Proof That Krugman Doesn’t Read Mises.org
Well I really thought a few weeks ago I demonstrated that you need more than simple accounting to come up with Krugman’s constant assertions that debt reduction will lead to lower incomes. But Krugman writes today, in a post entitled “Death By Accounting Identity“:
Martin Wolf has a somewhat despairing-sounding column this morning, in effect pleading with the Cameron government to admit that the laws of arithmetic must apply. Good luck with that.
Martin writes,
If the private sector is seeking to run down its debts, it is hard for the government to do so, too, because everybody cannot spend less than their income. That is the “paradox of thrift”. No, it is not a novel idea.
Here’s a challenge: Could Krugman please spell out this alleged accounting identity? I imagine he thinks the argument goes like this:
(1) A household reduces its debt by reducing spending below its given income.
(2) Therefore, a country on net reduces its debt by reducing spending below its given income.
(3) We can’t be silly and use the fallacy of composition like the Chicago School, Dark Ages economists. We know that income isn’t given, and if everyone reduces spending then income goes down.
However, notice there is a missing assumption:
(2′) Aggregate debt reduction doesn’t increase income through any mechanisms.
Maybe that’s true and maybe it isn’t, but that’s one of the major arguments between Keynesians and non-Keynesians. Krugman and Wolf’s conclusions do not follow from mere accounting. To see a simple example of how aggregate debt reduction can go hand-in-hand with rising GDP and incomes, see my article. Maybe it’s implausible, maybe it violates Keynesian economics, but it certainly doesn’t violate accounting rules.
There is even yet another assumption that these demagogues make.
They believe that “aggregate debt reduction”, or “everyone pays down their debts” somehow means EVERYONE is indebted. To who? It’s magic.
In reality of course every person who is indebted means someone else owns a claim to a cash flow. Thus, if every indebted person paid down their debt, then accounting-wise, every lender will earn an equivalent income (principle plus interest).
All paying back debt really is at the end of the day is a change in the names of the people who are going to spend a sum of money (the money that is owed via debt).
If I own $100, and you own $100, then we will have $200 total to spend. If I owe you $50, and I pay you back, then I will end up with $50, and you will end up with $150, and we will still have $200 total to spend. My reduction in spending $50 on consumer goods or capital goods or whatever, is matched by an equivalent rise in your income of being paid back for the money you lent to me.
If every indebted person pays back their debt, then all that will happen is the money that used to be spent by the borrowers, is now available to be spent by the lenders. The money available to be spent hasn’t shrunk. It just changed hands and there is now a difference in how much each person spends, with no change in the ability to spend in the aggregate.
Krugman et al are ignoring the fact that lenders who are paid back are earning an income. Sure, it’s not an income from selling consumer goods or capital goods, but it’s still an income.
Only if one DEFINES “income” as “all money earned from selling anything and everything EXCEPT loans”, can one then argue that paying back debt will reduce “income”.
MF wrote:
Only if one DEFINES “income” as “all money earned from selling anything and everything EXCEPT loans”, can one then argue that paying back debt will reduce “income”.
I appreciate your enthusiasm, MF, but you just denied the whole point of my article. 🙂
Most economists wouldn’t classify money from a loan repayment as “income,” just as you wouldn’t say my income was $300k because I took out a mortgage and bought a house.
What I was showing in the article is even if you did define income the way you’ve done here, then it still doesn’t follow that a net paying down debt in the aggregate, necessarily reduces income.
They don’t care about “income”, though. They care about money circulating (“spending”). In this sense, what MF said does debunk their claim at its heart. Money just doesn’t disappear when a loan gets repaid… oh yeah, it actually does, but our dysfunctional banking policies aside, it doesn’t need to be that way.
I have to admit, that particular quoted portion of MF’s comment kind of reminds me of the idea of deferred income that is found in accrual accounting.
I am sure that MamMoth would eat this kind of stuff up.
😛
Man-Moth, where ya at?
Here, having a laugh
Aww, I think I didn’t enunciate my last comment properly. I wasn’t trying to deny your argument. I in fact agree with it fully.
The point of that last comment was to add, to supplement, to tack on another argument in addition to the one you made. The first sentence I wrote: “There is even yet another assumption” I hoped to convey the impression that I agreed with you in your position on what assumptions Krugman et al are making when they say paying down debt reduces income. I just wanted to add the further assumption they make in that they deny that earning interest/principle is a form of income.
You just happened to agree with THAT assumption, so I guess that is why it seemed like I was “denying” the argument you made.
“Only if one DEFINES “income” as “all money earned from selling anything and everything EXCEPT loans”, can one then argue that paying back debt will reduce “income”.”
For my point of view it doesn’t matter how you define income. Important is that spending equals income.
As you say not all people are in debt. There has to be lenders as well, to whom the money is owed. So sticking to the definition of income (without counting loan repayment), then it would only mean:
When all debtors pay down their debt and spend less than their income, then all lenders will be able to spend exactly that much more than their income. In the aggregate you still have spending equals income and of course no reason to believe that spending and income decreases just because of debt repayment, just as Bob showed in his article.
“They believe that “aggregate debt reduction”, or “everyone pays down their debts” somehow means EVERYONE is indebted. To who?”
They are called “the Chinese.”
Then the relevant “economy” is USA + CHINA, not just “USA.”
If all the borrowers in “USA + CHINA” paid down their debts to the lenders in “USA + CHINA”, then the same argument Murphy is making would apply to the economy “USA + CHINA.”
Guys, let’s just make sure you get the (fairly minor) quibble I am making in reference to MF’s comment. If I have an income of $100,000 and normally spend it all on consumption, but then one year I decide to use $20,000 of it to reduce credit card debts, then other things equal nominal income really does fall by $20,000.
The act of me giving $20,000 to the credit card companies, and them reducing my principal owed to them by $20,000, isn’t “income” from their point of view. It’s a swap of assets. (I know I sound like MMTers, but that’s because they’re not totally wrong!) Economically, “income” is how much you can consume, without reducing your wealth. So if the credit card companies went out and spent that $20,000 on consumption like I used to do, then total nominal income would be restored in the community, but we’d lose the aggregate debt reduction. Someone like Krugman could plausibly argue that my saving of $20,000 was offset by the credit card companies’ dissaving of $20,000.
(Already this is fine for a defense of Cameron or Dave Ramsey: When they say everyone should “get out of debt,” they don’t have in mind that creditors must maintain their assets too. But let’s move on.)
So what I then did in the article was up the ante, and show that I can get nominal income to not fall (to rise, actually) even in this stronger sense. So now, the credit card companies don’t sit on the $20,000, and they don’t consume it either. Instead, they buy newly issued corporate stock with it. Then the corporation uses it to hire a programmer to do some work, making its computer system better than it was before.
So in this scenario we are fine. Nominal income is at least the same as it originally was (the $20,000 earned by the programmer offsets whoever lost income because of the original $20k in saving) and the corporation didn’t go into debt to offset my debt reduction. Instead they issued equity.
In conclusion, all I was really saying about MF’s comment is that you don’t have to classify a transfer of money to reduce debt, as “income.” And it’s a good thing, because that’s not how economists would classify it, and if our position really relied on that, Krugman et al. could rightfully say we’re laypeople who don’t know the technical terms. MF is totally right that what the creditors do with the money once they receive the principal repayment can affect the answer.
Someone like Krugman could plausibly argue that my saving of $20,000 was offset by the credit card companies’ dissaving of $20,000.
Correct, that is always the case.
So in this scenario we are fine. Nominal income is at least the same as it originally was (the $20,000 earned by the programmer offsets whoever lost income because of the original $20k in saving) and the corporation didn’t go into debt to offset my debt reduction.
Previous shareholders, at the moment of issuance, dissaved $20K.
There is no way around it, someone must be willing to dissave the amount others are saving, to the penny, or nominal income will fall.
Only for financial assets, which are not the only assets in the world (fortunately).
Anyhow even if we were only talking about financial assets, the David Cameron suggestion that households pay down their credit cards and store debts remains perfectly possible as far as accounting is concerned.
What freaks me out even more is that Krugman believes that debt forgiveness is possible (apparantly accounting is OK with write offs) but yet debt repayment is not possible (go figure). Even stranger is that Krugman believes that with sufficient inflation, suddenly the accounting identity vanishes and debts can get repaid. So exactly what percentage inflation to it take to bend the accounting identity?
I’ll say one thing for the MMTers, at least they are consistent. Consistently wrong, but Krugman’s constant each way betting is just annoying.
MMTers are consistently right.
There is no way for debt to be repaid without income falling if debtors decrease their spending in order to increase their savings, if someone else doesn’t want to dissave by the same amount, to the penny.
Defaulting on debt is one way to force creditors to dissave.
As soon as a non-financial asset (i.e. anything physical) enters the picture your whole conceptual world view falls apart.
Show me you can go the accounts when the creation of just one single capital good is involved.
There is no way for debt to be repaid without income falling if debtors decrease their spending in order to increase their savings, if someone else doesn’t want to dissave by the same amount, to the penny.
That is not an MMT argument.
That is what everyone already knows. If nominal spending falls, then nominal income falls.
The point is that it is not methematically, accounting-wise certain that paying down debt leads to nominal fall in spending, for the lenders could spend the money they receive from the borrowers.
I wanted to ask you something about this sort of agree with MMTers sort of not thing you’re saying.
You say that lenders who receive principle and interest back from borrowers is not an income, it’s just a “swap of assets.” But aren’t ALL consumer goods sales a swap of assets as well? From say Wal-Mart’s perspective, their inventory is an asset that they value at the expected market price on their financial statements. When consumers go in and buy stuff, isn’t that also a “swap of assets”? Isn’t Wal-Mart “swapping” inventory assets for cash assets? If Wal-Mart selling consumers goods is an income from Wal-Mart, despite it being a “swap of assets”, then why isn’t a lender who receives principle and interest from the borrower, which is a swap of assets, ALSO an income?
I guess maybe we have different definitions of income, which I think is why I felt it important to mention definitions of income. I mean, in my view, in a division of labor, monetary economy, income is ANY receipt of money. It is money in. In comes the money. Income.
What about people who buy and sell financial securities for a living? If they own a stock, then they sell the stock, the money they earn from that is income, even though it is a swap of assets in the accounting sense. The money they receive is gross income, is it not? And the difference between the price they paid in the past, and the price they receive from future buyers, is their net income, is it not?
I know that you defined income “in the economic sense” as “how much you can consume, without reducing your wealth.” But that makes no sense to me. I don’t see how you can consume without reducing your wealth. To me, consumption reduces wealth, period. I am thinking of that old classical quote from John Stuart Mill: “Saving, in short, enriches, and spending impoverishes, the community along with the individual.”
I guess I am getting confused, and my arguments are causing confusion, because I am using totally different definitions of income and wealth that you seem to be using.
So to me, I define income as money receipts, and I define wealth as real material goods of economic value.
Your example of the credit card company can be, CAN BE, perceived as reducing income (the way you define it) if we are playing around with the relevant TIME PERIODS, and say that yes, it might be the case that LATER ON, the credit card company might take the money, then invest in stock, then the receiver of that money then hires people and buys capital, etc. But until those actions are taken, in between that future time and now, income has fallen, and I think because Krugman is a Keynesian, he doesn’t appreciate TIME as an economic factor. So he thinks only in the immediate moment. If people pay down their debts, then income falls, AT THAT TIME.
So when you argue “But the lenders could then turn around and spend money!” I think they believe you are missing their point, even though you’re really not. Because you’re an Austrian, you don’t ignore time. You think dynamically. Krugman on the other hand thinks without time. So he only treats the act of paying down debt as “mathematically reducing incomes.”
Using your definition of income, which excludes lenders getting paid back, then you are going to have to agree with Krugman when he says that paying back debt reduces income, if we weirdly take into account only the past actions, say of buying consumer goods in the past, which is our frame of reference, but not taking into account the future, where lenders can turn around and spend money on consumer goods.
Krugman probably thinks that you aren’t entitled to make that assumption about the future. You can only say what definitely happens in the NOW, and in the PAST. That’s it. So ignoring the future, the act of paying back debt in the present, assuming that borrowers used to be spending money on consumer goods, then yes, paying back debt does mathematically reduce incomes from the frame of reference that is the past.
Why the past and the present are the only relevant time periods is something that Keynesians are forced to stick with, because they don’t appreciate the fact that action is directed towards the future, and action is the Austrian foundation. Austrians are thinking what if, Krugman is thinking what now?
It’s probably why Keynesian polices are so short sighted. They deny cause and effect in economics, which is a way for us to know what will happen in the future, given actions that take place now. They can only see the present and the past.
MF let me think about the Wal-Mart thing before I answer. But in the meantime, just to clarify: The interest you receive from a loan (as a lender) is income. But the principal isn’t.
E.g. if I lend you $1,000 and 12 months later you pay me back $1,200, then I earned $200 in interest income. To wit, I can buy a $200 steak dinner and be left with the same amount of assets I started with. But if I buy a $1,200 steak dinner, then I just lived beyond my means; I “ate the seedcorn” metaphorically.
Your example makes sense. The principle is not income but the interest is income.
How would you account for the market value of the loan? If the market value of the bond goes above or below par, then the lender has to charge the difference to his income. If the market value goes above par, then that’s a gain in income. If the market value goes below par, then that’s a loss in income.
If the borrower defaults, the lender has to write off the loan, and he incurs a loss to income that is equal to the par value of the bond. I guess that change in market value of the bond is income, but the par value is not.
MF right, those would be capital gains or losses and would count as net income or would lower other sources of net income. (I’m not saying it would be done like that for tax purposes, but rather for pure economic theory.)
So e.g. if I lend someone $1000 and he defaults, then I would have to restrict my consumption elsewhere by $1000 to restore my original wealth. That’s the sense in which my true net income (how much I can consume without impairing my wealth or my capital) would have fallen $1000.
What if we defined wealth as real material goods only? That’s what I define wealth to be.
I mean, someone who is living on a deserted island who owns a claim to $1 million through an outstanding loan contract with someone else on that island, would be far poorer than someone who has access to the US market who owns a claim to $1 million through an outstanding loan with someone else in the US.
By this definition then, loans, stocks, derivatives, etc, would all be indirect claims to wealth, not wealth themselves. A stock is a claim to the company’s real assets like buildings, machinery and inventory. A loan is a claim to someone’s car or house, until they pay off the loan, or, in the case of an unsecured loan, to the equivalent amount of real wealth that could otherwise be bought by the borrowers with their incomes.
I don’t treat fiat money, nor claims to fiat money, as wealth in and of itself.
The ultimate reason why I don’t treat money or claims to money as wealth is because that would imply that printing fiat money, or creating new claims to money via banks issuing fiduciary media ex nihilo, would somehow generate more wealth. It doesn’t. Former Zimbabweans were not wealthier even though they were millionaires and billionaires.
The wealth produced in an economy, and the total money value of that wealth, are two distinct phenomena. They can go in opposite directions. More wealth produced without an increase in money, is still more wealth, the wealth just sells for lower prices. More money without more wealth, doesn’t produce more wealth, it just makes prices rise.
Only if money were free market driven, say precious metals, would there be a connection, albeit rough and not exact, between the amount of wealth and the amount of money. Here, more money would represent more wealth to the extent that more precious metals was used in industry, and to the extent that an overall increase in the economy’s ability to produce, entailed the byproduct of a greater ability to produce more of everything, including more precious metals.
MF, with all of this stuff, I am saying wealth (or capital value) is denominated in market value, i.e. money units. So if I’m saying, “I own a laundromat, and I could probably sell that dryer for $3,000, and that cash register for $100, and that table for $50, then my business’ assets are $3150,” then how could I not count the actual cash in the cash register at par value?
If I’m the government and print up another $100,000 in paper money, then my assets have indeed gone up by $100,000 in nominal terms. But by so doing, I reduce the real value of a $1 bill.
If you want to talk about wealth in terms of a specified basket of real goods, you can do that too. But I’ve been talking about it in terms of nominal market value.
MF, with all of this stuff, I am saying wealth (or capital value) is denominated in market value, i.e. money units. So if I’m saying, “I own a laundromat, and I could probably sell that dryer for $3,000, and that cash register for $100, and that table for $50, then my business’ assets are $3150,” then how could I not count the actual cash in the cash register at par value?
At the risk of belaboring this point, I would say that I would count the laundromat building, the dryers, the washing machines, the cash register, etc, as wealth. The money in the till is not wealth.
Acoounting-wise, they’re all assets though.
If you want to talk about wealth in terms of a specified basket of real goods, you can do that too. But I’ve been talking about it in terms of nominal market value.
Ah, but isn’t money the datum of determining market value in the first place? To me, you’re saying that the market value of the laundromat is $1 million, say, because it can be sold for $1 million in the market, but that we should also include the money in the till, because that too can be sold in the market for…money? Like, you can take the $500 in the till and “purchase” $500 of someone else’s money? That seems off to me.
Market prices depends on and is traded against money, so I don’t see how you can talk about money being included in the very same category that money itself has giving us the meaning of “market price”.
MF wrote:
Ah, but isn’t money the datum of determining market value in the first place? To me, you’re saying that the market value of the laundromat is $1 million, say, because it can be sold for $1 million in the market, but that we should also include the money in the till, because that too can be sold in the market for…money? Like, you can take the $500 in the till and “purchase” $500 of someone else’s money? That seems off to me.
Heh, for me it’s the other way around. If you agree that a cash register (which can be sold for $100 in paper money) should be considered $100 of “wealth” to me, then I can’t see how you deny that $100 in paper money should be counted as $100 in wealth to me. As you note, I can certainly trade my $100 bill for $100 in the marketplace.
It’s true that if there is a sudden injection of more paper money, that in the new scenario all of a sudden the “real” goods I held will have much higher market values than the paper money portions of my previous wealth. But so what? That doesn’t change the fact that if you are calculating my wealth at any moment, and your unit is the money in use, then how could you possibly not include money holdings?
Heh, for me it’s the other way around. If you agree that a cash register (which can be sold for $100 in paper money) should be considered $100 of “wealth” to me, then I can’t see how you deny that $100 in paper money should be counted as $100 in wealth to me. As you note, I can certainly trade my $100 bill for $100 in the marketplace.
I can deny it because I hold the $100 in money to be a claim to wealth, not wealth itself. The datum of relative valuation of wealth is the trading against money. Money isn’t traded against itself. Praxeologically, money is what goods trade against.
It would be like me saying “This ruler is one yard long, and I used it to measure my foot to be 11 inches.” Then you say “Well, if you agree that the yardstick can measure your foot to be 11 inches, then surely you cannot deny that your foot is now in the realm of standard measurement.” So there should be inches, feet (12 inches), yards (3 feet or 36 inches), and “Major_Freedom feet” as well, as if the 11 inch foot should be added to inches itself. It’s confusing to me.
And following this logic through, we should also include EVERYTHING else that has spatial dimensions as well into the totality of measuring standards. Of course, when we do that, the whole concept of measurement loses meaning, inches loses its meaning, and all we’re left with is relative size differences, of “bigger” and “smaller” with no common denominator that tells us by how much things are larger and smaller relative to other things.
Same thing with money, IMO.
Money has to be traded against something in order to determine its value. What is it? It can’t be “wealth”, because we’re already including money into the category of wealth. I think it’s wrong to just say “$100 is valued by its nominal amount $100.”
“Valued by” is something that to me must be learned through exchanges, before one can know of its market value.
Yes, conceivably, we can picture someone giving another $100 in exchange for $100, but money is fungible, so there is no exchanging going on that can tell us that this $100 bill is valued at $100 versus something else. If one person traded $100 for $25, then this doesn’t mean that the $100 is valued at $25. It just means the first person gave $75 to the other.
Simply looking at the number amount on the bill is not enough.
Just like Ron Paul couldn’t get Bernanke to DEFINE what a dollar is, I think the same problem is happening here. There is no definition of the dollar, it’s pure fiat by violence.
Imagine we had a gold standard and each dollar was exchangeable on demand for 1/20 ounce of gold. In that case, each dollar would be defined as 1/20 ounce of gold. THEN it would be more clear that we can’t include money in the totality of wealth. We’d include the gold, but not the paper claims to the gold, because we’d be double counting.
But with fiat money, our minds tend to still search for some objective foundation for the value of the money, and when there isn’t any, as is the case in our economy, we loop the meaning of money around back in on itself, and say that paper money is wealth itself, so that we can give meaning to money as if it had some real foundation, rather than just brute violence.
I mean, if the tomorrow the government declared dog vomit to be legal tender, and enforced it through violence, would we all of a sudden determine that dog vomit is wealth? If so, then you just admitted that the government can create value for people through violence.
Look at the government’s paper money not as wealth, but as a threatening letter saying “if you don’t accept me and pay me to the government on April 15th, then you hereby give notice to armed thugs to come to your house, knock down your door, kidnap you at gunpoint, and throw you into a cage, and if you resist, then you will be shot and killed and your wealth will be confiscated.”
When you do that, then any notions of paper money being wealth, will disappear.
MF: As far as the Wal-Mart thing, yes, technically I would say it’s a swap of assets when they exchange goods on the shelf for the customer’s money. And that actually makes sense, economically: You don’t “earn an income” as a retailer, from the act of selling stuff. No, you earn an income because you establish a relationship with a bunch of suppliers, you rent (or buy) a storefront, you hire personnel, you correctly anticipate customer demand, and ultimately it’s because you make goods available to your customers on better terms than they could get elsewhere.
If you want to say swapping inventory for money counts as gross income, OK I’m fine with that. But it’s not net income. If Wal-Mart has total sales of $1 billion during a certain period, they don’t report $1 billion in income, either on their shareholder reports or their tax forms.
Krugman et al. are talking about net income when they say paying down debt reduces income.
Just to plug the gap here, Wal-Mart declares a profit which is the sale price of the goods, minus COGS (Cost of goods sold) minus a long chain of expenses and crap.
From Wal-Mart’s point of view, the exchange is just an exchange, and the price you pay for the goods is not income from their point of view. However, the fact that they sell the goods at a substantial markup does create an income. Very similar distinction to the repayment of interest on a loan as compared to the repayment of principle.
If all Wal-Mart did was buy and sell with no markup (i.e. a pure, non-profit exchange) they would have no income, and also they would go out of business.
If all Wal-Mart did was buy and sell with no markup (i.e. a pure, non-profit exchange) they would have no income, and also they would go out of business.
How can they go out of business when they are paying all their bills? Their company would not grow, that’s for sure, but that doesn’t mean they’d go out of business.
Isn’t the money Wal-Mart receives through sales a gross income? Profit is the difference between revenues and costs, and revenues are an income.
I think you’re talking about net income, as opposed to just income, as well.
Possibly you and Tel are miscommunicating on what “no markup” means. I think Tel is thinking of the markup over the cost of acquisition, meaning Wal-Mart would have nothing left to pay its electric bill and other overhead? (Not sure what he meant.) But MF I agree with you, if “no markup” means Wal-Mart earns enough to cover its fixed costs, including the market interest rate on invested capital, then sure it can stay in business. But in that case, their books would show net income (that’s how the investors would get a return on their capital).
Possibly you and Tel are miscommunicating on what “no markup” means.
I think Tel meant “no markup” on full, total costs, meaning COGS and all other expenses. I get that from his first paragraph.
But MF I agree with you, if “no markup” means Wal-Mart earns enough to cover its fixed costs, including the market interest rate on invested capital, then sure it can stay in business. But in that case, their books would show net income (that’s how the investors would get a return on their capital).
That makes sense. If they can cover the costs of capital, then investors must be making a return on their capital by definition.
Maybe Tel meant that if no profits are earned, then the result will be that company owners, since they need to eat and live as well, will start to consume out of the company’s capital instead of the company’s profits, and thus shrink the company’s size. After making zero profits for some time, at some point the size of the company will shrink to nothing, no matter how large it started out. Then it would truly go out of business.
If all a company ever does is break even, the shareholders will revolt.
However, it is workable for a small family-owned business providing the business pays wages back into the family (just an alternative way to claim the profit, different on paper, but no different in principle).
To be honest I didn’t carefully think through the finer details of exactly when a company goes out of business, it was more to make a clear distinction between gross income and actual profit — where profit stands in contrast to just a “swap of assets.” as described above.
Let me put it this way: so long as the business is profitable, it must do more than merely swap assets.
Thanks, that makes sense. If they’re talking about net income, then everything you said follows.
“you don’t have to classify a transfer of money to reduce debt, as “income.”’
This is from the creditor’s perspective, correct?
Joseph: If I do a consulting project for a guy and he gives me $20,000, that is clearly income. (We could come up with some weird scenarios where it might not be–like if I’m consulting for the KKK and by doing I destroy my career and future prospects for income. But leave that aside.) But if my brother owed me $20,000 and paid it back, that’s not income. Just like, if I sold my car for $20,000, that’s not income, in an accounting sense.
If it were, then the “national income” of the US would be a gajillion dollars. Think of how much “income” is earned every day in the stock market from people selling shares.
Right, if I am the creditor (who loaned money at some earlier point), I could not see the repayment of the principle as income, because it is merely the same income that was earned in the past, loaned out, and then paid back at a later date (essentially it is the same money). Is this the point that you’re driving at?
In either case, the interest upon the principle must surely be income. Is this wrong?
No, you’re not wrong. In his article Bob identified the interest paid to Cathy as income to Cathy. The principal paid to her is not income to her.
Ok, that’s what I thought Bob’s articles said, but I didn’t actually go back to reread it (I read it when it first came out).
But Krugman has been discussing the scenario where everyone saves or pays off debts simultaneously.
Your scenario is that only one person saves or pays off debt, and the other person spends.
That’s fine, but that’s a completely different scenario Bob. The claim isn’t that the accounting identity says paying off debt is always bad. The claim is that the accounting identity says that saving or paying off debt is bad if everybody does it at once. Please tell me you’re not one of those people that thinks that Keynesians say saving is bad for the economy!
DK wrote:
But Krugman has been discussing the scenario where everyone saves or pays off debts simultaneously.
Your scenario is that only one person saves or pays off debt, and the other person spends.
Aaaaahhh!! Daniel, those two scenarios are not mutually exclusive. That’s what I’m trying to say! Krugman thinks they are, and he is wrong.
Everybody can reduce debts, without “total spending” dropping. Krugman keeps pointing out that if total spending drops, then total (nominal) income drops. Yes, but there’s many a slip twixt “everyone pays down debt” and “total spending drops.” Krugman keeps implying that that step in the argument is arithmetic or accounting, but he’s wrong.
I guess I’m confused. Can we have an example where everyone increases savings and spending increases? You don’t seem to be offering one.
In your example, Larry spends and invests the same, Willy reduces spending, and Cathy increases spending.
Can you provide an example where Willy reduces spending and Cathy reduces spending and income increases?
I don’t think Krugman would disagree with your example at all. I certainly don’t disagree with your example. But it seems to be addressing something very different from what Krugman is worried about.
I mean – you’re not really demonstrating any problems with the argument – you’re just considering a completely different scenario.
The question is – if the government reduced its debts – if it increase net public savings – is there any reason to think that other people would increase their spending. If we had a mechanism for that, then of course this accounting identity would be a moot point. This is what you allude to in your “missing assumption”. We have to consider the behavioral underpinnings of an accounting identity. I certainly agree with this.
But I guess I feel like that assumption – ISN’T missing for Krugman. He’s spelled out why people aren’t spending now – reduced net wealth from the housing crisis and uncertainty about future returns on investment, future job security, future income levels, future everything. To me, it seems like that alleged “missing assumption” has been spelled out very clearly.
What is not clear to me is why you think debt reduction might INCREASE spending by others. And your Larry/Willy/Cathy example doesn’t answer the question – it just assumes Cathy spends more without providing a reason.
One could even say, you’ve got a “missing assumption” you’ve got to explain before this becomes a relevant critique of Krugman.
And perhaps I’m making this harder than it needs to be – are you just suggesting it’s a confidence argument? People will spend more because they are more confident in a government paying off its debts? If that’s your mechanism – your missing assumption – I would simply say that seems highly unlikely and at least in this country market actors don’t seem to lack confidence in the government’s ability to pay off its debts.
Here’s where I think you and Murphy are missing each other’s point.
Murphy does not presume that EVERYONE in the whole country is indebted. The statement “everyone pays down their debts” does not mean that 300,000,000 people are paying down their debts. It means that everyone who is indebted is paying down their debt. That means there are people who are not indebted, or who are indebted but are also lenders to a degree that makes them NET lenders.
When everyone who is indebted pays down their debt, then this is a huge windfall for all lenders. They have the money that the borrowers used to have.
Murphy’s point is that this won’t necessarily reduce incomes, because the lenders can turn around and spend the money, because his frame of reference is the past, present and future.
Krugman is saying it will reduce incomes, because his frame of reference is the past only, which means if the choice is consume, consume, consume in the last three days, but then pay off debt on the fourth day, then stopping at this point, there has been a reduction in incomes compared to the past.
Murphy is saying why limit ourselves to the past? If we adopt a dynamic outlook, and view the economy as a going concern, then paying back debt is just one decision in the flux of decisions, the overall result of which will see the same incomes. Instead of the borrowers spending the money, the lenders are spending the money.
Murphy is not talking about a different example as Krugman, he is just using a different time period frame of reference. Murphy is taking into account the future, Krugman is not.
At the exact moment that debt is paid back, if we compare that action to past consumption actions, then yes, income falls. But if include what Murphy says we should not exclude, namely, possible future actions on the part of the lenders, then the frame of reference shifts. Instead of ignoring the future, and saying “income falls” relative to the past, we take into account a possible future, and say that if the lenders do spend the money, then there is no reduction in incomes.
No, MF, the issue of frame of reference is irrelevant. Bob Murphy is missing Krugman’s point. Krugman is explaining the paradox of thrift — which is dependent not on “everyone paying down their debts” (and the implicit assumption that everyone is indebted), but instead on the idea that everyone is trying to increase their own savings at once. “Everyone” includes the financiers/whoever owns all the debt we owe.
Here’s some quick math to prove Krugman right:
National Expenditures = Sum of all individual expenditures
National Income = Sum of all individual incomes
National savings = Sum of all individual savings = national income – national expenditures
Because income = expenditures, we see immediately that national savings = 0
This means that if everyone tries to save all at once, expenditures necessarily drop (saving consists of spending less than you take in, so by definition if spending increased not everyone is trying to save) and, by the above math, national income drops to match it.
This is where the liquidity trap comes from: everyone tries to save, but because every loan requires both a lender (the saver) and a borrower — and remember, NO ONE is wiling to take on net new debt, so there are no new borrowers — debt markets get swamped with savings that no one wants to borrow, and you get the supposedly impossible “general glut” in money markets. This wouldn’t happen in a normal market because most markets, even if they’re sticky, can allow prices to adjust downward. But interest rates can never drop below zero (you’re better off not lending) so the market doesn’t get cleared, and stays uncleared until a) inflation rises high enough to make nominal rates positive in spite of negative real rates (but inflation is almost impossible during a liquidity trap) or b) people stop trying to save because [insert reason of your choosing].
JM, I think you have done a good job trying to defend Krugman, but I think your “proof” is wrong. Do you care if I put this in the big lights as a stand-alone blog post, or do you want to tweak anything? Also, tell me if I should use your name or not.
Certainly not the most rigorous “proof,” but I wouldn’t mind in the least if you made it a stand-alone post. I’d prefer my real name not be used. I’m still in college and don’t want anything silly/incorrect/non-PC that I say showing up when prospective employers google me.
I’m assuming that as an admin you can see our email addresses (?).
Yep I can see them.
JM, you’ve made quite a large number of errors here, and even though Murphy is going to do a blog post to show them, I’ll take a stab at it as well, just to see if what I say is similar to what Murphy will say. You seem to be only repeating the fallacious talking points from Keynesian professors and textbooks without having a deeper understanding of why these talking points are believed in the first place, because of the hidden/tacit incorrect assumptions behind them.
Here’s some quick math to prove Krugman right:
National Expenditures = Sum of all individual expenditures
National Income = Sum of all individual incomes
National savings = Sum of all individual savings = national income – national expenditures
Because income = expenditures, we see immediately that national savings = 0
These definitions of saving, income, and expenditures you are using imply that
saving = increasing one’s cash balance
income = money earned
expenditures = money spent
These definitions are very problematic because they lead to confusion as to what is going on in the market.
First off, this notion that saving is increasing one’s cash balance, is something that everyone necessarily does every time they earn money. Every time they earn money, their cash balance increases, and some other person or persons decrease their cash balance. So in the aggregate, total “savings” never changes. All money that exists, exists in bank accounts. If money changes hands, then some bank accounts decrease, and other bank accounts increase.
Therefore, given the assumption that there is no inflation, we can see that it is impossible for everyone to increase their cash balances, even if everyone actually tried to increase their cash balances. No matter what, total cash balances will remain the same, because we are assuming there is no inflation of the money supply.
Now, alongside this, what if we suppose that everyone did try to increase their cash balances at the same time. What would happen? Well, in these circumstances, the relevant agents who would increase their cash balances would be business enterprises. Deflationary periods are marked by businesses cutting back on their productive expenditures. True, wage earners tend to cut back on their spending, but that is if they fear or if they know that their wage incomes are going to fall in the future. Since wage incomes are a productive expenditure from business enterprises, and since we are considering “everyone tries to raise their cash balances”, what we are really dealing with are business enterprises trying to increase their cash balances and cutting back on their nominal productive expenditures. We can ignore wage earners trying to increase their cash balances and the effects of this because it is subsumed under business enterprises reducing their productive expenditures and trying to increase their cash balances. If wage earners did not expect or fear being laid off, or receive reduced wages, then there is no reason for them to suddenly cut back on their spending. Their reaction is due to businesses and their reducing of their productive expenditures, which provide almost the entire demand for labor in the economy.
So if all businesses cut back on productive expenditures, and all attempted to increase their cash balances, then asset prices will fall.
The more businesses try to increase their cash balances, the lower will asset prices will go. As this happens, net investment can turn zero or even negative, and thus aggregate profits will decline almost immediately. This is because a reduction in productive expenditures reduces revenues immediately, but not costs. Costs are a function of past productive expenditures, which were higher. So if current productive expenditures fall, then at some point, costs will fall as well.
As this is happening, business owners will consume out of their savings because they need to eat and live as well. This will further reduce asset prices as business owners try to sell assets to bring in more cash.
At some point in this attempt to increase cash balances, asset prices will fall enough such that the decreasing demand for them will level off, because at some point, profits can be made by purchasing those assets at the new lower prices. No matter how low future expected demand happens to be, there exists a profitable price for assets. As this restoration in investment happens, net investment starts to become positive again. As net investment becomes positive, profits become positive as well, virtually to the dollar. This is because net investment results in revenues that are greater than the costs. Net investment IS a positive difference between revenues and costs. For example, when a business buys the now bargain prices of a set of machines for say $1 million, this generates $1 million in revenues for the sellers of those machines, and because of depreciation, costs will be lower than $1 million. Costs would be the price $1 million divided by the expected lifespan of the machines, say 10 years, or $100k. Net investment would therefore be $900k. Aggregate profit generated would be $900k as well since profit is revenues minus costs.
As profitability is restored, and as net investment takes place, it is almost certain that there will be an accompanying demand for labor as well. For there needs to be workers for those machines. In a free labor market, wage rates can fall to whatever extent is necessary to cure unemployment, but this nominal fall in wage rates will not, contrary to Keynesian belief, result in a lower standard of living for the average wage earners. This is because wage rates are also a business cost, and with lower business costs, the prices of capital goods and consumer goods fall as well.
As net investment is restored, and as profitability is restored, (note that Keynesians fallaciously believe that more net investment reduces aggregate profits, instead of increasing them), interest rates on loans will rise as well, since interest rates are determined by the rates of profit. Note that it is false to believe that “nobody lends” during a depression. Not once in the entire history of the US economy has lending ever dropped to zero. Only something on par with a nuclear holocaust could totally eradicate lending. Interest rates will rise back up as profitability is restored, provided the central banking system doesn’t inject more new money into the loan market trying to reduce interest rates.
As for your definitions of income and expenditures, they are always necessarily equal. This is because whenever someone spends money, another earns that money, and whenever someone earns money, another must have spent that money. It is therefore impossible for incomes to be greater than or less than expenditures, and vice versa. They are two sides of the same coin. If incomes rise, then expenditures must have risen to the dollar. If expenditures rise, then incomes must have risen to the dollar.
Therefore the equation
Saving = Income – Expenditures
is nonsensical. It is always zero.
Someone increasing their cash balance can only come about by them earning income, which means another is making an expenditure. But as we have seen, everyone can’t increase their cash balances at the same time. We can only talk about the effects of everyone’s ATTEMPT to increase their cash balance. The attempt will result in, as we have seen, an eventual economic recovery as asset prices fall to a level where net investment and thus profitability is restored. The end result will be a profitable economy with people holding higher cash balances. Their incomes and expenditures are nominally lower, but then so are nominal revenues, nominal costs and nominal profits. The RATES of profit will still be positive and a function of time preference.
This means that if everyone tries to save all at once, expenditures necessarily drop (saving consists of spending less than you take in, so by definition if spending increased not everyone is trying to save) and, by the above math, national income drops to match it.
Right, nominal incomes and nominal expenditures fall. But so what? Yes, there will have to be liquidation of bad investments, made on the basis of past easy money or past judgment errors, but that is a necessary correction. You can’t argue on the basis of accounting alone that malinvestments should not be liquidated but rather bailed out by inflation.
This is where the liquidity trap comes from: everyone tries to save, but because every loan requires both a lender (the saver) and a borrower — and remember, NO ONE is wiling to take on net new debt, so there are no new borrowers — debt markets get swamped with savings that no one wants to borrow, and you get the supposedly impossible “general glut” in money markets.
There will always be someone willing to take on new debt. It is false to believe that lending and borrowing go down to zero. And even if borrowing and lending fell to zero, that still wouldn’t be a long term problem, accounting-wise!, because people can just directly invest in their businesses through equity. There does not have to be borrowing and lending, accounting-wise, for a functioning economy. Sure, it might be a worse economy than one with borrowing and lending, but borrowing and lending is not absolutely necessary, accounting-wise, for the economy to progress over time.
At some point in the attempt of people increasing their cash balances, the demand for and hence prices of assets will fall enough to restore investment in them, which then restores aggregate profitability, which then increases interest rates on loans that are being made.
I have no idea why you can imagine “nobody lending” when even during the worst year of the Great Depression, lending was positive.
Borrowing and lending will increase if the rates of interest are allowed to increase, and not be kept down by the central banking system. If you’re worried about lending and borrowing, and you think there should be more lending, then go out and lend your money!
This wouldn’t happen in a normal market because most markets, even if they’re sticky, can allow prices to adjust downward. But interest rates can never drop below zero (you’re better off not lending) so the market doesn’t get cleared, and stays uncleared until a) inflation rises high enough to make nominal rates positive in spite of negative real rates (but inflation is almost impossible during a liquidity trap) or b) people stop trying to save because [insert reason of your choosing].
That is false. The market does eventually get cleared because interest rates will eventually rise along with profitability as profitability is restored due to the re-emergence of net investment.
Inflation does not need to rise, and will only short circuit the recovery process, because the problem was too many bad assets were bid too high in price in the past, due to previous inflation into the loan market, and those prices need to fall. This is a “painful” part of the recovery, but it is necessary. Central bank Inflation, and lowering the interest rates on loans even more, will only delay the needed corrections.
Interest rates will definitely rise if the central bank made a credible promise to stop inflating. For then interest rates can approach the now higher rates of profit.
The liquidity trap is a fallacious doctrine based on an ignorance of what determines interest rates.
Mr. Murphy-after our back and forth in a prior post on assets = liabilities + equity, I would have hoped you would have boned up on your accounting principles. Guess not :). Remember, public deficits = private surplus. Too the penny. All day. Always. Operating reality. Martin Wolf understands this. Krugman (and unfortunately you as this post demonstrates) does not. It’s all in the chart in this post
http://pragcap.com/sectoral-balances-and-the-united-states
And Mr. Murphy, what your simplistic story in your Mises essay fails to account for is a taxing public sector. In your essay, which conveniently excludes the government sector,the currency is worthless and you are living in a barter system. Last time I checked, despite Austrian economists wanting to return to much simpler times, we live in a free floating convertable monetary system. Your comparing apples to oranges, and it’s leading you to faulty accounting.
Yeah! Totally irrelevant post.
You do know that private citizens can be indebted to other private citizens, do you not?
You keep shoehorning in net savings with the government and lending as lending to the government only. Take a chill pill dude, and realize that a private citizen can be indebted to another private citizen, the paying back of debt of which does not necessarily reduce incomes, if we don’t assume away the possibility of the lender turning around and spending the principle and interest himself.
Good lord man, you come here so many times like a Seagull manager who squawks and says stuff that is totally irrelevant, then you disappear until the next annoying presence.
Read the examples given, and read the arguments being made. Your comment here shows that you have absolutely no clue who is saying what, and all you wanted to do is say the same old tired and worn out MMT accounting tautologies that nobody here denies, but they do deny your disgusting twisting of definitions and word meanings away from how they are being used, as if others are using the same definitions as you, and when you see those same words, you think the argument underlying the words is also wrong.
Get a grip.
BTW Major Freedom, can you shoot me an email? Someone wants to contact you about something, and I realized I don’t think I have your email.
Funny that you’re always the middleman of emails.
😉
Don’t do it, Major! It was me that asked, and I was going to send you a bomb.
Paradox of thrift doesn’t apply. People aren’t saving.
Then we have the problem of what caused the banking crisis. Too much borrowing and spending.
As if the solution is more of the cause.
Financial Voodoo
The problem now is far simpler. Governments have run up debts they can’t pay, mainly by using the same accountant as Bernie Maddoff. That destroy’s people’s lives.
Bob:
This is a little off topic, but I’m sure you’re aware of the Nullify Now tour. It’s probably been the best thing for me to have found after starting to wake up the first time I picked up copy of the Federalist Papers, and subsequently started on my journey of studying the creation of the Constitution. One thing I am curious about is why we bother arguing with these people about the Fed at all when the individual never lost sovereignty, only had it buried so deeply under reams of jurisprudence that takes advantage of our desire for order that we have forgotten it. If we can rebel over raw milk, why not the Fed? We don’t really need government to take care of money, do we?
These things that come out of Krugman’s mouth (keyboard) are just mind games designed to keep us misinformed and shackled to the system like slaves to the collective which we were never intended to be, not by our creator, and not by the framers. Certainly if we keep down the path they would have us follow, we will end up having to manage our own exchange anyway when the whole thing meets with the inevitable spectacular collapse. While it would likely be better if we could convince them to take the shackles off and let us go, we should never forget that the shackles exist only in our minds; they are not real. Someone like Krugman, who benefits more than others from the mind games will never willingly let it go. We have to take it upon ourselves to be free.