstonm, on 2011-June-09, 07:29, said:

At the other end the 3-4% inflation idea is the crushing affect inflation has on fixed incomes, but I doubt a hardline Randian free-marketeer cares much about the difficulties of the lower 95% and especially when Soylent Green prices have gone up dramatically and you own that stock.

This is not a real argument, as wages respond to inflation. Inflation as high as 10% has not been uncommon in developed ecnonomies since WW2, in the UK inflation averaged 13% for the 1970's for example, inflation, but gdp at PPP still rose in the UK through this time.

[PassedOut]

phil_20686, on 2011-June-09, 14:16, said:

This is not a real argument, as wages respond to inflation.

Many retired people here no longer receive wages, but live on income that is fixed, such as an annuity or a set pension. Inflation reduces the buying power of these folks.

[Winstonm]

phil_20686, on 2011-June-09, 14:16, said:

This is not a real argument, as wages respond to inflation. Inflation as high as 10% has not been uncommon in developed ecnonomies since WW2, in the UK inflation averaged 13% for the 1970's for example, inflation, but gdp at PPP still rose in the UK through this time.

What part of fixed income do you not understand? Wages are not fixed income. Retirement accounts, Social Security, Disability - these are fixed incomes. Inflation crushes those who are on fixed incomes and depletes the value of savings, leading to a buy and spend economy, leading to borrow and spend, leading to a crash...oh, didn't we just do all that?

[Winstonm]

phil_20686, on 2011-June-09, 13:56, said:

The government can also pay the wages of its employees with this money, for example. Provided the amount printed does not exceed the value of the goods and services that the Government purchases is can buy `real stuff' rather than debt.

Buying debt is a strategy for helping the banks, it seems mostly irrelevant to the printing money argument.

What exactly do you think wages owed by the government to its employees would be other than a government debt - sure it is short term debt but it is still an obligation (a debt) to pay a certain amount.

Besides, I don't think you are right about this. The U.S. Treasury would have to fund the payments, and all the Fed can do is fund the Treasury, so the Fed still has a debt obligation to own by way of the Federal budget which is funded by taxes and bonds.

[y66]

Of poss. interest:

The Interest Rate That Did Not Bark in the Night: The Surge in U.S. Treasury Debt and the Non-Reaction of Rates by Brad DeLong. Excerpt:

Quote

It is in this situation that we want a government deficit--the government to print and issue the safe bonds that private investors really want to hold. As these bonds hit the market, people who otherwise would have socked their money away in cash--thus diminishing monetary velocity and slowing spending--buy the bonds instead. A large and timely government deficit thus short-circuits the adjustment mechanism, and avoids the collapse in monetary velocity that was the source of all the trouble. And as long as output is depressed--as long as monetary velocity is low and there is slack in the economy--printing more and more bonds will have next to no effect increasing interest rates.

I will never doubt John Hicks again.

But how much longer can this go on?

It seems to me that sensible policy should cater more to unemployed dogs who are barking now than to the fat cat dogs who will be barking when their bond portfolios become imperiled by so far non-existent inflation.

Clearly, the fat cat dogs and their political pals are winning the barking contest.

[PassedOut]

y66, on 2011-June-10, 06:51, said:

The Interest Rate That Did Not Bark in the Night: The Surge in U.S. Treasury Debt and the Non-Reaction of Rates by Brad DeLong.

It seems to me that sensible policy should cater more to unemployed dogs who are barking now than to the fat cat dogs who will be barking when their bond portfolios become imperiled by so far non-existent inflation.

Clearly, the fat cat dogs and their political pals are winning the barking contest.

Good article in that it addresses the crucial importance of the velocity of money (as opposed to the formation of capital, which affects the economy more slowly) in restoring jobs and economic health.

Quote

And so the speed with which cash turns over in the economy, the velocity of money, falls. And as the velocity of money falls, total spending falls, and workers are fired, and as workers are fired and lose their incomes their saving goes from positive to negative.

Because the velocity of money is so important, a short-term deficit in hard times is most useful when the money goes directly into the hands of those who spend it immediately. Government programs that build infrastructure put money into the hands of otherwise unemployed construction workers, and at the same time provide the conditions for continuing economic growth: a double benefit.

[Winstonm]

PassedOut, on 2011-June-10, 07:40, said:

Good article in that it addresses the crucial importance of the velocity of money (as opposed to the formation of capital, which affects the economy more slowly) in restoring jobs and economic health.


Because the velocity of money is so important, a short-term deficit in hard times is most useful when the money goes directly into the hands of those who spend it immediately. Government programs that build infrastructure put money into the hands of otherwise unemployed construction workers, and at the same time provide the conditions for continuing economic growth: a double benefit.

There is another school of economic thought that gives no credence to velocity at all, the Austrian school:

Quote

Contrary to mainstream economics, velocity does not have a "life of its own." It is not an independent entity--it is always value of transactions P(T) divided into money M, i.e., P(T/M). On this Rothbard wrote: "But it is absurd to dignify any quantity with a place in an equation unless it can be defined independently of the other terms in the equation." (Man, Economy, and State, p. 735)

Since V is P(T/M), it follows that the equation of exchange is reduced to M(PxT)/M = P(T), which is reduced to P(T) = P(T), and this is not a very interesting truism. It is like stating that $10=$10, and this tautology conveys no new knowledge of economic facts.

Their take is that currency only facillitates exchanges and it is the underlying work that actually finances the economic exchanges.

Say's Law states that supply creates its own demand. IMO, this means that work product (supply) creates its own demand (ability to consume). Unfortunately, it seems many people misunderstood this Law to read that if one overbuilds millions of McMansions that magical pixie fairies will suddenly materialize to buy them with no money down.

Reality is that the overbuilding did temporarily create jobs which created demand, but the demand it created was unsustainable because of a misapplication of Say's Law, and the pixie fairies of supply-created demand did not materialize to consume the oversupply.

Last quarter U.S. consumption grew at an anemic annualized 0.7% according to Caroline Braun of Bloomberg. With an unemployment rate of 9.1% (no work product) to produce demand (ability to consume), is it any wonder consumption is so low?

[PassedOut]

Winstonm, on 2011-June-11, 07:20, said:

There is another school of economic thought that gives no credence to velocity at all, the Austrian school:

I understand that, as I understand that some people give no credence to evolution and some no credence to global warming. In reality, many transactions that would occur if folks had money do not occur at all when folks do not have money.

[cherdano]

phil_20686, on 2011-June-09, 03:51, said:

There seem to be several points here. I think everyone agrees about the benefits of a mildly inflationary economy. However, it does not follow that borrowing is a sensible tool to achieve this. Afterall, a government can inflate the economy easily by "printing" money. It feels like borrowing from the private sector is inflationarily neutral since, in general, the private sector will find a way to put their capital to use anyway. This means that government borrowing is (relatively) inflationary only if the private sector was planning to sit on the money. Further, by printing enough to put inflation at 3-4% the government gets the best of both worlds, since it makes it expensive to sit on capital and therefore forces the private sector to invest even without borrowing money.

I think we agree pretty much. However, unless I misunderstood s.th. very basic, what you describe as "printing money" would be described as the following two things in the US:
1. The federal government runs a deficit.
2. The federal reserve does "quantitative easing", i.e. basically printing money and using it to buy government debt.

I am just pointing this out since what you suggest (printing money to keep the inflation at 3%) seems to be the considered an irresponsible lunatic leftist position in the current public debate in the US.

(Me, I mostly think that unemployment in the US is currently at 9%.)

[blackshoe]

Winstonm, on 2011-June-11, 07:20, said:

Say's Law states that supply creates its own demand.

You can supply all the mud pies you like. Nobody's going to eat them.

[Winstonm]

PassedOut, on 2011-June-11, 07:42, said:

I understand that, as I understand that some people give no credence to evolution and some no credence to global warming. In reality, many transactions that would occur if folks had money do not occur at all when folks do not have money.

IMO your analogies fail as global warming and evolution are backed by evidence. Velocity is a mathematical expression. Rejecting the former two is not the same as understanding that a mathematical equation cannot be a cause of an event.

It seems rather odd to me to attempt to express economics (human activity) in only mathematical terms - when the preponderance of human activity is much more emotionally or psychologically based.

Although I do not accept all of Austrian thought, I do think they are much ahead in the area of incorporating some psychological aspects of ecomonic activity.

[y66]

Does Austrian economics understand financial crises better than other schools of thought? posted at Martin Wolf's Exchange. Excerpt:

Quote

I think we can say that conventional neo-classical equilibrium economics did a poor job in predicting the crisis and in suggesting what should be done in response. We can also say that neo-Keynesians pointed out some important precursors of the crisis, in particular, the destabilising role of huge private sector financial deficits in countries with large external deficits, such as the US, and the Keynesian view certainly played a big part in the post-crisis response, as did that of Milton Friedman.

Yet some would argue that economists working in the Austrian tradition were more nearly right than anybody else. In particular, they have argued that: inflation-targeting is inherently destabilising; that fractional reserve banking creates unmanageable credit booms; and that the resulting global “malinvestment” explains the subsequent financial crash. I have sympathy with this point of view. But Austrians also say – as their predecessors said in the 1930s – that the right response is to let everything rotten be liquidated, while continuing to balance the budget as the economy implodes. I find this unconvincing. Mass bankruptcy is extremely costly. Moreover, it is impossible to separate what is healthy from what is unhealthy during a general economic collapse triggered by an implosion of the financial system.

Excerpt from Brad DeLong's comments:

Quote

Let me give eight propositions that I think of as "Austrian," meaning that they have been maintained by some "Austrian" somewhere and somehow, and assess them:

(1) IF THE FEDERAL RESERVE HAD FOLLOWED A "SOUND" MONETARY POLICY--"SOUND" MEANING THAT IT SHRANK THE STOCK OF HIGH-POWERED MONEY AT THE SUM OF THE TREND GROWTH RATES OF THE INSIDE MONEY MULTIPLIER AND OF VELOCITY--THEN WE WOULD NOT HAVE FINANCIAL CRISIS OR BIG RECESSIONS.

Status: FALSE. Requiring trend deflation at the rate of labor force and labor productivity growth in order to keep nominal spending without a trend would be more likely to generate waves of universal bankruptcy, deep financial crises, and big recessions than our current system.

Excerpt from Paul Krugman's comments:

Quote

My view is that the fatal flaw in Austrian economics is that it can’t explain unemployment — or, worse, that it thinks that it can explain unemployment, but is deluding itself. The Austrian view is that unemployment in a slump results from the difficulty of “adaptation of the structure of production” — workers are unemployed as resources are painfully transferred out of an overblown investment-goods sector back into production of consumption goods.

But this immediately raises the question, why isn’t there similar unemployment during the boom, as workers are transferred into investment goods production?

I’ve asked this question repeatedly over the years, and all I get is one of two things: gobbledygook, or “but during the phase of rising investment, the economy is booming!”, which is of course circular.