Thanks for both writing back to me. I’ve actually pretty much decided to go back into education and get an Economics degree. I am frustrated at my lack of knowledge and desperately want to fully understand things so that I might help bring about some greater awareness of the nature of economics among others.

I was wondering what you both think about the system of unrestrained bank lending we operate under? Obviously there is logic (from a banks point of view) to banks restricting credit in a recession as they want to be paid back. So I find it greatly amusing whenever the politicians are berating the banks for not lending enough when it was their reckless lending of too much money that largely got us in this mess!

But in boom times it seems to me that the current system of centrally set interest rates and lack of restrictions on bank lending means that no one wants to ‘stop the booze flowing’ so to speak. Isn’t there a way that Interest Rates could naturally adapt to the prevailing economic conditions rather than being set by human beings with political motivations (even central bankers are not immune!). And isn’t there some fiscal policy that could be implemented to stop asset bubbles? It seems like all easy-money does is in fact constantly fuel them. For example in the last decade: The DotCom Bubble; the Housing Bubble; the mini Oil Bubble from last year; (arguably) the current Gold Bubble now.

Best wishes to all,

Alex

“On the topic of the comparison between the UK and Latin American countries, it is important to note that past debt crises in Latin America have occurred while the countries were attempting to manage a currency peg to the US dollar”.

You’re right, Stubborn, about the exchange rate regimes in LatAm being based on pegging. I checked this for the 90s.

“Doing this loses the true flexibility that fiat currency otherwise provides”.

But why is it? I mean, Dani Rodrik and Joe Stiglitz are very critical of the IMF (and WTO and World Bank, for that matter) for many reasons, other than exchange rate considerations.

PS: Merry X-Mas!

With regard to your question about interest payments, there is no need for new net financial asses to he created for interest to be paid. For any interest payment someone is paying and someone is receiving, so money is just moved around in the same way that it moves around for any buying/selling transaction. In fact, I would argue that you should not get too concerned about the notion of net financial assets. If one party in the private sector (eg a bank) lends to another party, then no net assets are created for the private sector (there is an asset for the first party offsetting the liability of the second party) but this loan can still serve an important purpose in generating economic activity that may not have otherwise occurred. The time that the net position becomes important is, as recently, the is such a significant decline in private sector demand and the private sector in aggregate wants to reduce debt. Then if the government sector tries to run a surplus too, major problems result.

On the topic of the comparison between the UK and Latin American countries, it is important to note that past debt crises in Latin America have occurred while the countries were attempting to manage a currency peg to the US dollar. Doing this loses the true flexibility that fiat currency otherwise provides.

Finally you asked the question about how a government can know when they have spent too much and moved into inflationary territory. This is an excellent question. I suspect that it is actually impossible until it is too late. For this reason, the smartest approach to government spending is to make it counter-cyclical. Much government spending is already like this, such as taxes which tend to diminish in economic downturns and vice-versa. Similarly welfare payments increase in economic downturns and vice versa. Even if you get the aggregate spending right, too much in one place can cause localized inflation, as in your housing example. Bill Mitchell is sensitive to this issue when he proposes his Job Guarantee. Because it would pay minimum wage it is designed to avoid government-induced wage inflation.

I will aim to respond to more soon!

Happy Christmas :-) Yes that book is a bit mathematical and formal and slow but yeah I do have a copy and its always with me! Bill Mitchell’s book which you can find on his site is good too. Very direct and to the point. Randall Wray’s Understanding Modern Money is another good one.

Re the $4.5T : That is just the sum of deficit of each year. The government would have issued the debt every year and interest keeps accumulating so we have around $9T of total debt.

Yes understanding reserve accounting /open market operations is very important. If the Treasury/CB does not drain them, then overnight rates would fall to zero and the central bank will not be able to achieve its interest rate targeting. One simple strategy is to just pay interest on them so that banks don’t lend them to other banks below the rate paid on them by the central bank. However reserves do not cause inflation.

I am the same Alex if you mean the Alex who has started posting in the last day :-)

I am away on holiday and it’s Christmas day so I’ve only been able to take a quick look but thanks for the links! One problem I have is that I my only formal Economics education is A-Level Economics here in the UK which is barely better than no Economics education at all! Plus I haven’t done any maths since GCSE.

Still, I took a quick look at the Money, Distribution & Economic Policy excerpts you linked to and get what’s going on there. But would I understand “Monetary Economics: An Integrated Approach to Credit, Money, Income, Production and Wealth”? Did you buy a copy of this book? Are there any more basic ‘foundation’ books you can recommend to get my basic knowledge to a superior level?

2 quick things I was wondering…

In one of your comments on the “Stock-flow consistent macro models” post on Bill’s site you state that total fiscal deficits over the years in the US are “$4.5T. The total public debt seems to be $9T or so…” How is this possible if bonds are issued to match deficits? Also, $4.5t sounds much lower than I would have thought?

Also, if a sovereign nation started creating new money with no matching debt to spend what would be the ideal procedure for draining excess reserves in the banking system? Would you have to? And what would happen to the currency of the country relative to others on a floating exchange rate system? I noticed a post about “Automatic Stabilisers” on Bill’s site… I get a feeling I need to read that. Will do ASAP :-)

With regards to Greece, of course you are right. Greece can no longer issue its currency. It makes me so glad the UK has not! But I fear it is only a matter of time… the conspiracy theorist in me thinks the UK could be purposefully being drowned (and the US) in order to push us into the Euro and America into an American equivalent (Amero?). I try not to let the conspiracy theorist side of me out too much but to take a recent example then how else to see things like EU Constitution being forced down our throats!

Hope you’re enjoying Christmas :-)

Alex