This web site is dedicated
to my fellow World War II
4th Cavalry Reconnaissance Squadron
“A” troopers.
My “Fighting Fourth”
was a regular US Army unit
with a history reaching back
before the Civil War.
Before entering combat,
all the commissioned officers
were graduates of West Point
or of the Virginia Military Institute.
All the non-commissioned officers
had five to 25 years of service
in the mounted cavalry.
These were men
who devoted their lives
to the defense of their nation.
All the privates
were wartime volunteers
from every corner of the nation:
Brooklyn Italians,
Chicago Poles, Irish, and Jews,
Minnesota Scandinavians,
Carolina Appalachians,
Dakota Sioux.
For the D-Day assault on Normandy,
in the wee hours of the morning,
long before H-Hour,
“A” troop
cleared a fortified island
lying off the coast,
opening the way to the mainland.
My sergeant, Harvey Olson,
and Corporal Thomas Killoran,
both of the 2nd platoon,
were the first American soldiers
to land on a French beach,
swimming ashore from a raft,
with flashlights
to guide the landing craft.
As a boy,
Sergeant John Onken,
of the 3rd platoon,
came to America from Germany
with his parents after World War I
and retained a slight accent.
Especially friendly
toward Jewish troopers,
John could not understand
why Germany followed the Nazis.
John Onken
was the first American soldier
to die on a French beach.
In 11 months of combat,
from Utah Beach
to the heart of Germany,
“A” troop,
no more than 140 men at full strength,
(and never at full strength),
suffered
more than a hundred battle wounds
and 36 deaths,
including
two captains
and
four lieutenants.
President Franklin Delano Roosevelt
awarded his Distinguished Unit Citation
to the
4th Cavalry Reconnaissance Squadron
for its:
“...gallantry and esprit de corps...
above and beyond the call of duty...”
during the “Battle of the Bulge”.
These troopers
saw their nation in peril,
and,
in keeping with the highest traditions
of the US Cavalry,
rode to its rescue,
and did extraordinary deeds of valor.
While honoring their service,
may this web site also enhance
the heritage they preserved.
Marvin Sussman
Please note:
For brief definitions of unfamiliar terms,
click on "Jargon" at the top of the page
or search Wikipedia online
for more complete definitions.
National Debt (ND)
The wealth of nations is measured by their assets and
liabilities. Our nation’s assets are its natural
resources and its productive capacity, including its
infrastructure and its people.
Our liabilities are the net sums owed to creditors by the
federal government: the National Debt (ND). Throughout this
course, the ND refers to “Gross Debt”, which includes both
Treasury bonds and notes held by the public and insurance
payments eventually due to Social Securty, Medicare, and
other beneficiaries.
Throughout this course, we deal essentially with the federal
government, which can issue currency. In economic terms, a
state or local government, which cannot issue currency, is
like a branch office of the federal government: it can tax,
borrow, and spend but cannot issue currency. It does not
have a central bank, like the Federal Reserve, that can
create currency. If successfully sued by its creditors, it
can become insolvent. Only the federal government is
sovereign and solvent because it can ultimately create
currency.
Government Power and Impotence
By law, the Federal Reserve has a delicate balancing act:
"...to promote effectively the goals of maximum employment,
stable prices, and moderate long-term interest rates."
The Fed is now (mid-2011) failing at the first and most
important goal: jobs.
During the 1930s and 1940s, Marriner Eccles was the
chairman of the Federal Reserve. He steered the economy
through the Great Depression, WW II, and into a flourishing
post-war era. When Japan bombed Pearl Harbor,he did not
call in the Treasury bond holders and beg for sympathy.
He laid down the rules. To compare his command of a crisis
with the impotence of the current Fed, it is worth reading
this full description of his strategy, including this excerpt:
"Today’s fiscal conservatives prefer to ignore
the history of the 1940s, a period when the
Federal Reserve was far more accountable to
elected officials and far more independent of
the private financial interests that have come
to dominate the Fed in recent decades. During
the 1940s, the federal government spent and
borrowed far greater than today as a percentage
of overall economic activity. Today, federal
spending is about 25 percent of gross domestic
product; in the 1940s, spending peaked at nearly
45 percent of GDP. Today’s federal deficit is
about 9 percent of GDP; in the 1940s, the
deficit peaked at 31 percent of GDP. Today, the
federal debt held by the public is about 61
percent of GDP; in the 1940s, it peaked at over
114 percent of GDP. Did those higher spending
and debt levels bankrupt the U.S. economy?
Quite the contrary — federal spending was
critical to the war effort and the success
of the U.S. economy.
"After the war, massive federal spending funded
social policy on a grand scale through the GI
Bill of Rights and made available job training,
tuition-free higher education,health care, and
housing subsidies to nearly 16 million returning
veterans, a third of the workforce. The GI Bill
thereby bolstered an expanding middle class and
created the conditions for sustainable economic
growth. The growing economy pushed up tax
revenues, lowering the debt burden and helping
the federal government pay down debt."
While blaming "Washington", we must also blame the real
culprits: the voters, past and present, whose stupidity
and/or ignorance of economic and political matters have
saddled our nation with four self-inflicted problems:
1. The Congressional struggle to raise the
debt limit. Due to a law that violates the separation
of powers, Congress first votes to assume a debt and then
forbids payment of the debt by the executive branch
until it gives its permission. The turmoil threatens the
global economy for purely political reasons.
2. Our self-imposed, legal dependence upon the
Treasury bond market to finance the administration of the
US government (and therefore our economy). According
to law, Congress must either tax or borrow whatever it
spends. But a sovereign nation, which issues its own fiat
currency, cannot physically fail to pay its
debts as long as the computer keyboards of the Treasury
Department and the Federal Reserve are still functioning.
Treasury bonds offer the public a risk-free haven for
savings at an interest rate usually high enough to protect
against inflation. There is no good reason to pay a higher
interest rate. If bond holders stop buying bonds, we will
continue to feed, shelter, clothe, and defend ourselves.
Requiring Congress to tax or borrow before it can spend
is beneficial only to the bond holders. Our nation
thrived for a century before Congress tied its own hands.
As a result, over 200 million adults are supposedly at the
mercy of a small number of bond-holders, all of whom have
willingly invested in Treasury bonds and don't know what
else to do with their money.
To explain the problem and propose a solution would be
outside the scope of this course. Interested students
should look into the "New Economic Perspectives"
blog for a good explanation of the operations of the
Treasury and the Federal Reserve.
3. The maldistribution of wealth, income, and
political power. This is best explained by this excerpt
from Michael Hudson's article in the "New Economic
Perspectives" blog:
"Altogether, the post-2008 crash saw some $13
trillion in such obligations transferred onto
the government’s balance sheet from high
finance, euphemized as “the private sector” as
if it were the core economy itself, rather
than its calcifying shell.
"Instead of losing on their bad bets, bad
loans, toxic mortgages and outright fraudulent
claims, the financial institutions cleaned up,
at public expense. They collected enough to
create a new century’s power elite to lord it
over taxpayers in industry, agriculture and
commerce who will be charged to pay off this
debt.
"If there was a silver lining to all this, it
has been to demonstrate that if the Treasury
and Federal Reserve can create $13 trillion
of public obligations – money –electronically
on computer keyboards, there really is no
Social Security problem at all, no Medicare
shortfall, no inability of the American
government to rebuild the nation’s
infrastructure. The bailout of Wall Street
showed how central banks can create money,
as Modern Money Theory (MMT) explains. But
rather than explaining how this phenomenon
worked, the bailout was rammed through
Congress under emergency conditions.
Bankers threatened economic Armageddon if
the government did not create the credit to
save them from taking losses.
"Even more remarkable is the attempt to
convince the population that new money and
debt creation to bail out Wall Street – and
vest a new century of financial billionaires
at public subsidy – cannot be mobilized just
as readily to save labor and industry in the
“real” economy. The Republicans and Obama
administration appointees held over from the
Bush and Clinton administration have joined
to conjure up scare stories that Social
Security and Medicare debts cannot be paid,
although the government can quickly and with
little debate take responsibility for paying
trillions of dollars of bipartisan Finance-
Care for the rich and their heirs."
4. The obsession with debt, of which over 80% was
produced by the policies of those most obsessed by it.
In fact, the ND is important only when debt interest
payments are unsustainably high. This is not the case now
and can never happen with full employment and high tax
revenues.
Relative to the GDP, our post-WW II publicly-held debt was
twice its present value but was never reduced by a penny.
Instead, with unemployment rates rarely below 5% and top
tax rates over 50%, our GDP simply grew large enough so
that, at Reagans's first inauguration, 35 years later, the
ratio was down to 25% of its peak.
That is when the tax-cutters began to wreak havoc. Today,
the ratio is back up to 50% of its WW II peak. With pre-
Reagan GDP growth and tax rates, we could regain the pre-
Reagan ratio and also reduce our dangerous income and
wealth inequality.
We do not have a spending problem. Due to the
maldistribution of income and wealth, we have a demand
problem that results in an unemployment problem that
creates a tax revenue problem that looks like a deficit
problem that could become a debt problem if we don't get
rid of the maldistribution-of-income-and-wealth problem.Instead of voting for deficit hawks in both parties, an
intelligent, educated, and rational electorate would
demand a program of full employment based upon repairing,
rebuilding, and improving our obsolete and decaying
infrastructure. The purpose of this course is to show that
such a program finances itself in the same manner that
wasteful WW II spending created post-war prosperity.
Proceed to:
Lecture 2. GROSS DOMESTIC PRODUCT (GDP)
Thanks for your interest.
Marvin Sussman, retired engineer
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Economic activity consists of the production and sale of
goods and services, followed eventually by their
consumption. Only the retail value of the goods and
services adds to the output of the economy. Thus, the size
of our national economy is measured by its GDP, the total
retail value of domestic products and services delilvered
annually.
We call the average tax rate at all levels of government
the “Tax Burden” or TB. After paying taxes,
consumers have a disposable income, from which they can
either consume goods and services or save in various
accounts. In economic literature, the average proportion of
disposable income consumed is called the “Marginal
Propensity to Consume” or MPC. The disposable income
not spent is saved and the average proportion saved is
called the “Marginal Propensity to Save” or
MPS.
The partition of consumer spending among TB, MPC, and MPS
is critical to the economy. Consumers always have needs and
when they have a secure source of money, the “life
blood” of the economy, MPC will dominate MPS. When
consumers are insecure about their source of money, MPC
falls as MPS rises, the GDP drops, and - voilà - a
recession!
Therefore, to avoid a recession or to recover from a
recession, there are certain
BASIC REQUIREMENTS:
1. The amount of money in the economy must be sufficient and
assured.
2. The money in the economy must be distributed so that the
entire population can purchase essential goods and services.
(We now have the greatest maldistribution of wealth and
income since the Great Depression.)
3. Since, according to our Constitution, it is the basic
purpose of the U.S. government to “...promote the
General Welfare and secure the Blessing of Liberty to
ourselves and our Posterity,...”, the “essential goods and
services” include all the food, shelter, play, and health
care needed by children and all the education children
can absorb until their education is complete, regardless
of the wealth or poverty of their parents.
4. Since the well-being of children is inseparable from the
well-being of their parents, grandparents, guardians, and
employees of schools, hospitals, merchants, producers, and
other members of their community, “essential goods and
services” include the food, shelter, and health care needed
by adults, regardless of their weath or poverty.
5. Since the states cannont issue sovereign currency, it is
impossible for the states to to manage the economy so that
“essential goods and services” may be purchased by the entire
public.
Therefore, it is the sole responsibility of the federal
government to manage the economy so that “essential
goods and services” may be purchased by the entire
public. States cannot control their economies or maintain
the highest standards in delivery of health and education
services. They are bound to fail as they are now failing.
6. Since, according to the preamble of our Constitution,
it is the will of "We, the people, in order to form...,
establish..., insure..., provide..., promote..., and
secure..." whatever we need, the federal government should
be big enough to do what needs to be done.
The central thesis of Keynesian theory is that the
policy of the federal government should be to do what needs
to be done to fulfill these requirements.
A small government cannot build the world's greatest
infrastructure.
Without the world's greatest infrastructure, we will not
have the world's greatest industrial base.
Without the world's greatest industrial base, we will
not have the world's greatest military, naval, and air
defense.
Without the world's greatest defense, our very existence
as a nation is in jeopardy.
A small government is a betrayal of our heroes who died
so that a great nation could provide a great defense
against a dangerous world.
A small government is the road to serfdom.
A small government is only the fetish of small minds.
GDP = Productivity x Employment Rate x Time
While the GDP is our economy's output, the economy's
efficiency is measured by its productivity, defined as:
(1) Productivity = GDP / Total Annual Working Hours
Thus, nations differ in the average value of the goods
and/or services that each hour of work will produce. A
nation grows richer due to a gain in productivity.
Multiplying equation (1) by its denominator yields:
(2) GDP = Productivity × Total Annual Working Hours
To understand the factors that determine GDP, we define:
(3) Employment Rate = Total Annual Working Hours
÷ Total Annual Available Working Hours
Employment Rate is directly proportional to production
capacity. The economy is considered to be at peak
production capacity when the unemployment rate is 2%,
(This assumes that at least 2% of the working population
is always otherwise occupied.)
Multiplying equation (3) by its denominator yields:
(4) Total Annual Working Hours
= Employment Rate
× Total Annual Available Working Hours
Finally, substituting equation (4) into equation (2),
we have:
(5) GDP = Productivity
x Employment rate
x Total Annual Available Work Hours
Thus, the GDP depends on three factors:
1. Productivity increase can arise from two sources:
A. Technological innovation.
These productivity gains are the result of
two developments:
(a) Basic infrastructure: long-term developements,
such as systems of transportation,
communication, etc. These require political
commitment to large investments with distant
pay-offs. This can happen only with unusual
leadership and national unity.
It also requires an excellent system of
education, especially in science. Currently,
the US is behind dozens of nations in
science education. In particular, Asian
countries are running far ahead of us.
Worse yet, teachers salaries and pensions
are under severe attack by short-sighted
deficit hawks.
(b) Short-term innovations such as TV, cell-phones,
etc. Industry produces these inventions, but
industry depends upon a work force with a
sufficient level of technical education, which
is a long-term investment.
B. Increased human effort (“speed-up”)
This occurs especially during during a
recession when industry cuts costs by laying
off well-paid employees with fringe benefits
and ordering the remaining employees to take
on an additional load, sometimes augmented by
temporary aid without fringe benefits.
During the current recession, productivity has
increased over 9% during a three-year period
with negligible increase in hours worked or
salary.
Even during prosperity, the US falls behind
most advanced nations in vacation time, paid
maternity leave, and similar benefits. For
this reason, productivity comparisons between
nations is deceiving.
Thus, productivity requires long-term investment,
which requires an intelligent electorate.
2. During a recession, employment rate is a factor that
government can affect in the near term only by heavy
investment in infrastructure, including defense: a
stimulus. (World War II was an extreme example.) In
general, full employment is the responsibility of the
federal government, requiring the joint efforts of the
administration, Congress, and the Federal Reserve. In
particular, the nation cannot recover from a major
financial collapse, such as the Great Depression or our
2008 meltdown, without the joint effort of all branches of
government.
At present (mid-2011), the unemployment rate is about 9%.
Underemployment (those working less than 30 hours per week
and seeking full-time work) is at about 16%. Thus, the
effective unemployment rate is about 17%.
Raising employment by ten million workers would add over
$1T annually to the GDP. The tax revenue on such GDP growth
would be over $300B. The reduction in relief benefits would
add another $300B yielding a $600B total budget gain
annually. The ten-year gain would be $6T. For our 20 million
unemployed, the ten-year gain would be $12T. What deficit?
Thus, the employment rate is a measure of prosperity. The
view of Keynesian theory is that the federal government
should pursue a policy of full employment to meet the BASIC
REQUIREMENTS listed above.
Conservatives claim that tax reduction for the wealthiest
would increase the employment rate. That may happen during
prosperity, but that is exactly the point at which tax
revenue should be maximized to avoid inflation and control
the deficit. During a recession, the profits and tax burden
of industry (especially small business) are too low to
influence a decision. Low interest rates, cheap labor, and
abundant capacity insure that any good opportunity will be
easily funded.
The chart below (from the Bureau of Labor Statistics and
Tax Policy Center) plots average employment growth versus
top tax rate.
There is no evidence that lower tax rates for the rich
stimulates job growth. If everyone complaining about the
lowest tax level in 60 years would buy an automobile,
they would know who creates jobs.
3. Total Available Working Hours is a long-term GDP factor
dependent upon population, birth and death rates,
immigration and emmigration, and cultural changes such as
percentage of women at work, youth in school, etc. In
general, government can do little to affect Total Annual
Available Work Hours in the near term.
In the long term, pro-family programs could increase the
population and immigration policy could become more
liberal, especially with regard to foreign students and
scientists. Again, there is much anti-immigration opinion
among conservatives.
CONCLUSION:
The growth of GDP, the most important measure of our
national wealth and health, is dependent upon gains in
productivity and infrastructure. Gains in productivity are
likewise dependent upon infrastructure, especially our
system of public education. Thus, our future depends almost
entirely upon public investment in infrastructure.
Proceed to:
Lecture 3. THE ACCOUNTING MODEL OF GDP
Thanks for your interest.
Marvin Sussman, retired engineer
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Keynesian Economics 101
The ONLY way out of this mess
Free lectures on-line:
KeynesForum.blogspot.com2. To print and distribute single-sheet “invitations”
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Consider the GDP as national income that come only from
three sources: (For the present, we will assume that
exports = imports and thus ignore foreign trade balance
effects.)
C = Consumer Spending
I = Investment by Individuals
G = Govenment Spending
The nation disposes of this income by three types of
expenditures:
C = Consumer Spending
S = Savings
T = Taxes
Since, over time, income must equal expenditure, the
following equations are valid:
C + I + G = C + S + T, or, subtracting C from both sides:
I + G = S + T, or, transposing S and G:
(1) I - S = T - G
The left side of equation (1) represents the private
sector. If the difference is positive, the private sector
is a net borrower and, otherwise, a net saver.
The right side of equation (1) represents government. If
the difference is positive, government has a surplus budget
and, otherwise, a deficit.
Let us emphasize that this is not economic theory but
rather straight forward, uncontesable accounting, where the
numbers must "add up".
If either side of equation (1) is positive, so is the
other. In that case, when the government has a surplus
budget, the private sector is a net debtor. However rarely
this happens, and no matter how many billionaires there
are, there are many others in debt.
If either side is of equation (1) is negative, so is the
other. In that case, when the government budget has a
deficit, the private sector has a surplus balance. No
matter how many people are unemployed, there are, on
balance, trillions available for spending. This is our
current situation.
The Role of Trade Balance in the Model
When the foreign trade balance is considered,
the logic does not change. There is simply an additional
factor:
Exports minus Imports = X - M
= Net Exports
A positive balance in this account (also called the
the "Current Account") means that the private sector
has a net claim on foreign assets. Unfortunately,
this account has been negative for two decades.
It deficits are private sector debits.
The symbols above (from the blog:"New Economic
Perspectives", an excellent web site from which to learn
economics) portrays the flow of money between all three
sectors: private, public (government), and foreign.
Each sector has in-flows and out-flows to the other
sectors. Each transaction has two entries. For every
transaction, money goes in one direction and its value in
goods and/or services goes in the other direction.
If, by chance, all three sectors have "Net Exports"
balances equal to zero, the sum of the three balances will
be zero.
Otherwise, if only one sector has a "Net Exports"
balance equal to zero, the other two sectors will have
equal and opposite balances so that the sum of the three
balances will still be zero.
It would be impossible for only two of the sectors to have
a zero balance. The remaining sector would have a non-
zero balance but no debtor or creditor.
If two of the three sectors jointly have either a positive
balance or a negative balance, the remaining sector must
have a balance equal and opposite to the sum of both of
the other balances. Thus the the sum of the three balances
will still be zero.
That covers all possible cases. Thus, the economy of the
three sectors really is a zero-sum game! In the above
circuit, the sum of all balances is always zero. This
gives rise to an identity:
Private Sector Savings (S - I)
+ Public Sector Surplus (T - G)
+ Foreign Sector Surplus (M - X)
= zero
The Complete Accounting Model
Re-writing the above identity:
(2) (S - I) + (T - G) + (M - X) = 0
and multiplying by -1 yields:
(3) (I - S) + (G - T) + (X - M) = 0
and transposing (G - T) yields our final equation:
(4) (I - S) + (X - M) = (T - G)
Thus, from an entirely different concept,
we have again derived equation (1) above
with the addition of "Net Exports"
as a Private Sector claim on foreign assets.
Consequences
It is important to recognize that,
because of the zero sum of balances,
with Foreign Sector Surplus relatively stable,
Public Sector Surplus growth (less government spending)
implies Private Sector Savings decline (more consumer
debt).
Conversely, with Foreign Sector Surplus relatively stable,
Public Sector Surplus decline (more government spending)
implies Private Sector Savings growth (less consumer debt).
The government’s deficit is someone else’s surplus
and the government’s debt is someone else’s asset.
If we want the government to pay off its entire debt,
then we must want every single private portfolio
to lose its Treasury securities.
Since all of us agree that the private sector should save,
we must also agree that the government should borrow.
Now we can see why the attempt to balance the budget
in the early 1930s brought on the Great Depression
and why the same policy in 1937 caused another recession.
Reducing government spending during a recession is lunacy.
The Proof is in the Pudding
Having explained the model and stated our conclusion,
let us now verify the model with data.
It is interesting to confirm our accounting principles
by examining data from the NIPA (National Income and
Product Accounts) file in their Sectorial Balances
Data. (A hat tip to Scott Fullwilir and Stephanie
Kelton from the "New Economic Perspectives" blog for this
link.)
Please note: The data below is copied exactly from the
file, where the data is given in negative quantities so
that equation
(4) (I - S) + (X - M) = (T - G)
becomes:
(5) (S - I) - (X - M) = (G - T)
or in the terminology of the file heading:
(5) Domestic Private Surplus (S - I)
- Current Account (X - M) (Net Exports)
= Government Deficit (G - T)
But if you look at the data in the NIPA file you will see
that it is given (in the last three columns on the right)
with Current Account transposed so that the file heading
reads:
(6) Domestic Private Surplus (S - I)
= Government Deficit (G - T)
+ Current Account. (X - M) (Net Exports)
The file data is listed as percentages of GDP.
(Use algebraic addition/subtraction!)
In 1998 Q3, (file line 190) we had:
Domestic Private Surplus: -2.55%.
= Government Deficit: +0.01%
+ Current Account: -2.56% (Net Exports)
In this case,
with Government Deficit almost zero,
Domestic Private Surplus almost equals Current Account.
In 1988 Q1, (file line 148) we had:
Domestic Private Surplus: +1.61%.
= Government Deficit: +4.20%
+ Current Account: -2.59% (Net Exports)
In this case, the Current Account is almost the same as in
1998 Q3, but a large Government Deficit overcame the
Current Account, yielding a positive Domestic Private
Surplus.
Conclusions:
1. A government deficit is a private sector surplus.
2. The numbers "add up".
This is not economic theory.
This is simply Accounting 101.
3. Anyone who doubts the validity of the Accounting Model
should have an alternate explanation
for over 240 quarters of NIPA data such as given above.
Q: What happens when government reduces spending
during a recession?
A: Money necessary for consumer spending
or business investment is removed from the economy.
Q: What happens when government balances the budget?
A: If T - G = 0,
then (I - S) + (X - M) = 0 and
S = I + (X - M) or
Savings = Investments + Current Account
Since the Current Account is seriously negative and,
during a recession, the Investments account is
pitifully small, the Domestic Private Sector is a net
debtor.
These consumers will not be in a consuming mood.
Indeed, with our inequality of income and wealth,
the average consumer will be in serious debt.
Q: Why would politicians call for less government spending
or even a balanced budget during a recession?
A: They are either fools or charlatans
seeking votes from foolish or ignorant voters.
Government deficits are due to reduced tax revenue,
and necessary relief spending.
To increase consumer spending,
government deficits must be increased.
During a recession,
federal government austerity
is a recipe for a depression.
Proceed to:
Lecture 4. THE MONEY SUPPLY
Thanks for your interest.
Marvin Sussman, retired engineer
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Although this course is labeled "Keynsian Economics",
it could more accurately be labeled "Lernerian Economics"
since it is based upon the work of Abba P.Lerner (1903-
1982), student of (and collaborator with) Keynes at the
London School of Economics. On the economics faculty of
Roosevelt College, Chicago (1947-1958), he developed the
theory of "Functional Finance", explained by the following:
(ref: Wikipedia)
PRINCIPLES of FUNCTIONAL FINANCE
• The principal economic objective of the state should be
to ensure a prosperous economy. Governments have to
intervene; the economy is not self-regulating.
• Money is a creature of the state; it has to be managed.
The amount and pace of government spending should be
set in the light of the desired level of activity, and
taxes should be levied for their economic impact,
rather than to raise revenue.
• Fiscal policy should be directed in the light of its
impact on the economy, and the budget should be managed
accordingly, that is, a ‘balanced budget’ is not
important in itself. “Budget balancing” applies to
households and businesses, but does not apply to the
governments of sovereign states, capable of issuing
money.
RULES FOR FISCAL POLICY
1. The government shall maintain a reasonable level of
demand at all times. If there is too little spending
and, thus, excessive unemployment, the government
shall reduce taxes or increase its own spending. If
there is too much spending, the government shall
prevent inflation by reducing its own expenditures or
by increasing taxes.
2. By borrowing money when it wishes to raise the rate
of interest and by lending money or repaying debt
when it wishes to lower the rate of interest, the
government shall maintain that rate of interest that
induces the optimum amount of investment.
3. If either of the first two rules conflicts with the
principles of balancing the budget, or of limiting
the national debt, so much the worse for these
principles. The government press shall print any
money that may be needed to carry out rules 1 and 2.
AIMING FOR THE GOLDILOCKS ECONOMY
Economies exist between two opposing threats:
* Full employment, shortages, and inflation: an excess of
money in the economy.
* Unemployment, glut (excess inventory), and deflation:
a shortage of money in the economy.
A Goldilocks economy - not too hot, not too cold - can be
achieved by a financial policy that would avoid these
extremes by regulating the amount of money in the economy
with a judicious choice of the methods described below.
All that is required is political will. Currently,
(mid-2011), deficit hawks (with support of half of the
public) believe that removing money from the economy
during a recession will increase employment by "raising
confidence" - exactly the way George Washington's doctors
removed "bad blood" from his veins to allow his body to
gain strength.
The central thesis of Lernerian theory is that the
federal government should pursue a policy of full
employment consistent with low inflation and sustainable
debt in fulfillment of the basic requirements
listed in Lecture 2.
Currency and Money Supply
Being sovereign, the government is the unique issuer of
fiat currency. There is no physical limit to the
amount it may issue. We do not have a gold currency
standard that constricts our money supply.
Money enters the economy by several means:
1. Government purchase of private assets.
2. Grants, benefits, and wages to individuals or private
organizations.
3. On the open market, the Federal Reserve can purchase
Treasury bonds and other securities from financial
institutions. (The Bank of England has an excellent
description of the term “quantitative easing”.)
This money becomes available for investment but only
if banks and investors are both willing. Since that
depends upon their view of the economy, the policy is
always viewed with doubt. The purchase also has the goal
of lowering interest rates and stimulating more economic
activity.
4. Commercial Banks can, by making loans, create credit
accounts up to a multiple of their reserve funds.
5. Unless interest rates are close to zero, the Federal
Reserve can reduce the rates to promote movement of money
out of reserves.
6. An excess of exports over imports. This hasn’t happened
since 1990.
7. Foreign purchases of domestic property, foreign tourism,
etc. Also “repatriation” of foreign profits of domestic
firms.
Money is removed from the economy by several means:
1. Government sale of assets to individuals or
corporations.
2. Taxes, fines, fees, etc. have that effect but are not
enacted for that purpose. (It is interesting that, in a
recession, the conservatives call for tax cuts to spur the
economy. But, during prosperity with fear of inflation,
they never call for tax increases to curb the growth and
stop inflation.)
3. Among other open market transactions, the Federal
Reserve sells Treasury bonds and notes to the public.
This “tightens” the money supply and restricts the
ability of banks to lend.
4. The Federal Reserve can raise interest rates,
effectively impeding the money flow from reserves into the
economy.
5. An excess of imports over exports. This is a side-effect
of sending manufacturing jobs overseas.
6. Money transfers, such as domestic investment in foreign
nations (This is how US jobs are shipped overseas!),
corporations and individuals parking money in off-shore tax
havens, money spent by army privates in a foreign pub or by
generals bribing a tribal chief, tourism, etc.
Thus, the money supply (and consumer purchasing power)
grows or declines as a result of the difference between
these two flows.
To increase the flow of money into the economy, the in-
flow must exceed the out-flow. In a recession,
the federal government must accelerate spending relative to
taxation. The federal budget must have a deficit - the
larger the better to end the recession.
Maldistribution of Income and Wealth
To avoid recessions, an adequate money supply is not
enough. The money must also be well distributed so that
everyone can buy necessities. Maldistribution, for much of
the population, is the same as a short money supply.
Economists say that recessions are caused mainly by too
much borrowing, spending, and debt. This is true but begs
the question: why do people borrow? Obviously, they borrow
because they need more than their income. But why should
that happen during prosperity? Are salaries not high
enough?
For a large portion of the working population, salaries
slowly lose the struggle with even minor inflation and the
needs of a growing family. "Keeping up with the Jones
family" takes its toll. Then, consumers spend less,
producers produce less, and the downward spiral ends in a
recession.
When unions were strong and manufacturing was an important
industry, such recessions were short and were overcome by
inventory exhaustion and replenishment as well as by
counter-cyclical acts of government. People paid off their
debts, started buying again, and prosperity returned. And
the cycle could begin again.
But with the export of manufacturing jobs, the consumer
lost the battle. Personal debt for much of the population
has had a steep climb. Although national wealth has
increased, it is not in the hands of many who are in debt.
The booms are shorter and the busts are getting longer.
Our present crisis started when Reagan successfully bribed
the voters with their own taxes: beer and cigarette money
for the vast majority and vast wealth for a small minority.
Since that severe blow to progressive taxation, ten
percent of the US annual income has been
redistributed from the bottom 80% of households
to the top one percent of households. Now, the middle
class is being decimated and
infrastructure investment has been put on a starvation
diet.
↑
↑
↑
↑
START OF PERSONAL DEBT DEBACLE
Reagan also put America in hock with lax enforcement of the
1979 NAFTA free trade agreement, matching US salaries
against coolie wages without consideration for working
conditions, pension and health benefits, or environmental
standards.
To avoid or recover from a recession, the economy's money
supply must be both adequate and distributed well enougn to
enable the vast majority of the population to purchase
essential needs. The late 1920s and the early 2000s were
both periods of peak maldistribution of wealth and income.
Now, 80% of the US population owns less than 10% of its
wealth and income distribution is similarly distorted.
There are really only two cures for this disease:
* A return to the pre-Reagan tax rates, including steep
estate tax rates. There is no reason children of the rich
should inherit more political power (which comes with the
cash and begets more cash and more power, etc.) than
children of the poor.
* A policy of renewing domestic manufacturing and the
consequent restructuring of the trade balance, as
described by John B. Judis in The New Republic magazine.
Such renewal cannot occur without massive investment
in US infrastructure to give us technological
advantages over competition.
Proceed to:
Lecture 5. DEFICITS AND THE DEBT RATIO
Thanks for your interest.
Marvin Sussman, retired engineer
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In a free market, commodity prices seek a point of
equilibrium. But population growth and improving standards
of living continually induce buying, scarcity, and an
increase in the general level of prices: inflation.
Inflation causes money to continually lose purchasing power
and encourages spending or investment rather than saving.
High inflation rates generally occur with a scarcity of
goods or, said otherwise, an excess of money. Thus, the
need to closely monitor inflation when employment rates are
high or with high levels of production or investment. The
Fed counterattacks inflation by raising interest rates and
and otherwise reducing the money supply.
Inflation is complicated by domestic shortages, e.g., oil.
Then, competition for goods is world-wide and can occur
during low domestic employment rates. This may cause
"stagflation": unemployment plus inflation.
Inflation lowers the real interest rate (the nominal rate
minus inflation), which effectively lowers the cost of
borrowing. The threat of inflation is a spur to investment.
Inflation also helps the debtors by eroding the real value
of their debt. Lower real interest rates means faster
growth and lower unemployment, boosting job and wage growth.
For those living off of capital rather than wages,
inflation erodes their assets and capital. So investors are
not in favor of lower real interest rates, faster growth,
and lower unemployment. They like a "strong" dollar and are
opposed to "loose" money policy.
The Federal Reserve targets 2% inflation as a beneficial
goal because it induces high-return investments rather than
low-return savings. It also allows for some prime rate
reduction during a recession. Above all, it avoids
deflation.
Deflation
Deflation is the end result of a declining money supply in
the hands of consumers. The consumers simply lack cash.
Deflation causes money to continually gain purchasing power
and induces saving rather than investment. Who would spend
a dollar today if it could buy more tomorrow?
The Federal Reserve can control inflation by removing money
from circulation by methods described in Lecture 4.
Control of deflation is an entirely different matter. Money
must be inserted into the economy to promote spending, but
it requires enough political will to overcome the
opposition of deficit hawks.
During the Great Depression, the political will was
insufficient until an Austrian economist, Adolf Hitler,
showed us how to insert money into the economy. He ended
the Great Depression where all others had failed.
Deficits & Debt
Historically, inflation is almost permanent. The Great
Depression was a rare period of deflation. The Federal
Reserve targets 2% inflation to avoid deflation like the
plague. But to assure inflation, while we are a net
importing nation, the money supply must continually
increase and the government must almost always have a
deficit.
Proof? Suppose now that we want the government to have
a surplus consistently. Using our accounting model,
we would have:
Tax revenue - Government Spending > 0 (consistently)
or T - G > 0 and therefore
(1) T - G = (I - S) + (X - M) > 0
Because the trade balance has been and will be
negative for a long period,
Exports < Imports or X < M
so we can transpose (X - M) in equation (1), yielding:
(I - S) > (M - X) > 0
since M > X.
Therefore, (I - S) > 0 or more simply:
I > S
or Investments > Savings
With Investments being low during a recession, Savings
are even less. Thus a continual budget surplus dooms
the private sector to be a consistent net borrower.
And since most of the wealth and income is held by
millionaires and billionaires, the average consumer
will be very reluctant to consume.
Therefore, government spending (which inserts money
into the economy) must generally be greater than tax
revenue (which removes money from the economy):an
almost permanent budget deficit.
Thus, a budget surplus is rare and occurs only when tax rates
are high during a prosperity. Indeed, we have had only one
true budget surplus in the last 40 years. And that was due
to decreased military spending during a technology boom
with a higher tax rate than now.
The result of the Clinton budget surplus or low deficits was
the removal of money from the private sector, a fiscal drag
which led to a recession early in the first Bush
administration.
With near-permanent inflation, a growing economy must
continually have (minor) budget deficits and the ND must
almost continually rise. With Congress's need to tax
or borrow whatever it spends, it is mathematically
impossible to consistently lower the ND. A permanently
balanced budget is the fetish of ignorant fools and must be
avoided like the plague. As we will show below, the ND can
only be judged relative to the GDP and to the money supply.
In fact, permanent deficits are sustainable if, over the
long-term, the additional tax revenue provided by GDP
growth exceeds the added bond interest payment on the annual
budget deficit. This can be assured by adequate tax rates
and a full employment policy to assure both high tax
revenues and low bond interest rates.
Think of government as a corporation which starts its
growth by issuing bonds. As the corporation succeeds and
grows, it issues more bonds. Its outstanding debt rises
continually and everybody is quite happy - as long as
dividends are adequate!
Debt Ratio (DR)
While the ND has no direct effect upon GDP, another
important measure of our economic health is our national
indebtedness, the DR, the ratio or percentage of the ND
relative to the GDP:
(1) DR = ND ÷ GDP
Statements about the annual budget deficit or the ND become
more meaningful when compared to the GDP.
Essentially, the ND is an accumulation of debt over the
last 80 years. The GDP is an accumulation of retail sales
over a 12-month period. So, actually, the DR is not
really a pure, dimensionless ratio. The dimension of the
numerator is in dollars but the dimension of the
denominator is in dollars per year. Therefore, the
dimension of DR is in years.
How should we interpret the DR in terms of years? If,
starting January 1, all the retail income of the nation
were used immediately to buy Treasury bonds and notes, a DR
equal to 50% would mean that the entire ND could be
completely paid off in six months. A DR equal to 200% (like
Japan today) would mean that the ND could be completely
paid off in two years. Our DR (about 98%) would mean that
our ND could be completely paid off by Christmas.
Of course, this is nonsense. In fact, the ND is never "paid
off", is rarely reduced, and is indirectly related to the
GDP only by tax revenue and debt interest expense. The ND
is financed by paying interest on Treasury bonds and notes.
The only criterion upon which to judge the present and
future direction of our annual budget is the long-run
sustainability of annual interest payments on the ND.
A more pertinent ratio would be the ND relative to "base
money", or M0, the total sum of money issued by the
Treasury. M0 includes currency and bank reserves. It does
not include less liquid funds, such as CDs. That ratio
(ND/M0) would estimate how much the money supply is
encumbered.
The value of the DR is not as important as the rise or
decline of the ratio. The economy is headed in the right
direction when, over time, the ratio is being reduced,
no matter how slight the reduction. The thesis of this
course is that the fiscal policy of the federal government
should be full employment (consistent with low inflation)
through incremental reduction of the ratios by means of
stimulated GDP growth.
Substituting from equation (5) of Lecture 1 for GDP into
equation (1) yields:
(2) DR = ND / GDP
= ND / [(Productivity)
× (Total Annual Available Work Hours)
× (Employment Rate)]
The analysis of the denominator in Lecture 1 showed
that, in the near-term, the DR is dependent entirely upon
both the ND and stimulus. Unfortunately, these two factors
work against each other. A stimulus will increase both the
numerator and the denominator. The DR will then either rise
or fall, depending upon the efficacy of the stimulus. This
dilemma is the central question of Keynesian and Lernerian
theory and will be analyzed in other lectures.
Safe Upper Limit for the Debt Ratio
According to the deficit hawks, our DR is now beyond its
safe upper limit. But what is the safe upper limit?
Concerned about the Treasury bond market, Federal Reserve
Chairman Alan Greenspan favored Bush’s 2001 tax cut
because he found the DR too low at 56%. At that time, Rep.
Paul Ryan (R-Wisc) concurred. Speaking of the ND, Ryan
said, “It's too small."
On the other hand, the European Central Bank (ECB) requires
that member nations maintain a DR less than 60%.
Apparently, the only good DR is 58% ± 2%, which is
ludicrous. Obviously, the ideal DR is above“too low”.
But what is “too high”?
In fact, as we explained above, the DR is too high only
when Treasury bond “vigilantes“ are able to obtain
interest rates that are unsustainably high. Using
current data, our DR is 98.0%. Is that too high? Not yet,
since bond interest rates remain near historic lows.
The DRs of Germany, France, and Canada are about 80%.
Japan’s DR is over 200%. These nations are recovering
from recession but are generally prosperous. The
British Empire thrived for 200 years with DR values above
1,000! Apparently, bond holders look beyond the DR and go
for the best bet they can find. US Treasury bonds are still
the safest bet. Above all, GDP growth trumps the DR
when it lowers the DR.
In fact, there is no critical value for the DR. Our best
monitor for economic health is the employment rate or rate
of production relative to peak production. If our economy
is going at full speed and tax revenues are at maximum and
the DR is declining, the market will buy Treasury bonds at
a low interest rate.
The DR can be controlled by measures that maintain full
employment. The economy is almost always headed in the
right direction whenever the DR is reduced, no matter how
slight the reduction.
Proceed to: Lecture 6.
THE TRUE LIMIT TO DEFICIT SPENDING
Thanks for your interest.
Marvin Sussman, retired engineer
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To find our borrowing limit, let’s take the
banker’s viewpoint. A cautious banker will grant a
mortgage if the home-buyer has a good credit rating and an
income that can service the loan. So, one’s
creditworthiness depends upon one’s history and income.
The same criteria apply to nations. Our bond-holders will
be patient if our nation is thriving as judged by its DR
decline and its GDP growth. These determines our tax
revenue, liquidity, and credit. With strong enough GDP
growth, the DR can decline, even with modest annual budget
deficits. For that reason, the DR is much more important
than the ND.
In classical (not Keynesian) economics, this criteria is
recognized in undergraduate courses as the "Golden Rule":
As long as the long-term, inflation-adjusted
Treasury bond interest rate is lower than the
long-term, inflation-adjusted GDP growth rate,
the government should borrow as much money as
it can borrow and spend as much of it as it
can efficiently spend on infrastructure.
At present, the long-term, inflation-adjusted Treasury bond
interest rate is well under 2%. Since the long-term,
inflation-adjusted GDP growth rate is over 3%, there is at
least 1% of leeway for borrowing. Yet conservatives are
calling for a balanced budget! Their ignorance of basic
(not Keynsian!) economics is astounding.
Keynesian and Lernerian economics agrees with the "Golden
Rule" and goes a step beyond: the multiplier. Rather than
try to define the term, we will use an analogy.
The Ripple Effect
If you drop a stone into a placid pool, there is first a
splash and then a series of concentric circular waves
rippling outward from the point of impact, with the height
of each wave diminishing with distance until it finally
disappears. The number of waves and their height depend
only on the mass of the stone and the height of the drop.
In the language of physics, the potential energy of the
stone is converted into the kinetic energy of the waves
plus some heat energy due to friction.
If you gradually empty a sack full of stones of various
size into the pool over a period of time, the laws of
physics still applies to each stone, but the disturbance on
the surface is more diffused. The ripples are not as
obvious but the energy balance still holds.
Now think of a stimulus acting as a sack of stones, a
stream of federal government checks of different values
entering the economy over a period of time. The total
effect of the stimulus is equal to the sum of the
individual effects of each check. But what is the effect
of each check?
When government makes a purchase from a vendor, it is a
retail purchase adding to the GDP, akin to a splash of a
stone as it hits the water. And the check also has a ripple
effect as the vendor uses the funds from the check to write
other checks to pay other vendors and employees, as well as
to provide for her own salary and/or dividend. These
"ripples" also add to the GDP.
The chain of spending from vendor to vendor to vendor,
etc., has no effect upon the GDP. But when a vendor pays
employees and herself as individuals, they become consumers
who either save (about 10%) or spend the rest (about 90%)
of their disposable (after-tax) income. All of the consumer
retail spending adds to the GDP.
You can think of the tax payments (about 30% of individual
gross income) as similar to the friction that causes the
potential energy of the stone to generate heat instead of
waves. And you can think of the checks that go to
individuals as the waves that ripple through the economy,
individual to vendor to individual to vendor, etc., in
diminishing amounts.
The rippling through the economy of the original government
check is inexorable. The money goes to vendors and
individuals who can save little of it. There is little or
no extraneous effect upon the process. The total addition
to the GDP is determined by the mechanics of the economy -
how individual spend and how vendors "do business" - and
not by extraneous events.
As the rippling through the economy of each government
check eventually diminishes to zero, the total addition of
the government check to the GDP is the value of the check
plus the additional consumer purchases. The ratio of this
total GDP value to the value of the government check is the
value of the "multiplier". The value of the multiplier is
determined only by the mechanics of the economy, not by
extraneous events.
The effect of a stimulus upon the economy is the sum of
the effect of each of its checks distributed over time.
Thus, a stimulus S and a multiplier M will cause a total
GDP growth equal to M × S over a period of time,
regardless of extraneous events.
Numeric Example
As an example: (using mid-year 2011 approximate results
as reported by usdebtclock.org)
ND: $14.5T
GDP: $14.8T
DR: 97.97%
If a stimulus (S) generated its value in total consumer
spending (TCS), the value of the ratio TCS / S would be 1.0
and the value of the multiplier would be
M
= (S + TCS) / S
= 1.0 + (TCS /S)
= 1.0 + 1.0
= 2.0
With the multiplier M ≈ 2.0 and a 5-year stimulus S = $1T,
then average GDP growth,
ΔGDP,
= M × S / 5
≈ 2.0 × $1T / 5
≈ $0.4T
Since GDP growth increases tax revenue (TR) and, relative
to GDP, our tax burden (for all levels of government),
TB
≈ 30%,
therefore, our 5-year tax revenue growth,
ΔTR,
= ΔGDP × TB × 5
≈ $0.4T × 0.3 × 5
≈ $0.6T
And
the new ND would be
$14.5T (current ND)
+ $ 1.0T (stimulus)
- $ 0.6T (tax revenue growth)
≈ $14.9T (new ND)
And
the new GDP would be
$14.8T (current GDP)
+$ 0.4T (GDP growth)
≈ $15.2T (new GDP)
The new DR would be:
$14.9T / $15.2T
≈ 98.02%, which is only 0.02% more than the current DR.
Although $0.4T was added to the ND, the DR was hardly affected.
For that reason, GDP growth is more important than the value
of the ND or the annual budget deficit.
Q. What is the limit
to borrowing and deficit spending
during a recession?
A. Borrowing is justified when we expect
that the deficit spending will generate
enough consumer spending (and GDP)
to reduce the DR.
Remarks on the Multiplier
Please note: Because
(1) at 1% interest rate on debt due to the recession,
the annual interest expense due to the stimulus is
about 3% of the corresponding tax revenue gain and
(2) to simplify the explanation,
therefore,
we have ignored the added debt interest expense in
the calculation above and shall continue to ignore
it throughout this course.
In the calculation above, we hypothesized that $1T
stimulus would stimulate $1T of consumer spending.
Effectively, the stimulus was multiplied by 2.0 to
create the total consumer spending.
The multiplier is a controversial subject because of:
1. The difficulty of determining its theoretical value which
is dependent only upon the actual spending habits of
consumers and producers. We will devote two lectures to
finding the theoretical value of the multiplier.
2. The difficulty of isolating the effect of a stimulus
occurring in a dynamic economy also affected by a multitude
of other major factors: war and other disasters, declines
in revenue due to unemployment, trade deficits, etc.
In a later lecture, we will evaluate the 2009 stimulus
(ARRA) but it must be understood that the value of the
multiplier cannot be judged simply by a post-stimulus view
of the economy. The signal cannot be separated from the
noise if it is weaker than the noise. It is only when the
stimulus overwhelms other factors (e.g, WW II spending)
that the effect is obvious.
Whatever the dynamic factors may be, a stimulus will
superimpose itself upon the economy and have an effect
proportional to the true value of of the multiplier. That
is why we must understand the theory.
Proceed to: Lecture 7
DEFINING THE MULTIPLIER
Thanks for your interest.
Marvin Sussman, retired engineer
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Among consumers, by far the largest is the federal
government. Every government purchase of goods or services
for $X immediately adds $X to both the ND and the GDP.
Those who sold goods and services to the government will
spend their government checks to manage their enterprise,
(i.e., pay others for goods and services). Eventually, the
chain of economic events will lead to retail consumption,
increasing the GDP beyond government consumption. Thus,
government purchases stimulate private consumption.
The government's retail purchase of goods and services
from contractors adds directly to the GDP. When contractors
spend government checks for goods and services from other
contractors and vendors, that is not a retail purchase. But
payments to individuals as salaries, benefits, or as
dividends will eventually lead to retail consumer purchases
and thus become an addition to the GDP.
Assuming a stimulus spread over a 5-year period, its
effect may be analyzed as follows, where both stimulus and
consumer spending are divided by 5:
In algebraic terms:
(1) Post-stimulus GDP = Pre-stimulus GDP
+ Stimulus
+ Consumer Spending
Let M be a multiplier such that:
(2) M × Stimulus = Stimulus + Consumer Spending.
Substituting equation (2) into equation (1) yields:
(3) Post-stimulus GDP = Pre-stimulus GDP
+ (M × Stimulus)
Subtracting Pre-stimulus GDP from both sides of
equation (3) yields:
(4) GDP growth = Post-stimulus GDP − Pre-stimulus GDP,
= M × Stimulus
Dividing both sides of (2) by Stimulus yields:
(5) M = (Stimulus + Consumer Spending) / Stimulus
= 1 + (Consumer Spending / Stimulus)
Thus, M is always greater than 1.0.
The Tax Revenue Effect of the Multiplier
When the government and consumers buy retail goods and
services from producers, the amount spent is added to
the GDP. Since tax revenue rises with GDP, the revenue
from the added GDP growth reduces the stimulus cost.
The US tax burden for all levels of government is
historically about 30% of GDP, which gives us the
resulting infrastructure purchase discount:
Tax Revenue growth = ΔTR
= 0.3 × GDP growth × 5
= 0.3 × M × Stimulus
(This is the total tax revenue increase during
the five-year duration of the stimulus.)
Discount = ΔTR / Stimulus
= (0.3 × M × Stimulus) / Stimulus
= 0.3 × M
Thus, a multiplier value greater than 1.67 would result
in an infrastructure purchase discount greater than 50%.
A multiplier greater than 3.33 would have the stimulus
pay foritself!
Please note: To simplify the explanation in the
calculation above, we have credited the federal
government with 30% of the tax revenue growth
due to the stimulus. In fact, historically, the federal
government gets about 18% of GDP. The states and local
governments get the rest. As a result of this
simplification, our stated values for ND and DR will be
proportionally lower than the correct value.
Our point is
(1) that the simplification is necessary for proper
exposition and
(2) that when the federal government spends, the
entire nation does get about 30% back in taxes.
In a fair accounting, the federal government would
charge the states for the 12% benefit from the
stimulus.
The Critical Value of M
The value of the multiplier is critical because of the DR.
Since the tax revenue from the additional GDP will offset
the cost of the stimulus, we want the multiplier to be as
much greater than 1.0 as possible. Our purpose in this
course is to show that, contrary to some opinion, the
multiplier is substantial enough to reduce the DR.
By definition,
(6) Pre-stimulus DR = ND / GDP.
For a five-year stimulus S and multiplier M,
the average GDP growth,
ΔGDP
= M × S / 5
And the total five-year tax revenue growth,
ΔTR
= ΔGDP × TB × 5
= (M Δ S / 5) × TB × 5
= M Δ S × TB
(7) And the post-stimulus ND
= ND + S - ΔTR
= ND + S - (M × S × TB)
(8) The post-stimulus GDP
= GDP + ΔGDP
= GDP + (M × S / 5)
The post stimulus DR would be the result of dividing
equation (7) by equation (8):
(9) DR = {ND + S - (M × S × TB)
÷ [GDP + (M × S / 5)]
For the DR to be reduced, Post-stimulus DR must be less
than Pre-stimulus DR. Algebraically, it must be true that
equation (9) be less than equation (6).
For that inequality to be valid, M must be sufficiently
large. How large? That is the central question of
Keynesian/Lernerian economics. It will be discussed in
another lecture.
How Will We Know the Effect of the Stimulus?
Our claim is that a stimulus S will produce a GDP growth
equal to M × S / 5 during a five-year period but we have
not said why it takes five years to exhaust the effect of
the stimulus. Due to the fact that the federal government
does not have a Department of Infrastructure with a
backlog of “shovel-ready” programs in which to invest,
the entire quantity may be spent over a three-year period.
In addition, the process of stimulation is a chain reaction
from vendor to consumer to vendor to consumer, etc. The
speed of the reaction depends upon many factors including
the average consumer’s “Marginal Propensity to Consume”
or MPC, described in Lecture 2. During a recession, MPC is
relatively low. Hence, consumer spending can extend two
years after the last stimulus penny is spent.
And while the stimulated growth is stretched out by both of
these time constraints, it is also offset by the other
effects of the recession. With factory shut-downs, the
average consumer’s fear increases her “Marginal Propensity
to Save” or MPS, described in Lecture 2. This causes sales
to decline, more factory shut-downs, more fear, and more
GDP decline.
Also, while the federal government increases its spending,
the state governments are cutting their budgets and laying
off thousands of employees. Thus, the GDP growth caused by
the stimulus is simultaneously counteracted by the
recession’s GDP decline. For all of the reasons given
above, it will be difficult to determine the effect of a
stimulus.
The answer to this puzzle is simply to understand that the
formula:
GDP growth = ΔGDP = M × S / 5
is correct and needs no post-stimulus confirmation by
analysis. Regardless of other events, the calculated GDP
growth will occur over time as S dollars are actually spent
and not hoarded in a bank account.
Given the true value of S, the amount of GDP growth
depends only on the true value of “M”, which
in turn is related only and entirely to the actual process
of producing, spending, and consumption. It is independent
of extraneous factors.
That process is the subject of the next two lectures.
Proceed to: Lecture 8.
THE PRODUCER/CONSUMER MODEL.
Thanks for your interest.
Marvin Sussman, retired engineer
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Since the GDP is the total annual sum of retail buying
and selling, the players in this model are those who
produce for retail sellers, the retail sellers, and
those who buy from the retail sellers.
The retail buyers will be called "consumers". The
others will be called "producers". Among the producers,
we include the retail sellers, calling them "retail
producers".
To explain the process of stimulation, we make the
following two assumptions about consumers and
producers: (While the numbers used here are chosen
to simplify the arithmetic, they approximate reality.)
Assumption 1.
On average, from their gross income, consumers will
shortly pay:
Ct = 30% to all levels of government for taxes,
leaving the consumer with 70% disposable income.
Please note: since 30% = 30/100 = 0.3,
we will use percentage and decimal values as
equivalents. Thus,
Ct = 0.3 and 1 − Ct = 1 − 0.3 = 0.7 = 70%.
In economic literature, the proportion of after-tax
spending from disposable income is called the “marginal
propensity to consume” or MPC. We will assume that,
on average, MPC = 0.9 = 90%. Thus, consumers will,
on average, shortly pay to retail producers for goods
and services:
Cp = MPC × (1 − Ct)
= 0.9 × (1 − 0.3)
= 0.9 × 0.7
= 0.63
= 63% of their gross income.
The proportion of after-tax savings is called the
“marginal propensity to save” or MPS.
Since MPC + MPS = 100% of disposable income,
MPS = 100% - 90%
= 10%
Therefore, the consumers will save:
Cs = MPS × (1 - Ct)
= 0.1 × (1 - 0.3)
= 0.1 × (0.7)
= 0.07
= 7%
of their gross income. This account for the
consumer's entire gross income.
Assumption 2.
On average, from their gross income, producers will shortly
pay:
Pt = 2% to all levels of government for taxes.
Pp = 50% to other producers
for needed goods and services
(e.g., material suppliers, contractors,
utilities, etc.);
Pc = 47% to employees and owners (who are also consumers).
The payment includes employee benefits and
dividends.
That allocates 99% of their gross revenue. Therefore,
producers will, on average, retain
Pe = the remaining 1% of their gross income as
owner’s equity.
Remarks on the Assumptions
We have not made an allocation for investments because
these are made from savings, not income.
In this model, we ignore foreign trade in the belief
that, in the short-term, changes in trade imbalance
would not affect the efficacy of a stimulus. For the
same reasonn, we also ignore short-term inflation
effects.
We remind the reader that we are using averages to
represent frequency distributions depicting the
economic behavior of more than a hundred million
households and businesses.
Ideally, we would take samples of the population
and collect the needed data to form these
distributions. Then we would use a random number
generator to sample the distributions and do a
computer simulation of the economy over several
years. The result would then be a more accurate
picture of the stimulated growth of GDP and the
value of the multiplier than with our use of
averages.
However, in this course, we merely wish to portray
the process of stimulation and arrive at a
reasonable estimate of the multiplier value. We
believe the use of averages for that purpose will
not be misleading.
Follow the Money
To study stimulation, we assume that “Jane Doe”
is a producer who has a government contract to work
on infrastructure. She has received a check for
STIM dollars (STIM = $1,000) for goods delivered
or services performed.
We will first follow the money as it flows through
the economy and calculate the Total Consumer Spending
(TCS) provoked by STIM. From the value of TCS, we
will calculate the multiplier value from equation (5)
of the previous lecture:
M = 1 + (Consumer Spending / Stimulus)
= 1 + (TCS / STIM)
In the (identical) tables below, Column 1 is labeled
“Pp”. The Row 1, Column 1 cell displays the value
of Jane’s stimulus check. The other cells in Column 1
represent producers supplying goods and services. Their
cells display the payments received from producers
represented by the cell immediately above.
Column
1
2
3
Row
Pp=0.5
Pc=0.47
Cp=0.63
1
$1,000.00
$470.00
$296.10
2
500.00
235.00
148.05
3
250.00
117.50
74.025
-
-------
-------
-------
_
_______
_______
_______
Total
$2,000.00
$940.00
$592.20
.
The Row 2, Column 1 cell displays the value of goods and
services that Jane buys from other producers. As required
by Assumption (2), Jane pays 50% (Pp) of her gross
revenue to these producers. That cell and all following
cells of Column 1 display amounts equal to 50% of the
amounts in the cell above.
As a consequence of this procedure, the ratio of the value
of any Column 1 cell (except the first) to the value of the
preceding cell is 0.5 (Pp).
Column
1
2
3
Row
Pp=0.5
Pc=0.47
Cp=0.63
1
$1,000.00
$470.00
$296.10
2
500.00
235.00
148.05
3
250.00
117.50
74.025
-
-------
-------
-------
_
_______
_______
_______
Total
$2,000.00
$940.00
$592.20
.
Column 2 is labeled “Pc”. It represents the first wave
of consumers. Each cell in Column 2 displays the payments
that producers represented by the cell in the same row
of Column 1 pay to their employees and to themselves,
individuals who are now taking the role of consumers. As
required by Assumption (2), the amount is 47% (Pc) of the
producers’ gross revenue.
In Column 2, the Row 1 cell represents Jane and her
employees. The Row 2 cell represents producers who sell to
Jane and their employees. And so forth in the following cells.
As a consequence of this procedure, the ratio of the value
of any cell in Column 2 (except the first) to the value of the
preceding cell is also 0.5 (Pp).
Column
1
2
3
Row
Pp=0.5
Pc=0.47
Cp=0.63
1
$1,000.00
$470.00
$296.10
2
500.00
235.00
148.05
3
250.00
117.50
74.025
-
-------
-------
-------
_
_______
_______
_______
Total
$2,000.00
$940.00
$592.20
.
Column 3 is labeled “Cp”. It represents the first wave
of retail producers. Each cell in this column displays
the retail value of goods and services that first-wave
consumers, represented by the cell in the same row of
Column 2, buy from first-wave retail producers. As
required by Assumption (1), the amounts displayed in
cells of Column 3 are 63% (Cp) of the consumers’ gross
income. These amounts are the retail producers’ gross
revenue and are added to the Total Consumer Spending
(TCS).
Column
1
2
3
Row
Pp=0.5
Pc=0.47
Cp=0.63
1
$1,000.00
$470.00
$296.10
2
500.00
235.00
148.05
3
250.00
117.50
74.025
-
-------
-------
-------
_
_______
_______
_______
Total
$2,000.00
$940.00
$592.20
.
The amount of purchases made by Jane and her employees is
displayed in the Row 1, Column 3 cell. We will name this
amount: “Consumer Spending 1” or CS1. The following cells
in Column 3 (CS2, CS3, etc.) display the amounts spent by
the owners and employees of producers represented by the
corresponding cells in Column 2.
As a consequence of this procedure, the ratio of the value
of any cell in Column 3 (except the first) to the value of the
preceding cell is also 0.5 (Pp).
Column
1
2
3
Row
Pp=0.5
Pc=0.47
Cp=0.63
1
$1,000.00
$470.00
$296.10
2
500.00
235.00
148.05
3
250.00
117.50
74.025
-
-------
-------
-------
_
_______
_______
_______
Total
$2,000.00
$940.00
$592.20
Formulas
Since there is a constant ratio of value less than 1.0
between the amounts displayed in adjacent cells of
Column 3, the numbers form a geometric series of terms.
Elsewhere,we prove that the sum S of such a series
is equal to:
(1) S = A / (1− R),
where A is the first term in the series (CS1)
and R is the constant ratio between terms (Pp).
Thus we have TCS1, the Total Consumer Spending
of the first wave of producers and consumers:
TCS1 = CS1 + CS2 + CS3 + CS4 + ...
= CS1 + CS1×Pp + CS1×Pp2 + CS1× Pp3 + ...
= CS1 / (1 − Pp)
= $296.10 / (1 − 0.5)
= $592.20
Column
1
2
3
Row
Pp=0.5
Pc=0.47
Cp=0.63
1
$1,000.00
$470.00
$296.10
2
500.00
235.00
148.05
3
250.00
117.50
74.025
-
-------
-------
-------
_
_______
_______
_______
Total
$2,000.00
$940.00
$592.20
.
Although we show only three rows of an infinite series, the
Column 3 total is the sum of all its cells. (The reader
will notice that the sums for columns 1 and 2 follow the same
rule.)
Thus, the $1,000 check stimulated TCS1 = $592.20 of spending
by the first wave of consumers. That amount was received by
the first wave of retail producers.
The First Wave Consumer Spending Formula
We can now develope a formula for spending by the first
wave of consumers (TCS1).
In the formula for the sum of a geometric series
S = A / (1 − R), (from equation (1) above)
we have:
(2) A = CS1 (The Row 2, Column 3 cell value)
= STIM × Pc × Cp (from Assumptions (1) and 2))
and
R = Pp (The ratio of each Column 3 cell value
to the following cell value.)
Therefore, the formula for the first wave spending is:
(3) TCS1 = A / (1 - R)
= CS1 / (1 − Pp)
= STIM × (Pc × Cp) / (1 − Pp) (from equation (2))
= STIM × (0.47 × 0.63) / (1 − 0.5)
= STIM × 0.2961 / 0.5
= STIM × 0.5922
Dividing equation (3) by STIM yields:
(4) TCS1/STIM = 0.5922
In equations (3) and (4), the value 0.5922 is
dependent only on Assumptions (1) and (2)and is
independent of the value of STIM, Jane‘s stimulus check.In effect, Assumptions (1) and (2) provide us with a
constant, 0.5922, which converts a stimulus into a definite
fraction of the stimulus as the amount of spending by the
first wave of consumers by the first wave of retail
producers.
It may help to think of the above table as a calculator in
which STIM is the input and TCS1/STIM is the output. The
value of the output is entirely dependent upon Assumptions
(1) and (2).
In the next lecture we derive formulas for TCS and M.
Proceed to: Lecture 9.
FINDING THE VALUE OF THE MULTIPLIER
Thanks for your interest.
Marvin Sussman, retired engineer
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There is no evidence that lower tax rates for the rich
stimulates job growth. If everyone complaining about the
lowest tax level in 60 years would buy an automobile,
they would know who creates jobs.
3. Total Available Working Hours is a long-term GDP factor
dependent upon population, birth and death rates,
immigration and emmigration, and cultural changes such as
percentage of women at work, youth in school, etc. In
general, government can do little to affect Total Annual
Available Work Hours in the near term.
In the long term, pro-family programs could increase the
population and immigration policy could become more
liberal, especially with regard to foreign students and
scientists. Again, there is much anti-immigration opinion
among conservatives.
The symbols above (from the blog:"New Economic
Perspectives", an excellent web site from which to learn
economics) portrays the flow of money between all three
sectors: private, public (government), and foreign.
Each sector has in-flows and out-flows to the other
sectors. Each transaction has two entries. For every
transaction, money goes in one direction and its value in
goods and/or services goes in the other direction.
If, by chance, all three sectors have "Net Exports"
balances equal to zero, the sum of the three balances will
be zero.
Otherwise, if only one sector has a "Net Exports"
balance equal to zero, the other two sectors will have
equal and opposite balances so that the sum of the three
balances will still be zero.
It would be impossible for only two of the sectors to have
a zero balance. The remaining sector would have a non-
zero balance but no debtor or creditor.
If two of the three sectors jointly have either a positive
balance or a negative balance, the remaining sector must
have a balance equal and opposite to the sum of both of
the other balances. Thus the the sum of the three balances
will still be zero.
That covers all possible cases. Thus, the economy of the
three sectors really is a zero-sum game! In the above
circuit, the sum of all balances is always zero. This
gives rise to an identity:
Private Sector Savings (S - I)
+ Public Sector Surplus (T - G)
+ Foreign Sector Surplus (M - X)
= zero
↑
↑
↑
↑
START OF PERSONAL DEBT DEBACLE
Reagan also put America in hock with lax enforcement of the
1979 NAFTA free trade agreement, matching US salaries
against coolie wages without consideration for working
conditions, pension and health benefits, or environmental
standards.
To avoid or recover from a recession, the economy's money
supply must be both adequate and distributed well enougn to
enable the vast majority of the population to purchase
essential needs. The late 1920s and the early 2000s were
both periods of peak maldistribution of wealth and income.
Now, 80% of the US population owns less than 10% of its
wealth and income distribution is similarly distorted.
There are really only two cures for this disease:
* A return to the pre-Reagan tax rates, including steep
estate tax rates. There is no reason children of the rich
should inherit more political power (which comes with the
cash and begets more cash and more power, etc.) than
children of the poor.
* A policy of renewing domestic manufacturing and the
consequent restructuring of the trade balance, as