Dash a sound alternative to dollar as us national debt balloons higher
All four scenarios in the Table are them modelled in the following graph with the Real Unit Labour Costs converted into index number form equal to in Period 1. As you can see what happens to employment makes no difference at all. I could have also modelled employment falling with the same results. The following graph shows the four scenarios shown in the last two tables. What you learn is that if wages and prices fall at the same rate and labour productivity does not rise there can be no reduction in unit or real unit labour costs.
So the internal devaluation strategy relies heavily on productivity growth occurring. The literature on organisational psychology and industrial relations is replete of examples where worker morale is an important ingredient in accomplishing productivity growth. In a climate of austerity characteristic of an internal devaluation strategy it is highly likely that productivity will not grow and may even fall over time. Then the internal devaluation strategy is useless.
This graph compares the two scenarios in the first Table with the more realistic one that labour productivity actually falls as the government ravages the economy in pursuit of its internal devaluation. The internal devaluation strategy relies heavily on the external sector providing the demand impetus.
Given that Eurozone trade is heavily internal, it seems far fetched to assume that the trade impact arising from any successful internal devaluation will be sufficient to overcome the devastating domestic contraction in demand that will almost certainly occur. This is why commentators are calling for a domestic expansion in Germany to boost aggregate demand throughout the EMU, given the dominance of the German economy in the overall European trade.
That is clearly unlikely to happen given Germany has been engaged in a lengthy process of internal devaluation itself and the Government is resistant to any stimulus packages that might improve things within Germany and beyond via the trade impacts. To ensure that the financial system is stable, the central bank has to allow movements in the money supply to be driven by the movements in the monetary base. The question relates to the money multiplier.
Mainstream macroeconomics textbooks are incorrect when they discuss the credit-creation capacity of commercial banks. The concept of the money multiplier is at the centre of this analysis and posits that the multiplier m transmits changes in the so-called monetary base MB the sum of bank reserves and currency at issue into changes in the money supply M. The chapters on money usually present some arcane algebra which is deliberately designed to impart a sense of gravitas or authority to the students who then mindlessly ape what is in the textbook.
In their undergraduate courses introductory and intermediate macroeconomics; money and banking; monetary economics etc the money multiplier is usually expressed as the inverse of the required reserve ratio plus some other novelties relating to preferences for cash versus deposits by the public.
Accordingly, the students learn that if the central bank told private banks that they had to keep 10 per cent of total deposits as reserves then the required reserve ratio RRR would be 0. More complicated formulae are derived when you consider that people also will want to hold some of their deposits as cash. But these complications do not add anything to the story. The formula for the determination of the money supply is: The way this multiplier is alleged to work is explained as follows assuming the bank is required to hold 10 per cent of all deposits as reserves:.
None of this is remotely accurate in terms of depicting how the banks make loans. It is an important device for the mainstream because it implies that banks take deposits to get funds which they can then on-lend.
But prudential regulations require they keep a little in reserve. So we get this credit creation process ballooning out due to the fractional reserve requirements. The money multiplier myth also leads students to think that as the central bank can control the monetary base then it can control the money supply.
This leads to claims that if the government runs a fiscal deficit then it has to issue bonds to avoid causing hyperinflation. Nothing could be further from the truth. That is nothing like the way the banking system operates in the real world. The idea that the monetary base the sum of bank reserves and currency leads to a change in the money supply via some multiple is not a valid representation of the way the monetary system operates.
First, the central bank does not have the capacity to control the money supply in a modern monetary system. In the world we live in, bank loans create deposits and are made without reference to the reserve positions of the banks. The bank then ensures its reserve positions are legally compliant as a separate process knowing that it can always get the reserves from the central bank.
The only way that the central bank can influence credit creation in this setting is via the price of the reserves it provides on demand to the commercial banks. Second, this suggests that the decisions by banks to lend may be influenced by the price of reserves rather than whether they have sufficient reserves.
They can always get the reserves that are required at any point in time at a price, which may be prohibitive. Third, the money multiplier story has the central bank manipulating the money supply via open market operations.
So they would argue that the central bank might buy bonds to the public to increase the money base and then allow the fractional reserve system to expand the money supply. The open market purchase would increase bank reserves and the commercial banks, in lieu of any market return on the overnight funds, would try to place them in the interbank market.
Of-course, any transactions at this level they are horizontal net to zero so all that happens is that the excess reserve position of the system is shuffled between banks.
But in the process the interbank return would start to fall and if the process was left to resolve, the overnight rate would fall to zero and the central bank would lose control of its monetary policy position unless it was targetting a zero interest rate.
In lieu of a support rate equal to the target rate, the central bank would have to sell bonds to drain the excess reserves. The same futility would occur if the central bank attempted to reduce the money supply by instigating an open market sale of bonds.
Fourth, given that the central bank adds reserves on demand to maintain financial stability and this process is driven by changes in the money supply as banks make loans which create deposits. So the operational reality is that the dynamics of the monetary base MB are driven by the changes in the money supply which is exactly the reverse of the causality presented by the monetary multiplier. The cost of spending by a sovereign government increases when the bond markets push yields on new government bond issues up.
Note we are excluding non-sovereign governments such as the member states in the EMU which use a foreign currency. For a sovereign government that issues its own currency there is no binding revenue constraint on government spending. The interest servicing payments come from the same source as all government spending — its infinite minus one cent! The cost of government spending is the real resources that are deployed in the production of the goods and services being purchased rather than the fiscal transaction entry in the Treasury books.
In macroeconomics, we summarise the plethora of public debt instruments with the concept of a bond. In a modern monetary system with flexible exchange rates it is clear the government does not have to finance its spending so the the institutional machinery is voluntary and reflects the prevailing neo-liberal ideology — which emphasises a fear of fiscal excesses rather than any intrinsic need. Once bonds are issued they are traded in the secondary market between interested parties.
Clearly secondary market trading has no impact at all on the volume of financial assets in the system — it just shuffles the wealth between wealth-holders. In the context of public debt issuance — the transactions in the primary market are vertical net financial assets are created or destroyed and the secondary market transactions are all horizontal no new financial assets are created. Please read my blog — Deficit spending — Part 3 — for more discussion on this point.
Further, most primary market issuance is now done via auction. Accordingly, the government would determine the maturity of the bond how long the bond would exist for , the coupon rate the interest return on the bond and the volume how many bonds being specified.
The issue would then be put out for tender and the market then would determine the final price of the bonds issued. Imagine that the market wanted a yield of 6 per cent to accommodate risk expectations inflation or something else.
So for them the bond is unattractive and they would avoid it under the tap system. The mathematical formulae to compute the desired lower price is quite tricky and you can look it up in a finance book. National Security Agency collected million records of phone calls and text messages of Americans last year, more than triple gathered in , a U.
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