Lecture 4. THE MONEY SUPPLY

LERNERIAN ECONOMICS 101
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

If you don’t like the world as it is, change it this way!: 
1. Depress the Shift Key,
    sweep the cursor over the following URL,
    click, copy, and paste it on email to friends,
    and ask them to do the same:

     Keynesian Economics 101
     The ONLY way out of this mess     
     Free lectures on-line:
     KeynesForum.blogspot.com
2. To print and distribute single-sheet “invitations”
 to  this site, click here
 and ask your friends to do the same. 
3. To donate toward advertising this website,
 click the yellow “Donate” button below.

You will be asked for your PayPal account password.
If you  don't have a PayPal account,
 you will need a credit card. 
    
And ask your friends to do the same. 
Copyright © 2011 Marvin Sussman All rights reserved.