Friday, September 25, 2009

You CAN spend your way out of a recession!



Nice post from Bob McTeer's blog:


Can You Spend Your Way Out of Recession?


“You can’t spend your way out of recession” is a sound bite heard almost every day on financial TV. Recently a guest commentator combined that sound bite with this one: “You can’t borrow your way out of debt.” Perhaps the second one was intended to divert our attention from the first one. Clever. Perhaps too clever by half.

Of course you can spend your way out of recession, almost by definition. A recession can be defined as a shrinkage of spending and income. More spending is needed to generate more income. Therefore, more spending will do the job.

I think the problem is that spending your way out of a recession is the message of Keynes’s “General Theory of Employment Interest and Money, and people don’t want to be labeled a “Keynesian.” But surely one can cling to his classical economic principles while acknowledging that Keynes had a point, especially during recessions.

In a recession, income declines because spending declines, and spending declines because income declines. It’s a vicious circle that needs to be broken. One option might be tax cuts to increase business spending. Another might be lower interest rates to stimulate spending. Another is to have government spending make up the slack. That will work if it has monetary policy support, i.e. if the government spends newly created money so it doesn’t crowd out private spending.

I don’t necessarily want to be labeled a Keynesian either, but I see no reason to fear acknowledging that he had a point. To say that we can’t spend our way out of a recession may make a good sound bite, but it has no credibility.

He gets a little off track on the "crowding out" part, but in general it's a good piece.

19 comments:

Scott C. said...

Mike - please expand on your refutation of the crowding out theory since we hear it so often in the financial MSM and from doomers like Mr Schiff (the Republican Senate candidate in Conn - running on the Hoover platform of 1932!). I also recall the claims from the mid 80's that high gov. borrowing & related crowding would lead to exploding interest rates - but just the opposite happened. Are there some respected economists who promote this crowding theory?

googleheim said...

Interest rates are set by whatever tickles the Fed.

This has been covered redundantly by the Norman Theory of Capacity.

If they try an 80's Volcker, that is their choice.

However, they are not choosing Volcker's mindset, thankfully, at least for now.

That means they are choosing the Japanese technique from the 90's

while realizing that there is not one thing : republicans, deficits, currency dynamics, or anything else that causes any sort of required metric or force to make rates be high or low.

it is only a choice.

Mike Sandifer said...

Scott C.,

In reference to your question about the statement:

"That will work if it has monetary policy support, i.e. if the government spends newly created money so it doesn’t crowd out private spending."

In recessions, there is typically both a decrease of spending and investment as GDP growth recedes. Hence, the government can help fill the gap between the recession levels of spending and investment at full employment and GDP growth potential. it can do this with monetary policy and/or fiscal stimulus without crowding out the private sector.

There is no crowding out, because of the drop in spending and investment in the private sector.

Matt Franko said...

In his crowding out line, Mr McTeer states: "That will work if it has monetary policy support, i.e. if the government spends newly created money so it doesn’t crowd out private spending."; he
equates "Monetary Policy" with the spending. Ive come to view monetary policy solely as the Fed setting interest rates, "Fiscal Policy" in my current view is that related to spending...I think he is implying something related to "money supply" measures such as M1/M2 etc...ie he wants one of these "M" measures to increase due to the Gov't spending, he thinks only then will the Govt spending be helpful. Monetarism is a hard habit to break!

Brantley said...

I think Bob's post is shallow and of little educational merit. Yea, one can always say that you’ve finally spent enough when you get out of a recession or depression, but it’s how you achieve the environment that leads to the spending that’s the tough one.

There are two kinds of recessions. One is inventory driven recessions and the other, which we are experiencing now, is a credit driven recessions. Excessive credit creation drives speculative asset bidding wars, prices to go sky-high, necessitating greater debt loads, and income growth can’t keep pace the debt load. With effective interest rates approaching zero and leverage ratios effectively infinite (zero down home purchases), any hiccup effectively blows the gears off the machine and everything unwinds – rapidly.

Income didn't decline because spending declined; income declined because debt service increased beyond any rational metric and any excess income that was went to servicing debt. And by the way that’s where the supposed savings is going today.

Now, if they would only let the excesses, the fat, and the fraud get washed out of the system.....reset balance sheets, we might start making lasting and substantive progress sooner. It is the capitalist cycle…….Boom & Bust.

Once the debt load is wiped off and the institutions holding bad debt are liquidated, new, healthier business will take their places and it’s off to the races…..again.

googleheim said...

Yo Brantley

With a rally like this you'd think that they already took most of the junk out of the system with the plug-in-the-hole bailout monies.

Secretly they are already keeping all that garbage from view, and it is working.

Money is an illusion, and they are using another illusion to make the bad money invisible.

What other way is there to get rid of the bad stuff ?

The minute they go public with all the real details is the moment when the market will crash again.

I think they will do it when those who wish to supplant the U$D make their next move - and there will be another run to the USD and gold.

Otherwise, more of the same happy go lucky rally and it's all peter pan shucks paw.

Matt Franko said...

Warren Mosler recently posted this:
"first,deficit spending doesn’t generate anything. its the lack of a sufficient sized deficit that’s restrictive and keeping millions in the unemployment lines. the currency is a simple public monopoly and as with any monopoly the monopolist restricting supply results in excess capacity (unemployment)"
Now if this is what McTeer is getting at by newly created money, ie the spending must be increased deficit spending, (not offset by taxes) then he could be spot on.

Mike Norman said...

Brantley:

This statement shows you do not know what you are talking about:

"Income didn't decline because spending declined; income declined because debt service increased beyond any rational metric..."

Income in the aggregate also includes income paid to creditors. If I pay more on my credit card, yes, my disposable income may be reduced, however, the creditor's income increases. The net change in aggregate income is zero.

Furthermore, to the extent that credit fueled more consumption, national income increased, it didn't decrease.

Stop already...please. This stuff is not that hard.

Mike Norman said...

Scott,

A simple balance sheet example can explain why crowding out does not happen.

Suppose the total assets of the private sector are $100 in reserve funds.

Assume the gov't has zero, but wants to build a highway system. It sells $100 in bonds.

The private sector now has $100 less in reserves, but $100 in gov't securities. Assuming its liabilities have not changed, its net worth stays the same.

Now the gov't spends the $100 to build the road.

The public now has $100 in securities and $100 in new reserve funds. It's net worth has increased to $200. It has experienced a net increase in wealth of $100.

In reality the gov't spends first then sells securities later, so reserve accounts would be credited with the additional $100 even before the securities are sold. No one gets crowded out of anything.

One thing that Schiff and others ought to look at is the fact that in the past 60 years, gov't spending has gone from $46 billion annually to nearly $4 trillion. That's almost a 10,000% increase and guess what?? We haven't crowded out anybody. In fact, we have so much spare capacity that we are struggling to find ways to utilize it. In addition, interest rates are near zero.

Where crowding out can occur is when government deficit spending pushes beyond the limits of the nation's capital (both physical and human) to produce the goods and services being demanded. In that case you have sustained inflation.

We are nowhere near that level.

-Mike

Brantley said...

Mike:
Interest paid to creditors as income from Liar Loans was a total illusion and you know it. I do know what I'm talking about because mortgage brokers and bankers knew that all “no doc” loans could be seasoned for 3 to 6 months and sold to Fannie Mae with absolutely NO risk to them. ZIP! They took a fat pile of cash on the front and the back end of these transactions and they couldn't give a rat @$$ about any thing else.....period.

You can't be serious if you don't think you get crap if you give out loans with no docs, nothing down, 2% teaser rates for 6 months, roll closing costs into loan.....and drive by appraisals. Hell, even Fannie Mae’s ‘Desktop Underwriter’ software instantly gave the broker all the options to perfect the loan……..increase the value of an auto, lower some payment there.

The Income I’m talking about, "Income didn't decline because spending declined; income declined because debt service increased beyond any rational metric...", is the income of the individual, not the aggregate, which collectively causes the aggregate to diminish………enough of which came first, the chicken or the egg.

The fact that wealth on paper, built on fraud, doesn’t translate into sustainable value. What point don’t you get about that? What I do know is we are where we are because the entire market (global too) said I’m right, that’s why the house of cards came tumbling down.

Mike Norman said...

Are you saying that creditors did not actually get that money. That the payments they received were an illusion? What are you smoking?? Is the earth flat to you?

googleheim said...

I'd like to add to the Brantley/Norman subdialog about liar loans :

The problem was with the derivatives which were leveraged on liar loans by a factor of 30 to 1.

That means the 200 to 300 billion liar loan market could have been bailed out long ago if and only if they were loans in the traditional boring banker format.

Instead, wall street and the quant faker bakers blew up these financial instruments everyone based on collateral of these loans 30 to 1.

So the liar loans are not the problem since that bailout would only have been a 200 to 300 billion market anomaly.

Instead we are looking at 30 times that due to the wall streeters.

And that is where the Norman has pointed out the issue with the bailout of the bankers.

Matt Franko said...

Brantley,
Mike here is again just presenting the OPERATIONAL aspects/options of this situation. ie Govt sector can replace lost aggregate demand by being counter cyclical with fiscal policy...
Then you go off on this tangent about bad mortgages/appraisals/risk analysis, etc...no one disagrees that there was bad underwriting, etc., and that former debt holders are going to become equity holders in the resolution, and I agree with your take on the inventory recession here (btw not buying your credit recession theory) but that's a separate issue from what are our country's options to remedy the current unemployment/low utilization rates? A large enough fiscal transfer from the Govt to the non-Govt sector WILL do the trick...but for some reason our Govt "leaders" dont recognize how many tools they have in the bag!

Mike Norman said...

Matt,

I am not sure I even agree that there was bad underwriting. I agree with what Warren (Mosler) said many times, that the deficit became too small to support the credit structure.

If the deficit had remained sufficiently large, aggregate demand would have been high enough to sustain incomes and debt service.

-Mike

Matt Franko said...

Mike,
Point well taken. I didnt mean to imply any faulty underwritng was ultimately to blame, just it probably existed.
To your point I remember back in late 07 early 08 Steve Conover at Skeptical Optimist blog was tracking the deficit; it kept falling month after month and he projected it was on a collision course with BALANCE by summer 08, it got very low but never made it to balance before the crisis set in.

Brantley said...

Mike.....why didn't we experience a monster recession or even a depression in 1999 or 2000 during Clinton's surpluses. The economy should have been trending downhill as deficit spending transitioned to surpluses. I’m sure the deficits were contracting prior to 1999. You imply that deficits will keep us from recessions or the lack of deficits lead to recessions.

Brantley said...

Mike..... The question is….Are they getting their money now? NOPE! That's why we've got jingle mail, because the payment stream was fundamentally an illusion and now we have got some of the highest foreclosures on record.

Matt, they can try and transfer all the money they want but if credit is collapsing faster that their spending, you get little bang. We’ve been in a global credit contraction.

Credit destruction snip from Mike Shedlock...."Some still argue that Japan never went through deflation. One basis for that argument is that "money supply" never contracted over a sustained period. The other argument is that prices as measured by the CPI never fell much. Those are flawed arguments.

Although Japan was rapidly printing money, a destruction of credit was happening at a far greater pace. There was an overall contraction of credit in Japan for close to 5 consecutive years. Property values plunged for 18 consecutive years. The stock market plunged from 40,000 to 7,000. Cash was hoarded and the velocity of money collapsed. Those are classic symptoms of deflation that a proper definition incorporating both money supply and credit would readily catch. Those looking at consumer prices or monetary injections by the bank of Japan were far off the mark."

Snip from Karl Denninger..."Inventory-driven recessions are primarily about excessive industrial capacity for demand. That is, manufacturers and suppliers of services get too bullish about prospects, build too much capacity and inventory, and wind up engaging in a destructive price war in an attempt to "win". This drives down profits and ultimately forces the weaker firms out of business, ergo, recession - GDP and employment decline. Having cleansed itself of the excess, the economy recovers. The trigger for these recessions is often (but not always) an external shock such as the oil embargo in the 1970s or the collapse of the Internet fraud-and-circuses games in 2000.

The second sort of recession is a credit-driven recession. Excessive credit creation - that is, loans going too far toward "fog a mirror" qualifications (and in some cases, such as the most recent, actually reaching "fog a mirror") drives one or more asset bubbles. These pop when effective interest rates in the economy reach an effective level of zero, usually because the amount of leverage available becomes for all intents and purposes infinite (Bear and Lehman at 30:1, Fannie/Freddie at 80:1, AIG at god-knows-what, and duped "home buyers" buying with zero down for a true infinite leverage ratio.) This excessive credit creation drives a speculative asset bidding war which in turn causes prices to go sky-high for one or more types of asset.

The latter sort of recession is triggered because the cost of borrowing money is never actually zero, even if people pretend that it might be. As a consequence the lenders begin to earn a negative spread and lose actual purchasing power. This is an unsustainable situation because cash flow cannot be fudged nor can anyone sustain a negative cash flow for very long; no matter how much you start with if you spend more than you make eventually you go broke.
For a credit recession, however, there is a much larger problem: The reason real interest rates went negative is that debt has a carrying cost and consumes free cash flow; so long as the debt taken on in the credit binge remains the cash flow impact also remains.

Default and bankruptcy clears excessive credit (debt) from the system - if it is allowed to occur. But if it is not, then the bad debt remains on the balance sheets somewhere and the cash flow impact remains in the economy. Employment remains weak, capital spending restart attempts falter as demand fails to return and credit quality continues to remain insufficient to support new credit demand."

Matt Franko said...

Brantley,
Aren't most inventories financed? Whether industrial, retail, so on...even inventories of unsold homes are likely financed, one could look at the internet bubble as excess inventory of shares of public companies. Excess inventories, yes; but I'm just not sure I'm buying Denningers "Credit Recession" yet, Ill have to think more about it.

To get back to fiscal: Last year Bush admin did about a $165B rebate in 2Q '08 and things started to stabilize until just after the Olympics, when that fiscal adjustment ended and was not renewed (for election year political reasons IMO) the bottom fell out. Consider if this Govt fiscal adjustment would have been renewed for another $165B in 3Q, and then maybe again if necessary, incomes may have remained high enough to service much of the mortgages that eventually failed.

googleheim said...

the concept that the deficit needs to grow with an expanding real market is interesting.

Clinton's econonic condition did not have China, Iraq, housing, and the commodities speculation fiasco.

Commodities were driven down and paid for by a RReal strong dollar policy. Neither a China nor an Iraq gobble up commodities to somehow raise prices.

Goldman Sachs was not applying their math to the commodities ( like oil prices like Norman showed many, many times ) but and since they were trying to foster IPOs with dot Com advancing - which they applied their funny math.

Bush said he favored a strong dollar, but he did not. He and wall street weakened it on purpose.

A larger deficit would have been seen as printing money epidemic, but Norman showed ( again ) last year that the real money supply was not being increased 15% like everyone bantered about as if it was a crisis.

Ironically, had they increased the playing field with a deficit and therefore played a strong dollar policy - then it would have supported the expansion since it popped - and then and only then did everyone run to the dollar.