The government has pulled of a huge scam which screws the young in order to to ensure that their own generation does not have to face higher taxes or cuts in benefits.
The scam works as follows. The government lends money to students to pay their fees and maintenance and then collects payment in the form of increased taxes. Because repayment is only required when earnings rise above a threshold level, and the outstanding loan amount is cancelled after 29 years, there is a perception that the terms of the loan are very favourable. This is not the case. The key fact is that the interest payable on the loan is set at 3% above the retail price index or inflation rate. The current inflation rate is 3.6% so the interest rate would be 6.6%.
The huge cost of these loans can be determined by using the government's own student finance website (www.studentfinance.direct.gov.uk).
Students doing a standard 3 year degree who borrows the whole fee of £9000 pa as well as £3750 pa for living expenses will owe £38,000 when they graduate. If they earn the average graduate starting salary of £25,000 they will end up paying a total of £103,000 before the loan is paid off.
Medical students who take out the full loan for fees and maintenance for their 6 year degree will owe £100,000 when they graduate. If they have the average doctors starting salary of £35,000 they and will eventually pay £255,000.
These are huge sums. There is little chance of escaping payment as they are charged through income tax. Graduates with loans effectively pay a 9% higher income tax rate for most of their working lives.
One wonders how long it will take for graduates to realise that the only way to escape payment is to emigrate? If the system stays in place it could lead to emigration of graduate in huge numbers, doing enormous damage to the UK economy, and leaving the elderly who introduced these charges to protect their own pensions to fend for themselves. Perhaps then they will appreciate that the money is useless when there is no one left to actually do the work. And it will serve the misers right.
Thursday, 24 January 2013
Saturday, 12 January 2013
Why it would not matter if no one wanted to 'fund the deficit' by buying government bonds.
Let us consider the mechanics of government spending and borrowing. In a fiat currency system when governments spend numbers are added to recipient bank reserve accounts at the central bank. The money in reserve accounts earns little if any interest. When governments sell bonds what happens is that money in reserve accounts is moved into special interest-bearing accounts. If no-one wants to buy the bonds the money simply stays in the reserve accounts, earning no interest. Does this mean that the government is broke or will default? Of course not. In fact they are better off as they don't have to pay any interest. Government bonds are a benefit to the public and a cost to the government. The requirement to sell bonds is not needed to fund spending. Typically it is needed to execute monetary policy, as it enable central banks to target interest rates that banks pay to lend reserves to each other. When there are excessive reserves in the banking system and base rate is very low, as is the case now, there is no longer a need to sell bonds to execute monetary policy. If the economy recovers and starts growing rapidly, and it is felt necessary to reduce reserves then there are other ways of doing it that don't require the sale of new government bonds. The central bank could sell some of the bonds that it has purchased through the quantitative easing programme. The government could reduce the deficit or even run a surplus by increasing taxes and reducing spending. In fact this will happen anyway as the economy grows since tax revenues would rise and welfare payments such as unemployment benefits etc would fall.
If there is no need to worry about about our government being able to borrow to finance spending why is there so much anxiety expressed about the deficit? It is all down to mythology. There is a self-imposed rule that governments sell bonds equal to the value of the deficit, which gives the appearance that governments are financing the deficit. To implement this rule government have an notional account at the central bank. When tax payments are made this account is marked up by that amount. Similarly, when bonds are sold the account is also marked up. When governments make payments this account is marked down. Finally this account is not meant to fall below zero. These are all rules that the government imposes on itself to support the myth that government spending needs to be funded by taxes and borrowing. They can easily be bypassed or changed as the government enforces them. The myth is sustained because of the view of those who know better that the public and political leaders need to have a 'fear of bankruptcy' in order to convince them to raise or pay unpopular taxes and to restrain their impulse to spend excessively. It is analogous to the idea that religious belief in heaven and hell are needed to encourage virtuous behaviour. Myths can have tragic side effects. Suicide bombing is one example. The entirely unnecessary waste and misery induced by misconceived fiscal austerity is another.
If there is no need to worry about about our government being able to borrow to finance spending why is there so much anxiety expressed about the deficit? It is all down to mythology. There is a self-imposed rule that governments sell bonds equal to the value of the deficit, which gives the appearance that governments are financing the deficit. To implement this rule government have an notional account at the central bank. When tax payments are made this account is marked up by that amount. Similarly, when bonds are sold the account is also marked up. When governments make payments this account is marked down. Finally this account is not meant to fall below zero. These are all rules that the government imposes on itself to support the myth that government spending needs to be funded by taxes and borrowing. They can easily be bypassed or changed as the government enforces them. The myth is sustained because of the view of those who know better that the public and political leaders need to have a 'fear of bankruptcy' in order to convince them to raise or pay unpopular taxes and to restrain their impulse to spend excessively. It is analogous to the idea that religious belief in heaven and hell are needed to encourage virtuous behaviour. Myths can have tragic side effects. Suicide bombing is one example. The entirely unnecessary waste and misery induced by misconceived fiscal austerity is another.
Saturday, 5 January 2013
Reconciling MMT with New Keynesianism
Simon Wren-Lewis's recent post and work that he cites provides a fascinating insight into how modern monetary theory (MMT) and mainstream neo-classical views on the effect of government deficits can be reconciled.
According to MMT government debt represents accumulated net private sector financial assets and, since government's create the money and can never default, the level thereof should not be considered as a constraint. It represents the private sector's desired level of net savings. It never needs to be repaid, and even if it did, it could easily be repaid as the government/central bank could just issue the money. MMT regards the only constraint of deficit spending to be demand-led inflation. The deficit should be reduced if inflation rises above an agreed target. It should be used a second tool of monetary policy, in addition to interest rates, to hit inflation targets.
The neo-classical view, based on the notion of rational expectations, is that the debt has to be paid off and so a rational consumer will view this government debt as a future tax liability and adjust their behaviour accordingly. In other words they would not consider the debt to be a net financial asset. Simon Wren-Lewis discusses the implication of using 'printed money', which he refers to as outside money, instead of government debt to fund the deficit. Would this have a beneficial wealth-enhancing effect now that this debt did not need to be paid of by future higher taxes? He cites work suggesting that it would, but then argues that it may not if the authorities had an inflation target, as the printed money would be expected to expand the monetary base and inflate prices. He argues that, in order to hit the inflation target the authorities may increase taxes to contract the monetary base, neutralising the wealth effect of outside money.
The problem with this argument is that it assumes that the authorities to act in a way that conforms to the neoclassical view, and that this will be anticipated by the the rational consumer. How realistic is this? The authorities would surely not contract the monetary base under circumstances he cites (a liquidity trap) to counter inflation. First, the liquidity trap arises because there is a recession that the authorities will be trying to counter by loosening monetary and fiscal policy. Why would they raise taxes and contract the monetary base? The whole point of QE is to increase the monetary base. Second, the usual way to decrease the monetary base is by the authorities issuing securities (e.g. government debt), or reverse QE. Why would they not do this instead of increasing taxes? Third, the monetary base has a very weak, if any, relationship with the broad money. Look at the data. This is what you would expect if you understood how broad money is created, by bank lending, which is not reserve constrained.
The MMT view is that the rational consumer, if they really understood the monetary system, should and would consider government deficit spending to be financed by 'outside money'. In reality when government spend they introduce new (outside) money increasing the monetary base. Taxes remove most of this new money in order to ensure that demand is not excessive. Current self-imposed rules require that the difference or ’deficit' is borrowed back by issuing government debt certificates. In reality all this involves is them moving the money from reserve accounts at the central bank to interest bearing accounts at the central bank. In some countries this 'reserve drain' is necessary in order for central banks to hit their overnight interest rate target. The key point is that this government debt really represents government backed savings accounts for the 'outside money' that has already been introduced, much like National Savings Certificates in the UK.
So government debt actually is 'outside money' and represents net financial assets of the private sector. There is no need for it to be fully repaid and so no reason to expect tax increases just to pay this debt. A truly rational agent would not expect tax increases unless growth was so vigorous that it resulted in inflation, which would be associated with full employment and an economy functioning at full capacity. A rational agent would expect such growth to result in a reduction in the deficit (as tax revenue increase and welfare spending drops) and a reduction in debt/GDP ratio as GDP increases, and historical experience backs this up.
According to MMT government debt represents accumulated net private sector financial assets and, since government's create the money and can never default, the level thereof should not be considered as a constraint. It represents the private sector's desired level of net savings. It never needs to be repaid, and even if it did, it could easily be repaid as the government/central bank could just issue the money. MMT regards the only constraint of deficit spending to be demand-led inflation. The deficit should be reduced if inflation rises above an agreed target. It should be used a second tool of monetary policy, in addition to interest rates, to hit inflation targets.
The neo-classical view, based on the notion of rational expectations, is that the debt has to be paid off and so a rational consumer will view this government debt as a future tax liability and adjust their behaviour accordingly. In other words they would not consider the debt to be a net financial asset. Simon Wren-Lewis discusses the implication of using 'printed money', which he refers to as outside money, instead of government debt to fund the deficit. Would this have a beneficial wealth-enhancing effect now that this debt did not need to be paid of by future higher taxes? He cites work suggesting that it would, but then argues that it may not if the authorities had an inflation target, as the printed money would be expected to expand the monetary base and inflate prices. He argues that, in order to hit the inflation target the authorities may increase taxes to contract the monetary base, neutralising the wealth effect of outside money.
The problem with this argument is that it assumes that the authorities to act in a way that conforms to the neoclassical view, and that this will be anticipated by the the rational consumer. How realistic is this? The authorities would surely not contract the monetary base under circumstances he cites (a liquidity trap) to counter inflation. First, the liquidity trap arises because there is a recession that the authorities will be trying to counter by loosening monetary and fiscal policy. Why would they raise taxes and contract the monetary base? The whole point of QE is to increase the monetary base. Second, the usual way to decrease the monetary base is by the authorities issuing securities (e.g. government debt), or reverse QE. Why would they not do this instead of increasing taxes? Third, the monetary base has a very weak, if any, relationship with the broad money. Look at the data. This is what you would expect if you understood how broad money is created, by bank lending, which is not reserve constrained.
The MMT view is that the rational consumer, if they really understood the monetary system, should and would consider government deficit spending to be financed by 'outside money'. In reality when government spend they introduce new (outside) money increasing the monetary base. Taxes remove most of this new money in order to ensure that demand is not excessive. Current self-imposed rules require that the difference or ’deficit' is borrowed back by issuing government debt certificates. In reality all this involves is them moving the money from reserve accounts at the central bank to interest bearing accounts at the central bank. In some countries this 'reserve drain' is necessary in order for central banks to hit their overnight interest rate target. The key point is that this government debt really represents government backed savings accounts for the 'outside money' that has already been introduced, much like National Savings Certificates in the UK.
So government debt actually is 'outside money' and represents net financial assets of the private sector. There is no need for it to be fully repaid and so no reason to expect tax increases just to pay this debt. A truly rational agent would not expect tax increases unless growth was so vigorous that it resulted in inflation, which would be associated with full employment and an economy functioning at full capacity. A rational agent would expect such growth to result in a reduction in the deficit (as tax revenue increase and welfare spending drops) and a reduction in debt/GDP ratio as GDP increases, and historical experience backs this up.
Thursday, 3 January 2013
Time to be honest
A modern economy is incredibly complicated, and there is a lot that we do not fully understand. That is one of the reasons why making predictions is so difficult, and why there will always be plenty to argue about.
However, there are some complex things that we can understand because they were engineered by humans. There are no big controversies about how cars or smartphones work.
One example of a human-engineered system that we should understand is our monetary system. So why is there so much confusion and debate about it? I argue in this post that it is because the conventional description of how money works is intentionally misleading.
It is possible for anyone with an internet connection and sufficient time and determination to figure out the truth. But most people don't have the time and are not sufficiently interested in the topic. Others have found that, when they do manage to understand, it is very difficult to convince others. Why? Partly because it requires a counterintuitive conceptual leap, and partly because it requires people to ignore what they read in and hear from other trusted sources.
The key conceptual leap is to appreciate that money has to come from somewhere, and in modern fiat currency systems that somewhere is the government, which has monopoly power to create the sovereign currency*. Most governments have handed some of the authority for money creation to a central bank. However, for all practical purposes the central bank can be considered to be part of the government.
[*the Eurozone is different]
So how does this money get to us? In almost all cases by government spending. The action of spending introduces money into the economy for the first time. In practical terms when a government Department wants to pay, for example, a company for providing it with something, someone sits at a computer and types numbers to mark up the value in accounts that all banks have at the central bank. You could call it printing money but 'typing money' is more accurate.
If governments were very small relative to the size of the economy they could do this without any problem. However, when they get as large as they are now, they would be introducing a huge amount of new money into the economy each year, and this would cause inflation because the added demand for goods and services would exceed the capacity of the economy to supply them.
It is for this reason that taxation is necessary. It removes spending power from the non-government sector to ensure that overall demand does not exceed supply and cause inflation.
The sequence of events is important. First the government spends, introducing new money. Then it taxes to remove money. Creating the money is necessary before it can be removed. Removing it is not needed until it has been created. Governments must spend the money into the economy before it can be removed by taxation.
This simple reality of how money is created by spending and removed by taxation has two very important implications.
First, since the government does not need tax revenues to fund its own spending, or any other current or future obligations, it can never be forced to default on any of these obligations. It may choose to do this because of self-imposed rules, but this will be a choice made, ultimately, by the electorate. An analogy is a cricket scorer. They can never run out of points because they create them.
Second, there is no need to remove through taxation all the money introduced through government spending. In fact there are good reasons for wanting taxation to remove less money than introduced through spending. The main one is that it enables the non-government (private) sector to accumulate savings (net financial assets). If taxation always removed all the money the government spent then it would be impossible for the private sector to accumulate savings in the form of government money. When the government removes by taxes more than it spends, it is confiscating savings from the private sector.
Now you can see why the way that we talk about government taxation providing revenue to fund spending is misleading, and potentially dangerous. By implying that tax revenues need to be raised to fund government spending, and calling the annual shortfall a deficit, and the cumulative shortfall government debt, we give the impression that it is imprudent and unsustainable for government spending to exceed tax revenues. And we wrongly imply that it would be a good thing for the government to confiscate private sector savings, and that it is a bad thing for the private sector to accumulate savings. Surely this is wrong?
To repeat, a government deficit represents a private sector surplus, and government debt represents cumulative private sector saving. When understood this way it should be clear why it is potentially dangerous for the government to run a fiscal surplus and eliminate its debts, as this prevents private sector saving. It is only justified when the economy is operating at full capacity or there is demand-driven inflation. In fact whenever the US government has tried hard to run surpluses to reduce its debt this has ALWAYS followed by financial collapse and depressions. Coincidence?
So why we stick to an incorrect description of government spending and taxation?
Many people just accept the views of experts as it makes intuitive sense. We know from personal experience that we need to earn money before we spend it. So why do the experts not correct this misunderstanding. Some have admitted that the conventional (taxes fund spending) explanation is necessary to provide the 'discipline' needed to prevent excessive government spending. They reason that, if politicians and voters believe that increased government spending has to be funded by taxes, this provides a built in constraint on excessive public spending, since taxes are deeply unpopular. If they realised that this was not the case it might be difficult, in a democracy, to control government spending.
So the fundamental reason for maintaining the fiction is that the public cannot be trusted with this knowledge. Is this ethical?
Leaving aside the ethics, another problem is that when people make decisions based on a misunderstanding, the consequences can be devastating. In fact one could make the case that the global financial crisis, and the six depressions that preceded this in US history were the direct result of operating our monetary system based on this misunderstanding.
Isn't it time for the truth?
However, there are some complex things that we can understand because they were engineered by humans. There are no big controversies about how cars or smartphones work.
One example of a human-engineered system that we should understand is our monetary system. So why is there so much confusion and debate about it? I argue in this post that it is because the conventional description of how money works is intentionally misleading.
It is possible for anyone with an internet connection and sufficient time and determination to figure out the truth. But most people don't have the time and are not sufficiently interested in the topic. Others have found that, when they do manage to understand, it is very difficult to convince others. Why? Partly because it requires a counterintuitive conceptual leap, and partly because it requires people to ignore what they read in and hear from other trusted sources.
The key conceptual leap is to appreciate that money has to come from somewhere, and in modern fiat currency systems that somewhere is the government, which has monopoly power to create the sovereign currency*. Most governments have handed some of the authority for money creation to a central bank. However, for all practical purposes the central bank can be considered to be part of the government.
[*the Eurozone is different]
So how does this money get to us? In almost all cases by government spending. The action of spending introduces money into the economy for the first time. In practical terms when a government Department wants to pay, for example, a company for providing it with something, someone sits at a computer and types numbers to mark up the value in accounts that all banks have at the central bank. You could call it printing money but 'typing money' is more accurate.
If governments were very small relative to the size of the economy they could do this without any problem. However, when they get as large as they are now, they would be introducing a huge amount of new money into the economy each year, and this would cause inflation because the added demand for goods and services would exceed the capacity of the economy to supply them.
It is for this reason that taxation is necessary. It removes spending power from the non-government sector to ensure that overall demand does not exceed supply and cause inflation.
The sequence of events is important. First the government spends, introducing new money. Then it taxes to remove money. Creating the money is necessary before it can be removed. Removing it is not needed until it has been created. Governments must spend the money into the economy before it can be removed by taxation.
This simple reality of how money is created by spending and removed by taxation has two very important implications.
First, since the government does not need tax revenues to fund its own spending, or any other current or future obligations, it can never be forced to default on any of these obligations. It may choose to do this because of self-imposed rules, but this will be a choice made, ultimately, by the electorate. An analogy is a cricket scorer. They can never run out of points because they create them.
Second, there is no need to remove through taxation all the money introduced through government spending. In fact there are good reasons for wanting taxation to remove less money than introduced through spending. The main one is that it enables the non-government (private) sector to accumulate savings (net financial assets). If taxation always removed all the money the government spent then it would be impossible for the private sector to accumulate savings in the form of government money. When the government removes by taxes more than it spends, it is confiscating savings from the private sector.
Now you can see why the way that we talk about government taxation providing revenue to fund spending is misleading, and potentially dangerous. By implying that tax revenues need to be raised to fund government spending, and calling the annual shortfall a deficit, and the cumulative shortfall government debt, we give the impression that it is imprudent and unsustainable for government spending to exceed tax revenues. And we wrongly imply that it would be a good thing for the government to confiscate private sector savings, and that it is a bad thing for the private sector to accumulate savings. Surely this is wrong?
To repeat, a government deficit represents a private sector surplus, and government debt represents cumulative private sector saving. When understood this way it should be clear why it is potentially dangerous for the government to run a fiscal surplus and eliminate its debts, as this prevents private sector saving. It is only justified when the economy is operating at full capacity or there is demand-driven inflation. In fact whenever the US government has tried hard to run surpluses to reduce its debt this has ALWAYS followed by financial collapse and depressions. Coincidence?
So why we stick to an incorrect description of government spending and taxation?
Many people just accept the views of experts as it makes intuitive sense. We know from personal experience that we need to earn money before we spend it. So why do the experts not correct this misunderstanding. Some have admitted that the conventional (taxes fund spending) explanation is necessary to provide the 'discipline' needed to prevent excessive government spending. They reason that, if politicians and voters believe that increased government spending has to be funded by taxes, this provides a built in constraint on excessive public spending, since taxes are deeply unpopular. If they realised that this was not the case it might be difficult, in a democracy, to control government spending.
So the fundamental reason for maintaining the fiction is that the public cannot be trusted with this knowledge. Is this ethical?
Leaving aside the ethics, another problem is that when people make decisions based on a misunderstanding, the consequences can be devastating. In fact one could make the case that the global financial crisis, and the six depressions that preceded this in US history were the direct result of operating our monetary system based on this misunderstanding.
Isn't it time for the truth?
Tuesday, 1 January 2013
What the words on you pound note actually mean
Ever wondered why x pound notes have the statement 'I promise to pay the bearer the sum of x pounds'?
If this statement makes no sense to you or seems ridiculous then it is because you do not understand modern money.
To understand it you need to understand what the essence of modern fiat money is, and what gives it value. Fiat money gets its value from the fact that it can be used to pay taxes owed to the government.
There are two sorts of money that are issued in all modern economies. First there is government money or state money, also called base money. Only the government or central bank (which is part of the government) can create this sort of money. Government money exists in two interchangeable forms: as central bank reserves, which are just numbers on a spreadsheet, and as physical cash (notes and coins). When notes and coins are issued central bank reserve accounts are marked down by the same amount. When the central bank or government receive cash they mark up the appropriate reserve account. The central bank reserves plus all the physical cash equals the monetary base. So physical cash is simply an easily transferable and anonymous form of government or state or base money.
The second form of money is commercial bank money. This is created by commercial banks and only exists in electronic form. 97% of the money that is available to the public to spend is this form of money. Commercial banks can create this money whenever they want and they do this whenever they make a loan. They simply increase the numbers in the bank account of the borrower by the amount of the loan. In return they get a debt from the borrower, which they mark as an asset, and they receive interest payment. Effectively they are renting the money to the borrower. It is important to recognise that bank money has no official status in that it cannot be used to make official payments to the government, such as paying taxes.
When you write a cheque to pay your tax bill to the government, on receipt of this cheque, goes to your bank and requires that your bank pay it that exact amount using government or state money. Banks can do this either using money in their reserve account at the central bank or by using physical cash.
It is because physical cash, unlike commercial bank money, can be used to pay taxes owed to the government that it says what it does on the notes. If you or anyone else produces these notes the government has to accept them as payments of tax owed to them or, if you are a bank, it has to credit your reserve account with that amount. You can't do this with commercial bank money.
So currency notes can be considered as transferable government IOUs that can be used to pay taxes or settle any other obligations to the government. If you are a bank and have a reserve account at the central bank they will credit your central bank reserve account by the same amount.
If this makes sense to you then you understand more about modern money than 99% of people, including most economists.
If this statement makes no sense to you or seems ridiculous then it is because you do not understand modern money.
To understand it you need to understand what the essence of modern fiat money is, and what gives it value. Fiat money gets its value from the fact that it can be used to pay taxes owed to the government.
There are two sorts of money that are issued in all modern economies. First there is government money or state money, also called base money. Only the government or central bank (which is part of the government) can create this sort of money. Government money exists in two interchangeable forms: as central bank reserves, which are just numbers on a spreadsheet, and as physical cash (notes and coins). When notes and coins are issued central bank reserve accounts are marked down by the same amount. When the central bank or government receive cash they mark up the appropriate reserve account. The central bank reserves plus all the physical cash equals the monetary base. So physical cash is simply an easily transferable and anonymous form of government or state or base money.
The second form of money is commercial bank money. This is created by commercial banks and only exists in electronic form. 97% of the money that is available to the public to spend is this form of money. Commercial banks can create this money whenever they want and they do this whenever they make a loan. They simply increase the numbers in the bank account of the borrower by the amount of the loan. In return they get a debt from the borrower, which they mark as an asset, and they receive interest payment. Effectively they are renting the money to the borrower. It is important to recognise that bank money has no official status in that it cannot be used to make official payments to the government, such as paying taxes.
When you write a cheque to pay your tax bill to the government, on receipt of this cheque, goes to your bank and requires that your bank pay it that exact amount using government or state money. Banks can do this either using money in their reserve account at the central bank or by using physical cash.
It is because physical cash, unlike commercial bank money, can be used to pay taxes owed to the government that it says what it does on the notes. If you or anyone else produces these notes the government has to accept them as payments of tax owed to them or, if you are a bank, it has to credit your reserve account with that amount. You can't do this with commercial bank money.
So currency notes can be considered as transferable government IOUs that can be used to pay taxes or settle any other obligations to the government. If you are a bank and have a reserve account at the central bank they will credit your central bank reserve account by the same amount.
If this makes sense to you then you understand more about modern money than 99% of people, including most economists.
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