Epic Fail from William L. Anderson

Consider this statement made by William L. Anderson:

“The only think [sic] in the end that Keynesians have is inflation, and they believe that if the government inflates enough, somehow this will ‘rescue’ the economy.”
William L. Anderson, “Heading for double-digit inflation?,” Krugman-in-Wonderland, March 1, 2012.

I assume Anderson is using the word “inflation” in the sense of monetary inflation (though no doubt price inflation is envisaged as a consequence of the monetary inflation).

There are four obvious points to be made:

(1) Whatever the merits of partial or even total monetisation of a budget deficit, in relation to the type of Keynesianism practised by governments around the world today, if a government engages in a stimulus by way of a deficit, virtually all governments cover the deficit with dollar-for-dollar bond issues (some governments like Australia once had a tap system of direct purchases of Treasury bonds by the national central bank when the private sector did not wish to buy all bonds at some issue of government debt, but that system is long gone).

In the context of the US (though this also applies to other nations), when the government covers the deficit with dollar-for-dollar bond issues this process does not add to money supply as measured by M0, M1, M2 and M3 (now discontinued).

Some nations (such as Japan and Hungary) include government bonds in their highest monetary aggregate (M4 or L), but this is understood to be a measure of money plus liquid or reasonably liquid assets. The advocates of MMT say that a government deficit adds net financial assets to the private sector, and that is true. It is also obvious that, even if one were to include government bonds as money, the actual purchases made by people holding bonds must be so small as to have a marginal or insignificant contribution to price inflation. Who, for example, pays for ordinary goods and services in government bonds? Certainly the common items on the CPI are not bought with bonds.

Expansionary fiscal policy via deficits is the main policy proposal of Keynesian economics to stimulate aggregate demand. But, when government bonds are issued to cover budget deficits, the process does not expand the money supply, except by the highest monetary aggregate. And even then the newly created government bonds can only have marginal effects on price inflation, if they have any effect at all. The assertion “the only thing in the end that Keynesians have is [monetary] inflation” is rubbish.

Furthermore, the Austrians have their own idiosyncratic measures of the money supply, as follows:

(1) the True Money Supply (TMS) or TMS 1 (also called the Austrian Money Supply, or the Rothbard Money Supply, which can be found on Mises.org).

(2) Shostak’s Austrian Money Supply (AMS or TMS 2), and

(3) Mike Shedlock’s M Prime (M'), which is an alternative measure of (2).

True Money Supply (TMS 1) is made up of the following:

the currency component of M1 + total checkable deposits + savings deposits + US government demand deposits and note balances + demand deposits due to foreign commercial banks + demand deposits due to foreign official institutions.

Therefore the True Money Supply does not include government bonds. Nor do Shostak’s Austrian Money Supply (AMS) or Mike Shedlock’s M Prime. None of these Austrian measures of the money supply includes government bonds. On what basis do the Austrians argue that a bond-financed government deficit increases the money stock?

(2) Central banks expand reserves by open market operations or the more radical version of this called quantitative easing. That process is distinct from expansionary fiscal policy done by budget deficits. Yet Keynesian economists have often emphasised the feeble and comparatively futile effect of monetary base expansion in situations of depression, debt deflationary environments, or poor business expectations (“pushing on a string” was the old neoclassical synthesis Keynesian phrase). This monetary “stimulus” is unlikely to have a significant effect on aggregate demand in such circumstances.

Witness the actual facts about the base money created in QE1: it mostly stayed at the Fed. Aggregate base money went from $800 billion in 2008 to about 2 trillion in early 2010. The $1.2 trillion created in QE1 did not enter the economy, but has been held by the banks as excess reserves. QE2 did much the same thing, but added to the reserves of foreign banks and Eurodollar markets, adding to the US dollar carry trade. That US dollar carry trade no doubt contributes to asset price inflation and commodity speculation, but the inflationary effects of this on national CPIs are indirect, mostly via cost push inflation from factor input price increases.

(3) If a budget deficit were (1) covered by bonds or (2) partially or totally monetised (and in the latter case there would be monetary inflation), in a situation of depression or significant idle resources and unused capacity in an economy open to international trade, the primary effect of deficit spending is to increase output and employment – employing people, raising their income and increasing their standard of living. Price inflation is no doubt a secondary effect, just as it always would be even if the spending causing it under the same circumstances were private.

Keynesian stimulus policies confer benefits that outweigh the costs of secondary price inflation. The creation of greater employment and output drives real GNP to hit its potential. This makes the community richer than it would otherwise have been, if real GNP (that is, real output) had fallen below its potential, and provides a greater level of income owing to higher levels of employment.

But here the Austrians must switch to the meaning “price inflation” if they were to complain that “the only thing in the end that Keynesians have is inflation.” And even then they would be wrong.

(4) With regard to price inflation and movements in the price level, there are Austrians who argue that these have complex real and monetary causes:

“the essence of inflation is not a general rise in prices but an increase in the supply of money, which in turns sets in motion a general increase in the prices of goods and services .... While increases in money supply (i.e., inflation) are likely to be revealed in general price increases, this need not always be the case. Prices are determined by real and monetary factors. Consequently, it can occur that if the real factors are pulling things in an opposite direction to monetary factors, no visible change in prices might take place. In other words, while money growth is buoyant – i.e., inflation is high – prices might display low increases.”

Frank Shostak, “Defining Inflation,” Mises Daily, March 6, 2002.

That is essentially correct, and in environments of severe unemployment, idle resources and idle capital goods monetary inflation does not necessarily lead to sigificant price inflation.

BIBLIOGRAPHY

Anderson, William L. 2012. “Heading for double-digit inflation?,” Krugman-in-Wonderland, March 1.

Shostak, F., 2002, “Defining Inflation,” Mises Daily, March 6
http://mises.org/daily/908.

Herbert Hoover’s Budget Deficits: A Drop in the Ocean

The meme that Herbert Hoover was some type of big spending Keynesian seems to be an especial favourite of Austrians, and some examples of this idea can be seen here:

Stefan Karlsson, “Again Herbert Hoover Was No Deficit-Cutter,” Thursday, March 11, 2010.

Robert P. Murphy, “Did Hoover Really Slash Spending?” Mises Daily, May 31, 2010.

Typically, once such claims are examined they collapse like a house of cards.

It is of course true that Hoover often gets unfairly blamed as an advocate of the extreme liquidationist solution to the Great Depression, a solution which was actually recommended by Andrew Mellon (US Treasury Secretary from 1921–1931). In truth, Hoover rejected extreme liquidationism, and attempted to fight the onset of Great Depression with a number of limited interventions, including increased government spending.

But the idea that Herbert Hoover’s small budget deficits could ever have stopped the Great Depression remains absurd, and Herbert Hoover ran a federal budget surplus in fiscal year 1930, the first year of the devastating contraction that occurred from 1929–1933. A significant cause of his budget deficits in fiscal years 1931, 1932, and 1933 was the collapse in tax revenues, and his stimulative discretionary spending increases in the budget in fiscal years 1931 and 1932 were a stone in the ocean compared to the massive collapse in US GDP.

Far from disproving Keynesian economics, Hoover’s policies reinforce the basics of Keynesian deficit spending, and also show how financial crises and bank collapses need to be prevented, if one wants to arrest an economic spiral into depression.

In particular, Austrians and other libertarians refuse to properly understand basic Keynesian concepts, such as:

(1) Potential GDP,
(2) the Keynesian multiplier and
(3) the appropriate level of discretionary spending increases that actually bring about Keynesian stimulus and positive GDP growth.

To begin with, we need to understand some basic facts about the US budget, the fiscal year and Depression history:

(1) In the US, the fiscal year before 1976 ran from July 1 to June 30 in the next year. So in the relevant years the actual fiscal years were as follows:

Fiscal 1929: July 1, 1928 – June 30, 1929
Hoover inaugurated March 4, 1929
Fiscal 1930: July 1, 1929 – June 30, 1930
Fiscal 1931: July 1, 1930 – June 30, 1931
Fiscal 1932: July 1, 1931 – June 30, 1932
Fiscal 1933: July 1, 1932 – June 30, 1933
Roosevelt inaugurated March 4, 1933.

(2) Since Hoover did not become president until March 4, 1929 he was not essentially responsible for the budget in fiscal year 1929. Hoover was responsible for fiscal years 1930, 1931, 1932, 1933. Roosevelt was not responsible for fiscal year 1933, even though was inaugurated in March 1933.

(3) In fiscal year 1930, tax receipts were $4.1 billion. By fiscal year 1933, tax receipts had fallen to $2 billion. In other words, government tax revenue fell by 51.21%. The budget deficits that emerged were the result, to a very great extent, of the collapse in tax revenue, not because of huge increases in spending.

(4) The first contractionary phase of the Great Depression in America ran from August 1929 to March 1933. Thus, when Roosevelt came into office, a recovery was just starting to happen. The aftermath of the severe contraction from 1929 to 1933 was what neoclassicals would call a suboptimal equilibrium with high involuntary unemployment.

(5) The size of US government spending in 1929 was very small. As Herbert Stein notes:

“In 1929 total federal expenditures were about 2.5 per cent of the gross national product (GNP), federal purchases of goods and services about 1.3 per cent and federal construction less than .2 per cent. In 1965, for comparison, these figures were 18 per cent, 10 per cent and 1 per cent” (Stein 1966: 189–223).

Thus Hoover’s increase in federal spending of 30.25% in fiscal year 1932 is deeply misleading, because total federal spending as a percentage of GDP was very small in these years, and just 2.5% of GDP in 1929.

(6) We can the list the state of the US budget and federal spending, including Hoover’s budget deficits, below:

Government Spending
Coolidge (August 2, 1923–March 4, 1929)
Fiscal 1927: July 1, 1926 – June 30, 1927 – $2.857 billion
Fiscal 1928: July 1, 1927 – June 30, 1928 – $2.961 billion (3.64% increase on 1927)
Fiscal 1929: July 1, 1928 – June 30, 1929 – $3.127 billion (5.60% increase on 1928)
Hoover (March 4, 1929–March 4, 1933)
Fiscal 1930: July 1, 1929 – June 30, 1930 – $3.320 billion (6.17% increase on 1929)
Fiscal 1931: July 1, 1930 – June 30, 1931 – $3.577 billion (7.74% rise on 1930)
Fiscal 1932: July 1, 1931 – June 30, 1932 – $4.659 billion (30.25% rise on 1931)
Fiscal 1933: July 1, 1932 – June 30, 1933 – $4.598 billion (1.31% fall on 1932)

Budget Surplus or Deficit
Fiscal 1930 – $0.7 billion surplus
Fiscal 1931 – $0.5 billion deficit
Fiscal 1932 – $2.7 billion deficit
Fiscal 1933 – $2.6 billion deficit

As noted above, Roosevelt was not inaugurated until March 1933, so Hoover was responsible for the budget in fiscal year 1933 as well.

Hoover actually ran a budget surplus in the fiscal year 1930, not a deficit. Hoover’s first deficit was in fiscal year 1931, when the US economy had already begun contracting severely. He also cut spending in fiscal year 1933, and introduced the Revenue Act of 1932 (June 6) which increased taxes across the board and applied to fiscal year 1932 and subsequent years. These were highly contractionary measures, and these two policies are the very antithesis of Keynesianism!

An antidote to the conservative nonsense about Hoover can be found in Bruce Bartlett, “The Real Lesson of the New Deal,” Forbes.com, 2.13.09.

In order to understand whether deficit spending is truly stimulative, we need to understand the following terms: the output gap, potential GDP, actual GDP, and the Keynesian multiplier.

Bartlett shows that once the output gap is calculated and we have a rough estimate of the multiplier in the 1930s (possibly as high as 4) it can be shown that Hoover’s budget deficits and discretionary spending were woefully inadequate. Far from disproving that Keynesian stimulus doesn’t work, Hoover’s spending demonstrates that too little spending in the face of an economic catastrophe is a recipe for disaster.

US GDP was $103.6 billion in 1929. It can be estimated that potential GDP during the first years of the 1930s was about $100 billion.

For the moment, let’s ignore the impact of state and local budgets (though, as we will see below, that is in fact an important factor). In 1931, US GDP collapsed by $14.7 billion dollars, in a debt deflationary spiral with bank failures and a collapse in employment and investment. If we assume a multiplier of 4 (which is very high), then Hoover’s spending increase of $257 million dollars might have generated at most $1.028 billion of GDP in fiscal year 1931. But GDP fell by $14.7 billion dollars! Only an complete idiot or ignoramus would seriously argue that Hoover’s increase in spending in fiscal year 1931 could have prevented the depression, by effective stimulus to offset such a catastrophic fall in GDP.

In 1932, US GDP collapsed by $17.8 billion dollars. If we assume a multiplier of 4 again, Hoover’s spending increase of $1.082 billion dollars might have generated $4.32 billion of GDP in fiscal year 1932. But that was not even remotely enough to stop a collapse in GDP of $17.8 billion dollars. In 1933, Hoover cut spending, a very clear contractionary and anti-Keynesian policy.

Now the figures above are based on federal spending. Does anything change if we look at total (local, state, and federal) government spending in these years? Indeed it does. In fact, total US government spending gives us an even more accurate picture of fiscal policy. The figures for total government spending (federal, state and local) can be found here:

US Government Spending Fiscal Years 1910 to 1960.

You can see the collapse in GDP for every year from 1930 to 1933 above, and the increases in government spending. The only real difference is the total US government spending did increase in fiscal 1930 and 1933, but by small amounts, not even remotely large enough (even with a multiplier of 4) to arrest the collapse in GDP. What is also apparent in the figures above is that state and local austerity counteracted Hoover’s spending increases in 1931 and 1932. In particular, what looks like a large increase in federal spending of $1.082 billion dollars in fiscal year 1932 was reduced to just $0.26 billion by state and local austerity. What is also noticeable is that total government spending was significantly increased in fiscal years 1935 and 1936 under Roosevelt, and these were years of strong GDP growth.

The myth that Hoover attempted a Keynesian countercyclical policy designed to reverse the collapse in 1929–1933 is one of the most stupid things spouted by Austrians and libertarians.

Murphy on “Did Hoover Really Slash Spending?”: A Critique

Over at Mises.org, we have a perfect example of type of absurdity I point to above:

Murphy, R. P. “Did Hoover Really Slash Spending?” Mises Daily, May 31, 2010

Murphy is of course perfectly correct that Hoover increased spending in 1930, 1931, 1932, but in no sense does that refute Keynesian economics, as he claims at the end of his essay.

Let’s examine some of worst statements in his essay below:

“But the point is that the Fed had implemented record ‘easy’ policies from November 1929 through September 1931, some 22 months after the onset of the Great Depression.”

Murphy makes a great deal of the fact that the Fed lowered the discount rate from 1929 to 1931, which is true. He seems blissfully unaware that Keynesian economics tells us that monetary policy in times of severe economic contraction and depression will be ineffective. The old Keynesian dismissal of monetary policy in these times was summed up in the expression “pushing on a string”, which means that cheap money and low interest rates just don’t create significant aggregate demand when the economy is shocked. It is not remotely surprising that monetary policy did nothing to counteract the depression.

“Today’s Keynesians love to point to history to ‘prove’ the efficacy of their remedies. In particular, they adore Hoover’s budget cuts of 1932, and the Fed’s rate hikes of October 1931, as proof positive that ignorant conservatism caused the Great Depression. But prior to these turnarounds in policy, the federal government and central bank operated in a Keynesian fashion”

This is perfectly absurd. The aim of a Keynesian policy in a downturn is stimulate the economy so that GDP contraction is reversed and positive growth returns. If we assume a multiplier of 3 in 1930, to counteract the Great Depression, the US government would have had to increase spending by $4.13 billion in fiscal year 1930. Instead, the total government spending (local, state and federal) increase in 1930 was a miserable $240 million.

Again, if we assume a multiplier of 3 in 1931, to counteract the contraction that year, the US government would have had to increase spending by $4.9 billion in fiscal year 1931. Instead, the total government spending increase in 1931 was a feeble $260 million.

“If the Keynesians were right, the economy should have been in a tepid recovery by mid-1931, and yet it was in fact still freefalling.”

Murphy is perfect ignoramus. He hasn’t a clue about basic Keynesian concepts and how to apply them. The idea that the tiny spending increases in 1930 and 1931 could have stopped the depression is pure madness.

And even Hoover’s larger increase in 1932 was counteracted by state and local austerity, as we have seen above.


BIBLIOGRAPHY

Barber, W. J. 1985. From New Era to New Deal: Herbert Hoover, the Economists, and American Economic Policy, 1921–1933, Cambridge University Press, Cambridge and New York.

Bartlett, B. 2009. “The Real Lesson of the New Deal, Revisiting the 1930s,” Forbes.com,
http://www.forbes.com/2009/02/12/stimulus-depression-deficits-opinions-columnists_0213_bruce_bartlett.html

Cary Brown, E. 1956. “Fiscal Policy in the 'Thirties: A Reappraisal,” American Economic Review 46.5: 857–879.

Karlsson, S. 2010. “Again Herbert Hoover Was No Deficit-Cutter,” Thursday, March 11, 2010.

Murphy, R. P. “Did Hoover Really Slash Spending?” Mises Daily, May 31, 2010.

Stein, H. 1966. “Pre-Revolutionary Fiscal Policy: The Regime of Herbert Hoover,” Journal of Law and Economics 9: 189–223.

Stein, H. 1969. The Fiscal Revolution in America, University of Chicago Press, Chicago.

Temin, P. 1989. Lessons from the Great Depression, MIT Press, Cambridge, Mass.