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Answering Paul Krugman on his new way to "fight deflation" by changing expectations
02-22-2016, 08:25 PM,
#1
Answering Paul Krugman on his new way to "fight deflation" by changing expectations
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Answering Paul Krugman on his new way to "fight deflation" by changing expectations of future prices instead of inceasing money supply.by Dick Eastman
 Unable to keep up the lie that deflation is not a problem, the job goes to Paul Krugman to tell a story that admits deflation but that requires the same remedy of keeping consumers in deflation while giving a plausible explaination of why reflation can't work and must not be tried.

Krugman begins by admitting that deflation is "turning out to be a serious problem after all," a problem "not easy either to prevent or to reverse as we thought."

He offers a solution --  "giving the economy the inflationary expectations," but only the expectations, not the thing itself, which he says is impossible to do because of the liquidity trap.  The "obvious answer" to "sustained deflationary pressures" is "managed inflation" sufficient to "credibly" promise higher future price levels, to get people thinking future prices will be higher, while not necessarily making them so.  I say this is like tricking suckers to buy gold in a deflation by telling them that hyperinflation is around the corner, and announcing with trumpets the tiny momentary price increase as justification for that belief. 

Krugman says the strategy makes him nervous, but "not because the idea of fighting deflation by promising inflation is crazy,"  because the relationship between expected price changes and actual price change is implied in the standard macroeconomic models.  The reason it makes him nervous is that the very suggestion "sounds crazy" to "finance ministers and central bankers" who have "spent their whole careers preaching the "evils of inflation" and the virtue of prices that never go up.

 Krugman does not mention the reason those central bankers and finance ministers have liked it that way  -- because inflation (or reflation after deflation) robs them of a sizable amount of the future purchasing power of their money hoardings and their interest earnings, while deflation gives them a windfall, especially as deflationary depression allows them to buy deflation bankrupted businesses, privatized public lands and utilities, and foreclosed housing units that can become rental properties all at very very low prices.  But although he does not mention the reason why the creditor and cash-balance holding oligarchy wants deflation, he certainly is mindful of their desire which is why he has thought of his plan to fight deflation, not with reflation, but with the parlor trick of simply giving the (false) expectation that prices will be going up in the future.  

And notice that Krugman does not mention anyone doing anything to make the money supply in the real domestic economy of households, businesses and the tax-spending government to go up  -- but only the "expectation that prices will go up."   He does not say how that is to be done, but it is pretty obvious to me.  If real estate prices can be bid up, but not other prices in the economy, that price rise in that one sector can be trumpeted as a sign of a general price increase coming  -- even though it isn't.   And a sudden price rise only in real estate will benefit exclusively whom?  Not home real householder buyers and sellers, because as each of those gets a higher price the other has to pay a higher price, so in that group it is a wash.  No the real beneficiaries of real estate price increases will be those holding all of the repossessed houses of the great default wave that has been going on since 2008. 

So this strategy of addressing a world caught in deflation by getting people to believe that prices will be going up in the future by "managed inflation" in just one sector, is indeed, not so new as Krugman would have his readers think.  What after all is a bubble but an expectation of increasing prices and activity that after all falls short because there real money -- the inflation, the reflation -- is not really there to allow the transactions that would realize the economic growth promised.  What I am telling you is that Krugman's "managed inflation" to convince people that higher prices are coming is nothing but the old science of John Law and all scammers who take money promising that there will be more money later for retrun of money plus gain.  This is never the case when the "inflation" is merely managed in one sector or scheme without there really being new money spent to produce more econmic pie that will earn a return on the money sacrificed.

Krugman subscribes the view of Keynes that "deflationary pressure" obtains when the savings people of the economy exceeds the investment that is wanted.  This puts Keynes and Krugman in the over-saving and under-investment school of business cycle theory.  

Keynes, during the great depression, wanted am answer to the depression that that would not involve banks putting more money in the hands of consumers, like the populists and social crediters wanted to do.  Bankers and the economists they give money to tend not to want more money put in the hands of common people even to end a depression, or rather, especially to end a deflationary depression that prospers creditors at the expense of debtors.  Keynes argued against reflation by saying that if you give money to consumers they will just save it - which will not end the deflationary depression.  He also said that giving banks more reserves for lending will do no good because bankers will not lend in bad times, in a deflation, but instead hold on to their reserves as if the money was caught in a trap, a "liquidity trap."  Therefore Keynes solution was that government should borrow money and spend it -- with the banks assured that the loans to government are always safe because the government can tax as much as necessary and should that fail it could sell off its assets, incluing immense private lands and many national utilities that the government would undertake to build with the borrowed money such as hydro-power generation systems.

But Krugman is not that kind of Keynesian.  He is advocating "managed inflation" that will create a new bubble, so that people expecting higher prices will be tricked into acting as though there was more money being permanently added tothe economy to lift it, when if fact that is not the case.  (Again, think of people being tricked into buying gold in the midst of a deflation that is only getting worse.)


"Japan, euroland and the United States," Krugman says,  "are free to expand money supply as much as they like" yet are "not finding it easy" to prevent deflation.   Krugman does not explain.  This point, this unfounded conclusion,  is very important for two reasons -- 1) it serves as his argument of why reflation cannot  work and 2) it is a false argument for why reflation cannot work.

First it is not true that the levers of central banks -- the ones that they actually use -- do at all  put money into the real economy in a deflationary depression like we have had with us these many years.  The tools the central bank uses are 1) setting the discount rate, the rate at which the Fed lends to banks so they can avoid falling below the legal mimimum of required bank reserves;  and 2) the swapping with the world's great creditors, their IOU's (bonds, securitized mortgages etc) for new dollar deposits in those creditors' bank accounts.  The tools the central bank does not use, but should have used at the first sign of the defalut wave of 2008, is lowering  the reserve requirement to allow more lending, that is relaxing the restraints on lending.

But the question is, does the central bank by  either  lowering the discount rate or giving creditors cash for the securities really increase M in the domestic real economy?  The answer is, that in a deflationary depression they do not.

That raises another question, one that Krugman does not ask or discuss.  If the cetnral bank doesn't lower reserve requiements and if it can't increase money in the real domestic economy by lowering the discount or by QE (buying bonds from creditors with new deposits) then how can any economist dare claim that "M" has really been increased at all?  These measures do not increase M.  These measures in now way consitute reflation or inflation or counter-deflationary "pressure."  They are indeed fake and fraudulent  fighers of deflation, of depression, of recession, of unemployment.  They pretend to do something to stop deflation, while in reality allowing deflation to continue apace so that the creditor class -- whose interests are represented by those "central bankers and finance ministers" -- can continue to reap the windfall gain that comes to all creditors in an unhindered deflationary spiral. 

Krugman says that "relating deflationary pressures to an excess of desired saving over desired investment" is "fundamental to the whole issue."  Let me compare and contrast how Krugman "relates" them to how I do it.

I say that when money neither leaks out of the flow of earning wages, spending wages, collecting taxes, government spending,  borrowing investment funds and spending investment funds and then the lender using the interest earned to consume or invest himself  -- when there is a closed system of money circulation like this -- then there will be neither deflation and depression, nor inflation.  But when the financial sector -- the private lenders and the lending institutions  -- lend money  -- in fact lend the entire money supply that is in circulation --  and then take back principal and interest, there must be a wave of defaults, because not enough money exists to finance that debt as well as make businesses profitable and households able to keep current with all payments due.  There is a net interest drain, that must result in defaults, bankruptcies and the transfer of all forms of collateral to the creditor.  THIS CONDITION IS MADE WORSE BY THE MORAL HAZARD THAT REWARDS THE CREDITOR CLASS FOR PROMOTING DEFLATIONARY SPIRALS, because the money they are owed -- and there are trillions they are owed -- each dollar of what they are owed gains in purchasing power when there is deflation.  The real wealth of creditors increases and it does so at the expense of the debtors who are obliged to work more to earn scarcer dollars to pay down their debt.

  The creditors who pick the central bankers and the financial officers and the economists who write columns in the New York Times, the do not want to end the windfall gain gravytrain that creditors have with deflation.  So they come up with smoke and mirrors solutions that only appear to "increase M".

So how does Krugman accomplish this legerdemain.  He does so with the claim, expressed in aggregate supply and demand curves, with the claim that increasing the money supply will raise aggregate demand, and thus increase prices, but it will not increase output which would put more people to work -- and this is because the aggregate demand stops dead after a certain ouput is reached -- investors will no invest and consumers will not consume.  Investors won't invest because there is no consumer demand to buy the increased output that investment would provide.  Consumers won't spend new money they get, because they are afraid of times getting worse and are anxious to make sure that the future is provided for by more saving now.   This is the liquidity trap.

And how does he prove that more M can't help, that the liquidity trap is unresponsive to increased money supply?  He simply points to the fact that the discount rate has been lowered to zero and that trillions of dollars of QE (Fed bond buying) have failed to raise investment or consumption levels.  DOES HE CONSIDER THE FACT THAT NEITHER OF THESE MEASURES  ACTUALLY PUT MONEY IN THE CONSUMERS' HANDS?  HE DOES NOT.


He says there is something wrong in the economists'  "standard" linkage in their model of the problem, the linkage of deflation leading to lower interest rates and lower interest rates leading to more investing which investing leads to more hiring and higher wages resulting in higher  aggregate demand which will bid up prices ending deflation -- which doesn't happen.

Krugman does not tell you that the reason it doesn't happen is because the lower interest rates really do nothing to invite more investment.  All that a lower interest rate does in a deflationary depression in a big economy like ours is to allow debt-strapped homeowners over their heads in credit card debt to yet again refinance their homes -- and loose all of the front ended interest they paid without ever getting to pay down any principal --  refinance their homes so they can pay off the credit cards and buy some necessities -- a short breather while the deflation continues apace -- because the homeowners are starting from scratch again with the new mortgage and all of that interest they paid in the previous few years is as it never was paid.

So what does he say?

Krugman:  "...beyond some point an increase in [real money balances] doesn't lead to higher spending. The most likely reason this would happen is that the interest rate is already near zero, and hence cannot be driven any lower. Then it is still true that an increase in M shifts the AD curve up [raises prices] - but it may not shift it to the right [may not increase hiring, output, goods sold]."  In other words, "further increases in the real money supply have no further effect on real spending" because of the liquidity trap which Krugman fails to examine and really explain.

So Krugman not examining why, merely presents as a fact we must life with, that if aggregate supply and aggregate demand intersect in the liquidity trap where more buying of goods does not occur regardless of how many more dollars may added, then "monetarypolicy will no longer be effective in fighting deflation."  Translation, "forget about putting more money in the people's hand's it won't work."  But that is not true.  Krguman is wrong.  In fact Krugman is eliminating the possibility that money in the hands of consumers would cure the problem without even one of the measures he names having done a think to increase M at all.    Remember, lowering the discount rate will do nothing when banks already have large excess reserves and won't lend (because they get rich just sitting on their money and don't have to hassle with risk of investing in a deflation or the transactions costs of investigating prospective borrowers and the soundness of their business ideas etc.)  Remember too, the central bank giving the rich creditor class money for the bonds also will not translate into more consumption spending or more investment spending in the real domestic economy  -- again because it is better to sit on the money and wait until assets go on the market cheap following default and bankruptcy rather to risk it in investing during bad times.     

  Krugman talks about the paradox of deflation   -- his name for his false excuse why deflation should not be ended by giving people more money with which to buy, hire, pay taxes and settle debt.     He says "a change in the money supply can affect the real economy only if some other variable like wages is "sticky enough." 

In other words, Krugman is saying that adding money to the economy might be good as long as the extra money does not raise anyone's wages.  Why is this?  Because if wages rise with other prices than the effect of more money is neutral, prices and wages both rise and no one is doing anything more than they did before when wages and prices were lower.  But if wages are sticky "remain low as money and prices rise" then more people can be hired, more output produced" with the unemployed being hired but those already working not getting any better off.    And of course the people who pick what economist gets a column in the  New York Times financial page do not want their corporations paying higher wages  -- a thing almost as terrible as slowing their windfall-bringing deflation.

Notice that throughout his article Krugman talks not about how to end deflation  -- having told us why the task is impossible through monetary policy, that is through reflation -- but instead he talks about "how to make sense" of Japan's deflationary woes as resulting from the meeting  "demand for saving" and "demand for investment," that determines, he says, society's  trade-off decision between present goods or future goods that it can have. 

So instead of talking, as I do, in terms of money holders not choosing to either lend, direclty invest or consume with their money because they gain in wealth without either risk or transactions costs if they merely sit on their funds because of deflation  -- Krugman mentions nothing like that, he pretends -- he can't be as oblivious to it as his articles suggest  -- he pretends that this incentive of the monetary authorities and the creditor class behind them, that they gain in wealth with every revolution of the deflationary spiral  -- he pretends that that incentive is not there, but talks instead about this absurd "market for future goods bought at the expense of present goods involving interest rate, current prices and expected future prices. 

"Then the price of curent goods in terms of future goods is  the price of todays good plus the interest that amount of money would earn between now and the future date  divided by the expected price of the future good. Or as he puts it, "the price of current goods in terms of future goods (the quantity of future goods one must give up to consume one more unit in the present) = P (1+i)/Pe.

He is saying, absurdly, that the reason people with money don't spend is because the quantity of future goods they must give up to consume more today is too high  -- and the lower the expected prices in the future the higher the price of spending money today.

In other words, Krugman is hiding the true story about money hoarders not spending because deflation makes them better off by simply sitting on their funds.  He is hiding it by burying it in the denominator of that expression  p(1+i)/Pe.  The Pe, is expected price of the investment goods and consumption goods in the future  -- it is the deflated price one pays for a factory put on the market after the company is forced in bankrupcy and liquidation in the deflatioanry environment; it is the deflated price one pays for privatized goverment lands and utilities that can be had after deflation robbing people of income, robs government of taxes and forces government to sell the public's assets.   But Krugman does not want to tell you that.  He just wants to see  P(1+i)/Pe and just take his word that it means "savers" choose not to spend their on consumption goods, producers goods or lend it  because of this liquidty trap that has something to do with the term Pe in the denominator of the demand curve in the market for future goods in terms of present goods.

Krugman:   "Almost everyone agrees that what is happening in Japan right now is that the saving Japanese residents would want to undertake at full employment exceeds the investment (including net foreign investment) that businesses find profitable. This means, more or less by definition, that the price of current goods in terms of future goods is above its equilibrium level. ...  despite the fact that the nominal interest rate is virtually zero."

 What a round-about and obscuring way of saying the simple fact that the moneyed class will not spend or lend because their wealth grows through deflation when they just hold their money idle.   What a way to hide the fact that the deflation is theft of the people trapped in national economies where the entire money supply is borrowed and where the lenders get richer when they keep lowering the money supply further and further below what is needed for people to work and produce and keep out of debt and bankruptcy.

What Krugman calls the amount of investment that businesses find profitable is no investment.  In fact they profit by creating deflation.  The foreign investors are interested in taking the wealth of nations into their own exclusive possession  -- and that is achieved by lending with money plentiful and demand strong  -- and then allowing interest payments to drain away that infusion of money -- so that money can't be had to make interest payments, so the assets built up in the lending boom are foreclosed and put on the auction block for the cash rich foreign lenders to buy up  -- the people loosing everything they built up and the land they were born to taken from them.

Krugman talks about "sticky Pe"   -- and it is nonesense.  Deflation is profitable to creditors at all times and under all conditions -- period.  And they have the money to control poltiicians and opinion shapers to accept the deflation and do nothing about it  -- except spin wild and outrageous pseudo-scientific economic explanations about why giving more money to the people won't help.

No one who reads Krugman or takes his courses has ever been presented with the possiiblity that the all-borrowed money supply system could be abolished, that the government could, as a public utility, provide a national money supply by fiat, that it could simply give every citizen free bank deposit  - by the stroke of a keyboard that credits new money to everyones checking account  -- so that the economy would have a permanent money supply rather than a all-borrowed on on which interest is always being paid.


Krugman says, "clearly the economy "wants" a lower value of P/Pe" 

Remark:   This is Krugman's  circumlocution around the fact that  "liquidty trap ends when expected prices in the future are higher, i.e., not deflation lowered.  (Remember lower prices mean that dollars that are sat upon will be worth more, but higher prices (inflation) over the same time period would mean that hoarding money would cost the rich man, cost him the bigger money he could have in the future by earning money in an inflation  --more dollars each of less purchasing power  rather than fewer dollars of greater purchasing power.


Krugman quotes again:

"Japanese-type deflation is an economy's way of "trying" to get the expected inflation it needs. ..."

"...it is because spending in the current period is unattractive unless prices are expected to rise that the current price level is pushed down. ..."

"... the aggregate price level of an economy does not fall quickly and easily. In "trying" to generate the necessary expectations of inflation, the economy instead subjects itself to a slow, grinding process of deflation. And the great fear is that this gradual deflation may in turn get built into expectations (reducing the value of Pe) and create a self-reinforcing downward spiral. "

"The concern [ is that] that in the near future a large part of the world will start to look like Japan: that it will face deflationary pressures that cannot be offset simply by increasing the money supply."


That is Krugman's story about why deflation and default-crisis economies cannot be saved by increasing the money supply.  Since prices are not expected to increase the liquidity trap stays in place, the new M does not get spent.  That is his story.

What is his solution?  Of course, it is deficit financed goverment spending, as always for a Keynesian economist like him.

One answer is to "recapitalize banks"  -- more bailout  -- to pursue structural reforms that eliminate the savings-investment gap. ....


  "A second answer is to close the savings-investment gap with government dissaving. The trouble with this solution, of course, is that it poses problems for the long-term solvency of the government; Japan has already pretty much reached the limits of this approach.

And since these avenues have lost their credibility, Krugman offers another one:  " if the central bank were to undertake open-market operations in assets other than short-term government debt. By increasing the demand for, say, long-term Japanese government bonds the Bank of Japan could surely have a positive impact on the economy even now. But while such measures would probably have a substantial short-run impact, they would only be effective in the longer term if the central bank were actually to acquire a substantial share of the relevant assets outstanding - which would raise some uncomfortable questions about the nature of the central bank's role. "  [close quote]

So his solution is to monetize the debt  -- which of course would still keep the money in the hands of the creditor class  -- which would then become even bigger money holders -- but why this would encourage the money hoarding class to suddenly stop hoarding their money he does not explain.


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