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What a Jerk

April 1, 2011

Why would let your government default on debt?  Un-American, anti-democratic thinking.   Additionally, why are you talking about “pushing up the price level” during a time when the price level was pushed down?   Fed Governor Narayana Kocherlakota has never heard of the Asian Crisis:

Sargent and Wallace published their classic “Some Unpleasant Monetarist Arithmetic” in the Minneapolis Fed’s Quarterly Review in 1981. Since that date, there has been a growing appreciation of the role of fiscal policy in the determination of the price level. The idea is a simple one. Consider a government that borrows only using non-indexed debt denominated in its own currency. There is an intertemporal government budget constraint that implies that the current real value of government liabilities — including the monetary base — must equal the present value of future real surpluses. Because the liabilities are nominal and non-indexed, the government budget constraint provides a linkage between the public’s assessment of future real tax collections and government spending and the current price level.

There is no intertemporal budget constraint.  Read the first three pages of the paper he quotes.  The two major constraints they place on the government are factually incorrect.   First, the bond market does constrain the ability of the government to spend in excess of its tax receipts.  Second, the interest rate paid on the bonds does not constrain spending.  The major assumptions this Kocherlotka makes are factually and demonstrably incorrect.  He has never once thought of the accounting that surrounds government surpluses.

I like John Cochrane’s analogy here.2 He thinks of money and government bonds as being like stock in a company. Just like a firm’s stock, money and bonds implicitly represent claims to the ownership of the government’s stream of surpluses. And just like with financial assets, the variations in their prices are fundamentally linked to variations in the present discounted value of government profits — that is, surpluses.3

This simple insight has rather profound consequences for how we think about inflation. Inflation is no longer “always and everywhere a monetary phenomenon”. Instead, even apparently independent central banks may not have control of the price level. Thus, if the public begins to think that the fiscal authority is behaving irresponsibly, that belief will push upward on the price level.

This is correct in idea, but the word “irresponsibly” is irresponsible.

However, in the existing literature, the analysis of fiscal effects on the price level is typically based on the presumption that a fiscal authority will never default on liabilities denominated in its own currency. In my remarks today, I will relax this assumption. Once I do so, it will become clear that a sufficiently tough central bank does have the ability to control the price level, regardless of the behavior of the fiscal authority.4 I will argue that its ability to do so hinges on the nature of its response to the possibility of default on the part of the fiscal authority. I will talk about some of the short-run versus long-run tensions involved in that response. Throughout, I will refer to the central bank as CB and the fiscal authority as FA. I will refer to the currency as being dollars, but that should not be viewed as suggesting that I am talking about the United States — or Australia.

Check this out. The existing literature assumes insolvency is impossible. But they continue to talk about insolvency all the time.  They continue to threaten as a tool to control inflation- they want to abrogate power from democratically elected governments.

Why would you want to let your country default?  What outcome could be so horrible that default is better?

Does any one remember the Asian Crisis? Default is worse than inflation.

From Wikipedia:

“More long-term consequences included reversal of the relative gains made in the boom years just preceding the crisis. Nominal US dollar GDP per capital fell 42.3% in Indonesia in 1997, 21.2% in Thailand, 19% in Malaysia, 18.5% in South Korea and 12.5% in the Philippines.[34] The CIA World Factbook reported that the per capita income (measured by purchasing power parity) in Thailand declined from $8,800 to $8,300 between 1997 and 2005; in Indonesia it declined from $4,600 to $3,700; in Malaysia it declined from $11,100 to $10,400. Over the same period, world per capita income rose from $6,500 to $9,300.[37] Indeed, theCIA‘s analysis asserted that the economy of Indonesia was still smaller in 2005 than it had been in 1997, suggesting an impact on that country similar to that of the Great Depression. Within East Asia, the bulk of investment and a significant amount of economic weight shifted from Japan and ASEAN to China andIndia.[38]

8 Years later, these countries didn’t recover from the effects of default.  That’s 500,000,000 people.

Check out the passive language when talking about default as opposed to inflation:

“And, empirically, FA insolvency is associated with large short-term and even medium-term declines in output.”

What a jerk.



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