The mysterious Japanese macroeconomic factor: The national debt per GDP is 251.93%!

 

... well, Japanese national debt percentage of GDP is over 200%! This is one of the mysterious Japanese macroeconomic factors.

One of the reason is that approximately 90% or more of Japanese national bond holders are Japanese nationals. This is why the government can keep these bond holders even with a substantially low interest rate. The hidden cost of this policy is incurred upon Japanese economy because the government is hardly able to raise the interest rate even during the inflationary period.

 

Furthermore, the value of Japanese national bond is so stable that the capital loss risk is low. Because there is still a regular coupon payment (the income gain) with the low capital loss risk at the moment, the majority private banks in Japan keep holding the national bond as the secure asset. The majority Japanese citizens are so risk-averse that they hardly split their saving to private investment: Then, the private bank simply shift their saving account money to the national bond purchase. Although the coupon payment is not so high, the risk premium is still lower than any private bond for the moment. Their risk-averse personality is one of the strong drive of stabilising the national bond price. 

Nevertheless, it is sceptical to assume this mechanism can keep going on. Japanese economy has been stagnated for multiple decades since the last economic bubble burst in 1990s. Nowadays, Japanese economic indices show that Japanese economic strength is even weaker than before. In addition, the entire macroeconomic strength will keep going down due to the ongoing ageing population combined with the constant substantial population decline.

 

The European Monetary Union is inevitable, but has to be fundamentally revised

Published on 23/07/2011 09:18 British Summer Time

1. Introduction

This Eurozone crisis has been predicted by many economists. These economists put emphasis on the impact of the money supply volume on the stability of economic environments such as the price inflation rate, the unemployment rate, the gross domestic product (GDP), and the speculative trend on financial market. They argued that, when the monetary policy is unified, the common fiscal policy is also required to be established, all the member countries of this monetary union are supposed to have the financial regulation for all these countries, and the labour mobility needs to be flexible for workers in these member countries to move across these countries in order to stabilise the economic environments. In addition, the econometric analysis of the Eurozone average inflation rate indicated that the European Monetary Union (EMU) is beneficial to majority of the member countries owning to the harmonised inflation rate, but it still requires something to control the different inflation rate of each individual member country. The reason of German refusal of issuing Eurobond is assumed to be because of uncooperative attitudes of Greece. Mr. Trichet, the governor of the European Central Bank (ECB) also suggests that the EMU has to fundamentally change its overall structure before allowing any countries to keep incurring their debt. Overall, the solution of the currently ongoing Eurozone crisis is the fundamental improvement on the EMU fiscal, financial, and labour market structure, and getting rid of the common currency will never be a solution.


2. The problem caused by the monetary policy transformation

The disadvantage of abandoning the national monetary policy (to join the common monetary union) is that this country becomes no longer able to set her own interest rate and the volume of her own money supply. Greece used to be heavily relying on her own unique monetary policy, based on the money supply which was remarkably higher than the average of European countries, in order to finance her government expenditure which could not be sufficiently financed by her unsophisticated fiscal policy. However, after Greece joined the EMU, she could no longer use her high money supply. Greece may rely on the tax revenue burdened on her export revenue such as her tourist industry and the growth of her private sectors stimulated by the economic growth of the entire Eurozone economy. Nonetheless, unless she tightens her fiscal policy, when the entire Eurozone economy falls into recession and/or the demand of Greek tourist industry declines, Greece starts struggling to obtain her public finance resource. This problem has been seen in many Southern European Nations such as Italy, Spain, and Portugal. But, Greece seems to be more problematic than these Southern nations. Spanish government shows a strong commitment on tightening Spanish fiscal policy under the European central government’s induction. Italy still has her strong initiative in European economy thanks to her famous industries such as finance, manufacturing, and tourism. Portugal seems to be similar to Greece, but the quantitative data analysis shown in the next chapter indicates Portuguese suffers much less than Greece.




3. The econometric analysis of the Eurozone average inflation rate

This graph (Qualitative method) above shows the different inflation of the Eurozone countries (IMF, 2011). Majority of the Eurozone countries have a synchronised inflation rate trend from 2002 to 2010. The econometric analysis of the Eurozone average inflation rate, whose results are shown by the following figures, indicated that the price inflation of the individual countries joining the European Monetary Union (EMU) is influenced by the price inflation of the other different EMU countries.




This equation is the inflation rate of all individual Eurozone countries (〖Inflation〗_(i,t)) regressed on the inflation rate in the last year 〖Inflation〗_(i,t-1). As the coefficient of 〖Inflation〗_(i,t-1) is less than 1, this variable is stable enough to converge into a particular point in the long run as follows:




So, this proves that the Eurozone inflation rate is converging into 2% which is what the ECB targets to make! The following regression analysis proves that the GDP grows furthermore when the inflation rate becomes closer to 2%:




This result shows the natural log of the GDP in the Eurozone economy, ln⁡(〖GDP〗_(i,t) ) (Footnote 1.) , is significantly negatively correlated with the inflation rate deviating from 2% which is shown as the absolute number of the inflation rate minus 2, |〖Inf〗_(i,t)-2|. The following auxiliary regression shows both the GDP and the inflation are co-integrated each other:



〖 u〗_(i,t) is the residuals from the previous regression. As the lagged residuals 〖 u〗_(i,t-1) is negatively correlated with change in the residuals 〖∆u〗_(i,t), the variables used in the previous regression, ln⁡(〖GDP〗_(i,t) ) and |〖Inf〗_(i,t)-2|, are stable and co-integrated with the EU inflation rate, which means the movement of these variable affects on the other’s. However, the stability test for Greece and Ireland showed a relatively pessimistic result as follows:

Greek inflation on the inflation of the entire Eurozone countries



This analysis suggests that, , not only the percentage of the entire Eurozone inflation's contingency on Greek inflation rate is 47% in average, which is high,(Amended part) but also change Greek inflation is highly contingent to the entire Eurozone (Footnote 2.). Therefore, it is not only Greece suffers more than the other Eurozone countries and but also Greek economy is highly responsible on the entire Eurozone economy. This aspect may suggest both Greece and the entire Eurozone need to cooperate each other very seriously because Greece should not leave the EMU because her business cycle is already tied up with the EMU.

Irish inflation on the inflation of the entire Eurozone countries



On the other hand, Irish inflation rate is neither stable nor co-integrated with the entire Eurozone one. Therefore, Greece seems to suffer from the volatility of the inflation far more than the other Eurozone members so that she needs either the intervention by the European central government or the fiscal restructuration, or both, to calm down her inflation rate. Unlike Greece, Ireland may be benefitted when she leaves the EMU. Irish business cycle is not correlated with the Eurozone economy. But, if Ireland still wants to keep the membership, the Eurozone eventually needs to have a strong fiscal stimulus enough to enable Irish business cycle to harmonise with the entire Eurozone business cycle.

4. German refusal of participating into the Eurobond programme

The concern of Germany on Greece is that Greek catastrophic crisis will be permanent unless Greece tries to reform her fiscal policy fundamentally and cooperates with the EU central governmental policy rather than her own selfish and irrational nationalism. When a person purchases equity, s/he expects its value to be either stable in the long term or predicted to grow significantly. The value of Greek national debt seems to be neither stable in the long term nor predicted to increase its value in the short term. Even if German government is altruistic enough to sustain Greek public finance by purchasing Greek debt in order to rescue the entire Eurozone, there is a risk for Germany to be drawn into the recession or even to be bankrupt.
The Eurobond programme suggests the Eurozone countries to share both the risk and the benefit of issuing the government debts among the entire Eurozone countries rather than burdening the responsibility on each individual country for incurring the government debt. For example, as shown in the graph below, when Germany experiences the economic growth relatively higher than any other nations whilst France falls into the recession, it needs to tune the aggregate demand of both nations.


As there is no national monetary policy available for both France and Germany, one of the optimum solutions would be increasing the tax revenue of Germany to transfer it to subsidise France. The econometric analysis shown in the previous chapter indicates that French and German economies are highly contingent to each other so that French downturn has to be diverted by German contribution to save Germany herself. This is the idea of sharing the risk and benefit of the national debt and its usage under the collective responsibility among the countries.
Nonetheless, this mechanism may work efficiently and effectively because French fiscal policy does not have a problem like Greek. France and Germany have much more similar labour market situation than Greece. In addition, France and Germany are geographically closer each other than Greece. So, the labour mobility is much more flexible between France and Germany than between Greece and them. Furthermore, France and Germany balance their budget without relying on the excess money supply unlike Greece. If this case scenario were Greek instead of France, German tax revenue transfer to subsidise Greece is ineffective and inefficient.
The intervention from the European central government into Greek fiscal policy under the strict guideline of the central government is also emerged. Greece is still resisting against this intervention due to the sentimental irrational populist nationalism. The European central government regards that, in order to make this money transfer to Greece more effective and efficient, Greek fiscal reform lead by the further privatisation of the entire Greek economy are inevitably required. Greek labour market is rigid because of Greek economy’s reliance on the huge public sector, which disrupts the flexibility of the labour mobility. On the top of the inflexible labour mobility, Greek public sectors are not rational enough to balance their budget. They are not used to the market competition and the thread of bankruptcy because they are always protected by the nation unlike the private sectors. By contrast, the private sectors are much more used to balancing their budget under the market competition. As long as Greek public sectors struggle to rationalise their budget to be balanced by their own effort, the enforced privatisation seems to be only the antidote of the fiscal imbalance.
All in all, the responsibility of Greek fiscal policy should be burdened more on European central government to discourage Greek irrational populist nationalism which is notoriously uncooperative to solve this currently ongoing problem for both Greece herself and the entire Eurozone economy. In order to discourage this pathetic nationalism, the privatisation to minimise Greek national government authority can be a key solution before substituting the power of Greek nationalism with the European economic cooperation.


5. The ECB’s point of view and warning from Mr. Trichet

Focusing on the ECB’s point of view on the current Eurozone financial havoc, the ECB executives are suffering from the dilemma between putting priority on saving the Eurozone economy and focusing on calming the inflation by suggesting the fiscal policy of all Eurozone countries to be tightened. In particular, Mr. Trichet, the governor of the ECB, always rejects the optimism on the Eurobond programme without fundamentally reconstructing the fiscal structure in the entire Eurozone. Mr. Trichet has been always suspicious about the stability of the Eurozone economy since the ECB was established. His suspicion is related to the fiscal problem mentioned in the previous chapter.
The ECB has been purchasing a large volume of the national debt of the Eurozone countries by its quantitative easing. In order to keep the value of these bonds to invest to rescue these governments, the ECB has. The ECB cannot survive without an economic activity of these nations so that the ECB needs to save the national governments of the Eurozone. Otherwise, the value of Euro becomes zero so that the ECB itself disappears. However, the expected result still cannot be seen, and the aggregate government bonds incurred has never stopped expanding. This mechanism still enables the Euro exist, but it depreciates the value of Euro further. This phenomenon causes the inflation to hike up, and then the nominal interest rate eventually needs to rise. Overall, rescuing the Eurozone countries damages the private sectors and individual citizens by a high interest rate, and it creates further government deficit which requires the further ECB’s quantitative easing, which again induces a further inflation. Mr. Trichet has already warned this spiral would occur and urged to divert from it since the beginning of the Eurozone crisis (Footnote 3.). Thus, he rejects all the optimism of perpetuating this situation.
The ECB also struggles with negotiating with the private sectors. Although the previous chapter stated the positive aspect of the private sectors in terms of the fiscal policy, the private sectors cause problem in the monetary policy set by the ECB (Footnote 4.). The private sectors are willing to raise their profit and the wage for their executives, and detest the high interest rate. These characteristics of the private sectors perpetuate the inflation which discourages an economic growth of both countries and private sectors themselves in the long term. Generally speaking, the private sectors are uncooperative to the European economic stabilisation. Although the stabilised European economy which the ECB expects to establish benefits to the private sectors in the long term, these private sectors are less interested in it than the ECB.
This aspect infers a danger for European economy which is now also fund by the private sectors. This could be the reason why Mr. Trichet is modest about the private sector contribution to rescuing the Eurozone national economies .

6. Conclusion
In conclusion, there is no optimistic prospect on this current Eurozone economic situation. In order to solve these structural instabilities, the Eurozone may need a fundamental radical revolutionary act on altering both economic and political entire structure. But, they cannot stop the European economic integration because the almost all Eurozone economies are highly correlated with each other as proven by the econometric analysis. It seriously needs an IMF of Europe, which the ECB is trying to act like. The ECB should have a much stronger authority to instruct the fiscal policy of national governments in the Eurozone as same as the IMF does to the national governments in the globe. In addition, if the priority is saving the European economy, the heavy reliance on the private sectors contribution is very risky. Hence, the ECB policy based on Trichetian Monetarism, which is tough against the irrational egos of both the national government fiscal policy and the private sectors’ short-termism, seems to be only the reliable tool, and the economic agents had better listen to it.


-------------------------------------------------------------------------------
Footnotes:

1. When a variable is positively skewed, it needs to be logged or transformed into the root (E.g. square root and cube root) in order to offer a reliable, unbiased, and consistent statistical analysis.

2.


---------------------
My Additional Comment added on 4th of August 2011:

Well, as I mentioned in my essay, it depends on the hamonisation of the business cycles in these candidate nations (I referred to the price inflation rate as an indicator of the business cycle). When the business cycle is harmonised (Synchronised), the monetary union becomes necessary or inevitable, such as the Greek and the other Eurozone countries' case. Otherwise, such as Irish case, it should not join the monetary union or it has to have a great intervention to artificially harmonise the cycles.

Some African nations might be benefited because they trade each other often, and their economy is not self-sustainable i.e. needs to be corroborated each other. But, they indeed need to have a common fiscal policy to modernise and tighten the fiscal policy of all these nations.

South American nations should not have the monetary union yet. These individual South American countries are too big by means of the land mass relative to their population density (I.e. The cost of the inter-country trade inside South America is higher than the benefit from it). Furthermore, these countries do not trade each other often compared to the other blocks of countries in this world such as Europe, North America, Africa, and Asia (According to the statistics shown in Economics of Monetary Union (Paul De Grauwe)).

The trade frequency of among Asian nations is the highest of all the international trade made in this world. So, as Lee Kuan Yew, the first Singaporean prime minister, said forming Asian trade community could benefit Asian nations. However, other than economic factors, the political factors exist as the obstacles which disrupt forming this trade community.

Only the person concerning the EMU whom I can truely respect and trust is Mr. Trichet and his ECB. I claim that not only the EMU national fiscal policies but also all the private enterprises in the Eurozone economy should be instructed by the ECB based on Trichetian Monetarism...!

Python Experiment: Macroeconomic Theory: Income Price Inflation Control Simulator in the ADAS model

 I have created a macroeconomic policy simulator with Python programming. 

This refers to the aggregate demand and supply interaction based on the simplified IS-LM interaction influencing the aggregate demand (AD) and the labour market and the capital cost influencing the short-run aggregate supply (AS). These curves are composed of the two main parameters, the aggregate income level and the price level, as well as the money supply (MS) basing the IS-LM, and the wage index (W) basing the labour market. 

My Python codes are as follows: 

# Default Parameters

import random

Y=[20,30]  # The aggregate income level: Change here to see each effect

P=[100,102] # The price level: Change here to see each effect

W=[10]

WB=0.2

MS=[100]

rHD=10 

CapCost=[10]

# Function representing the price inflation

def PrInf():

    return ((P[-1]-P[-2])/P[-2])

PrInf()

# Higher function

# The aggregate demand influence

def Y_Inv(MSlmis,Ylmis,dp):

    r_MS=pow(MSlmis/10,-1.05)+rHD*(PrInf()) #LM side

    return pow(Ylmis,-1*(r_MS-PrInf())) #IS-side

Y_Inv(MS[-1],Y[-1],PrInf())

# A part of the short-run aggregate supply influence (The Labour Market).

def Y_Lab(Wlab,Plab):

    return (50-(50/(Wlab/Plab)))/100

Y_Lab(W[-1],1+PrInf()+0.000001)

def AggregateDemandCurve(Ydd):

    Pd=Y_Inv(MS,Ydd)/Ydd

    return Pd

def AggregateSupplyCurve(Wlab,Plab,Css):

    Ps=Css+Y_Lab(Wlab,Plab)

    return Ps

    

def AggregateSupplyCurveShift(Y1,Y2,Pinv):

    dp=(Y_Inv(MS[-1],Y1,Pinv))-(Y_Inv(MS[-1],Y2,Pinv)) #AggregateDemandCurve(Yd1)-AggregateDemandCurve(Yd2)

    return dp

print(Y_Inv(MS[-1],Y[-1],PrInf()),Y[-1],PrInf())

print(Y_Inv(MS[-1],Y[-2],PrInf()),Y[-2],PrInf())

AggregateSupplyCurveShift(Y[-1],Y[-2],PrInf())

def AggregateDemandCurveShift(Y1,Y2,Wlab,Plab,Csd):

    dp = (Csd+(Y_Lab(Wlab,Plab)*(1+WB*(Y1-Y2)/Y2)))-(Csd+Y_Lab(Wlab,Plab)) #AggregateSupplyCurve(Yd1)-AggregateSupplyCurve(Yd2)

    return dp

print(CapCost[-1]+(Y_Lab(W[-1],PrInf())*(1+WB*(Y[-1]-Y[-2])/Y[-2])))

print(CapCost[-1]+Y_Lab(W[-1],PrInf()))

           

AggregateDemandCurveShift(Y[-1],Y[-2],W[-1],PrInf(),CapCost[-1])

# Calculating the average aggregate income level across all over the time period to generate the long-run aggregate supply interaction

def Ymean():

    Ysum=0

    for i in range(len(Y)):

        Ysum=Ysum+Y[i]

    return Ysum/len(Y)

Ymean()

# Main function: The interaction of the aggregate demand and the short-run aggregate supply

def Shift1(MSlmis=MS,Y1=Y[-1],Y2=Y[-2],Wlab=W,Plab=PrInf(),Csd=CapCost[-1],Pinv=PrInf()):

    OutputGap=Y[-1]-Ymean()

    PriceInflation=((P[-1]-P[-2])/P[-2])

    if (OutputGap>0.05) & (PriceInflation>0.0001): # Positive Inflation

        dP=AggregateDemandCurveShift(Y1,Y2,Wlab,Plab,Csd)

        P.append(P[-1]*(1+dP))

        print(dP)

        MS.append(MS[-1]*(1+OutputGap/Ymean()))

        print(MS[-1])

        Y.append(Y[-1]*(1+(Y_Inv(MS[-1],Y[-1],dP)-Y_Inv(MS[-2],Y[-1],PriceInflation))))

        W.append(W[-1])

        CapCost.append(CapCost[-1])

    elif (OutputGap<-0.05) & (PriceInflation>0.0001): # Negative Inflation

        dP=AggregateSupplyCurveShift(Y1,Y2,Pinv)

        P.append(P[-1]*(1+dP))

        print(dP)

        W.append(W[-1]*(1+Ymean()/OutputGap))

        CapCost.append((1+dP)*CapCost[-1])

        print(W[-1])

        Y.append(Y[-1]*(CapCost[-1]/CapCost[-2]+(Y_Lab(W[-1],dP)-Y_Lab(W[-2],PriceInflation))))

        MS.append(MS[-1])

    elif (OutputGap<-0.05) & (PriceInflation<-0.0001): # Deflation

        dP=AggregateDemandCurveShift(Y1,Y2,Wlab,Plab,Csd)

        P.append(P[-1]*(1+dP))

        print(dP)

        MS.append(MS[-1]*(1+OutputGap/Ymean()))

        print(MS[-1])

        Y.append(Y[-1]*(1+(Y_Inv(MS[-1],Y[-1],dP)-Y_Inv(MS[-2],Y[-1],PriceInflation))))

        W.append(W[-1])

        CapCost.append(CapCost[-1])

    elif (OutputGap<-0.05) & (PriceInflation<-0.0001): # Dereguation

        dP=AggregateSupplyCurveShift(Y1,Y2,Pinv)

        P.append(P[-1]*(1+dP))

        print(dP)

        W.append(W[-1]*(1+Ymean()/OutputGap))

        CapCost.append((1+dP)*CapCost[-1])

        print(W[-1])

        Y.append(Y[-1]*(CapCost[-1]/CapCost[-2]+(Y_Lab(W[-1],dP)-Y_Lab(W[-2],PriceInflation))))

        MS.append(MS[-1])

    else: 

        print("Nothing")

    

    print(OutputGap,P,Y)

  # See the result

Shift1(MS[-1],Y[-1],Y[-2],W[-1],PrInf(),CapCost[-1])

print(Y)

print(P)

print(MS)

print(W)

print(CapCost)

 

 

 

Is Monetarism/Neoliberalism bad? Not at all!

Neoliberalism and its mainstream macroeconomic theory Monetarism are not bad theories like these old-fashioned Socialist and the other Left-wingers condemn at all! These theories teach very important socioeconomic lessons for all the individuals to live as long as the monetary economy where individuals use fiat-money for their intermediary of exchange in their daily life thrives to exist. 

Those who are against Neoliberalism tend to blame these theories as the severe survivalist Capitalist political theories leading the majority individuals to deprivation. However, it is the same nonsense as blaming Marxism and the other socialist theories for the disastrous mistakes of the United Soviet Socialist Republic (USSR). Both Marxism and Neoliberalism contain the non-negligible elements to study the political affairs and the human history. 

- The monetary policy channel instead of the fiscal policy

Focusing on Monetarism as he major base macroeconomic policy of Neoliberalism, the key element of this theory is analysing the nature of the fiat-money flowing into economy as the intermediary of exchange. In the long run, the money value is neutral to the other substances distributed in the world. By contrast, it regards that the change in the money supply volume affects the economic activities and productivity level in the short-medium run. 

Monetarism regards highly of the value of the fiat-money supplied by the central bank which should be supported by its credibility and its market demand. Therefore, it is sensitive to adjust the money supply level to the aggregate production level of this economy in order to avoid the value depreciation. 

It encourages the private sector based economy functioned by the spontaneous order of individual economic agents voluntarily deciding the aggregate production volume according to their needs and wants on spot. It discourages the excess reliance on the fiscal policy cutting tax and increasing the government expenditure while incurring national debts leaving their responsibility of repayment with the inevitably increasing future taxation and cutting the future government expenditure in the long run. Instead, it tackles with the temporary economic downturn by temporary pumping the extra money supply filling the temporary emerging negative output gap. 

- High-Powered Money as the antidote against the deflationary recession

In order to enable the fiat-money to stimulate economy, the velocity power of this money supply which is its value and credibility in both domestic and international market, is required. When individual economic agents appreciate its value and credibility, they find its extra supply as valuable and trustable to use as their intermediary of exchange in both domestic and international market. They may either spend for their exchange or save in their banks using the extra money from their saving account as the extra investment resource for increasing their profit. This is called High-Powered Money theory. 

According to Monetarism, the deflation inducing the recession, the negative output gap, is caused by an error of scaling the optimum market aggregate production level or a false information delivered to economic agents. Thus, the deflationary recession is caused by the stuck money circulation which means the money supply level is not balanced with the aggregate productivity level. In this scenario, the money supply as the High-Powered Money can be increased to directly inject it to economy to equalise it to match with the aggregate productivity level. 

- Killing inflation is more important!

On the other hand, Monetarism regards of Stagflation (the output stagnation + the price inflation) as the excess money supply unmatching with the aggregate productivity level.  Then, the decreasing output caused by Stagflation is considered as the long-term phenomenon which should be solved by cutting the cots including wages of the production even if it means to discourage their business activity level at least for a short run.

The reason to sacrifice the output to suppress the inflation is to maintain the money value as useful to be implemented as the High-Powered Money. Even to protect the employment by maintaining the wage distribution, the real value of their wage/income is consequently reduced when the price inflation, the money value depreciation, is perpetuated. Monetarism is actually a humanitarian political theory against depreciating their income/wage level to avoid consequently treating these employees as the quasi-slave labour. 

Monetarism antagonises the perpetuated inflation even for diverting the negative output gap is bad for economy overall. Even though the extra money supply is injected into the real good and service market to push the output level up, the value depreciation negatively affects the capital market. 

Most of the capital asset value is based on the base money so that the money value depreciation implies the capital asset value depreciation in the international financial market. Almost all the firms producing goods and services are invested by banks and shareholders through the capital market.

In addition, firms in the good and service market also face the import cost up under Stagflation as the excess money supply perpetuating Stagflation. Because all the regions of this world are interdependent on each other so that the relative value decline of the fiat-money used in one regional economy causes the purchasing power depreciation of this regional economy. 

- Monetarist, Consequentialist Ethical Philosophy

Overall, Monetarism supports the gradual and natural economic recovery encouraged by private individuals and firms under the stable market economy propped up by the balanced money supply adjusted to the aggregate productivity level. This ethical policy is what Neoliberalism shares with and aspires to achieve so that Monetarism is the core macroeconomic policy of Neoliberalism.

Monetarism and Neoliberalism are often regarded with a bitter cold attitude towards those suffering from economic downturns by these antagonists. However, it is really a prejudice to accuse them as such because these theories take account of the majority individual citizens such as their about preventing their real income depreciation caused by the monetary value depreciation.

Monetarism and Neoliberalism may be categorised into the Consequentialist ethical philosophy which attempts to maximise the overall net benefits by maximising the sum of the gross benefits while minimising the sum of the various cots as a total at the end. Monetarism criticises the big government policy directly caring their citizens by incurring a massive debt and the non-stoppable inflation depreciating their income and the market value of financial assets in the international market. Monetarism counts on the rationality of each individual's free will and the spontaneous order based on these free wills to recover their economy with the minimum assistance by the small government. 

It does not mean that both Monetarism and Neoliberalism neglect the public support with government assistances. They simply suggest the minimum required assistances. Furthermore, the High-Powered Money of Monetarism maintains the real value of the assistances provided by government and the procurement power of this government gathering the resources for their provision. This is why the European countries implementing Social Democratic socioeconomic policies adopt Monetarism for their core macroeconomic policy.

- Monetarism in Europe

The weight on each different macroeconomic theory which Neoliberalists adopt to follow depends on each Neoliberalist. Some of them mildly adopt Keynesian theory meanwhile the devote Neoliberalists base their thoughts and plans purely on Monetarism. As a matter of fact, the European Central Bank (ECB) and the central banks of Scandinavian countries, whose countries are famous for their Social Democratic socioeconomic policy, follow the monetarist macroeconomic policies especially for their tight prudent money supply policy. This proves that Monetarism is worth referring to not only the economic Right-wing but also the relatively more centralist counterparts. 

Social Democracy is actually the friendly version of Liberal Democracy (Capitalism) (※) and not technically Socialism. Therefore, it makes sense that these Social Democratic European countries are happy to install Monetarism as the principle macroeconomic theory of handling their market economy. Their socially minded intervention is not stimulated by the proactive positive macroeconomic intervention by a central government expenditure or the extravagant money supply from a liberal central bank which Keynesian economic theory often uses. 

    ※ Liberal Democracy and Liberalism by means of this comparison are treated as the synonym of Capitalism, the market economy, because Neoliberalism is mentioned to explain in this essay. Liberal Democracy is therefore the synonym of Neoliberalism here. Then, Social Democracy is the derivation of Neoliberalism rather than Socialism. 

The level of tax and expenditure rarely changes flexibly unlike those adopting Keynesian theory as their core principle macroeconomic policy. Their costs for the socially minded public intervention of these European countries are covered by the tax revenue from the progressive taxation levied on individuals and firms their steadily growing market economy. These European countries especially since 1997 (The European Monetary Union conducted by the ECB was introduced then) have been actually reluctant to artificially stimulate their economy.

It is because their macroeconomic tradition, especially of Germanic and Nordic, puts high priority on prudence over expansion. Their Social Democracy sustains the diverse income distribution allowing the slow but steady human capital development. Therefore, Monetarism matches with their prudent attitude towards economy to slowly but steadily raising their economy backed up by the human capital development requiring the steady continuous public investment in the long run.

- Conclusion: Monetarism and Neoliberalism are good!

In conclusion, having re-evaluated Monetarism and its ethics basing Neoliberalism, it is actually an ethically good functional socioeconomic political philosophy. Their characteristic is simply different and unique from the other political economic theories.  Their quality depends on how, where, and when it is implemented in real.

    To my admiring economists, Irving Fisher and Milton Friedman

Excel File: Ricardian Equivalence Simulator

 

Click https://uranaisearchastrology.files.wordpress.com/2022/07/recardianequivalencetest-1.xlsx to download.

You may simulate how individual economic agents react to keep/change their consumption-saving proportion by means of both the income effect (consumption + saving/borrowing) and the utility function showing their propensity to consume.

The income effect is calculated with the income of each time period (Yt), the interest rate for borrowing and saving (r), the additional interest payment rate of incurring debt (+d), and the wage growth rate (g).

The utility effect is calculated with the quadratic equation opening downward whose maximum is set differently for each different propensity to consume. 

Click https://uranaisearchastrology.files.wordpress.com/2022/07/recardianequivalencetest-1.xlsx to download.

The interesting factor is that the number of the economic agents drastically change their preference of incurring debt to increase consumption over saving only when the inflation rate is significantly higher than the interest rate in terms of this simulator.

By contrast, under the severe recession/depression where the inflation rate and the wage growth rate are negative, the economic agents rather change their attitude to save more than spending and those with the substantially high propensity to consume simply disappear.  The current saved income as well as the future value of the debt borrowed at the past become higher so that they rather change their attitude to save more. 

The propensity to consume is fixed regardless of any situation unless either the high inflation or the severe depression strikes. Therefore, as long as the economic agents behave rationally to their income effect, the Ricardian Equivalence holds.

 

Mr. Rishi Sunak will well remain in the history of Macroeconomics for his Hawkishness

It is a surprise to see such a Hawkish Chancellor of Exchequer after a decade of the Dovish regime in the world economic policy.  Mr. Rishi Sunak is certainly brave while being a little bit reckless.  It is certainly brave to reveal such a tough Hawkish characteristic . He puts emphasis on his prudent attitude toward balancing the budget. Even under the still anticipated downturn with a still remaining strong anxiety, he is willing to increase the overall taxation (generally slowing down economy) to balance the budget.  He claimed that, failure of balancing the budget eventually results in the rise of both the price inflation and the interest rate for bonds and mortgages is certainly alarming for economy.  

Regarding the usage of the term Hawk and Dove, it does not refer to diplomatic and military policies.  This term is uniquely used in macroeconomic policies related to neither diplomacy nor military.  In terms of macroeconomics, Hawk is tough and prudent whilst Dove is tolerant and loose.  It sounds similar to diplomatic and military policies but the implemented channels and the targets for setting these policies are different and unique in economics. Both have advantages and disadvantages.

Hawks are intolerant towards the enemies of the macroeconomic environmental stability such as the high price inflation (devaluing the income value and disturbs financial planning) and the rumour of distrust from investors and foreign exporters&importers.   They put emphasis on eliminating the root causes of the instability by tightening controls over balanced budgets and setting the central interest rate relatively high enough (plotting to consequently lower the high interest rate and stabilise the real income value). 

Doves are on the other hand tolerant for using loose policies to save individuals and their economic environment from the hardships (such as unemployment and lack of rescuing resources) even with some expected negative side effects.  They frequently claim for need of the looseness because the overall benefit covers the cost incurred by the negative side effect, and it should take place temporarily at least.   

Both are equally good as well as bad because both have disadvantages indeed. Hawks are remarkably unpopular during the unexpected economic downturn because Hawkish austerity is possible to be tough also on majority individuals suffering from the downturn, and then is likely to delay the recovery from the downturn.  Doves are blamed for their speculative projections often underestimating the cost of their policies so it is likely to misjudge of the timing of both imposing and cancelling their loose policies, and then their tolerance contains the high contingent risk of losing the administrative capability. 

Focusing on what Mr. Rishi Sunak is attempts to put into practice, he manages his policies by handing the fiscal policy-channels such as increasing tax rates to increase the inland revenue to reduce the national debt and various bond interest rates. He promises to consequently protect British citizens' income from either the high mortgage interest rate, the high price inflation, and lack of foreign investments with this policy implementation.  

The fiscal policy-channels are able to tune the different tax rate for various targeted segments of economic. Nonetheless, the fiscal policy always contains the mis-selection of the target sectors to increase the tax rate causing the systemic risk collapsing economy caused by penalising the certain sector's performance interrelated to many of the others. This Sunakian fiscal policy is expected to effectively handled to hopefully induce the positive aftermath.    

Mr. Sunak's policy is neither misguided nor irrational.  There are many worthy qualities accountable for encouraging the sustainable robust British economy. Especially, this seems to function for keeping the value of Great British Pound Sterling and secure the trust in the capital market and the foreign trades. Furthermore, his policy takes account of ordinary majority British citizens for securing their future real income value.  At the same time, the biggest concern is to determine whether or not this is the right moment to be tough as Hawk meanwhile the popularity of the looseness is still enthusiastically supported by the mass.

Having analysed these aforementioned aspects, Mr. Rishi Sunak's Hawkishness is neither absolutely good nor absolutely bad; but it is yet controversial.  Only the future might be able to provide the convincing appropriate judgement over his policy-aftermath.

The IS-LM Model is wrong!

This was originally posted on Wednesday, October 22, 2014

* Preface *

Many students of economics may have studied about the IS-LM model, and then tackled with various homework assignments requiring to solve the excessively complex formulas and understand the theoretical reasoning behind them. These macroeconomic teachers always expect students to consume their precious time and energy to solve a ton of equations and memorise the theory to explain what these algebras denote. The mathematical formulas applied to this model are mostly linear and straightforwardly simple but all equations are interconnected to all the others. As long as they are familiar with economics in general, it should not be a big problem to understand the theoretical bases. But, these teachers require these students to interlink all the necessary theories which textbooks show to all equations. In addition, when the interpretation of these students differ from what the textbooks and the teachers expect, their mark tends to be lowered. Therefore, studying the IS-LM model is very exhausting.

Nevertheless, despite their efforts and well-understanding, there is a big scepticism about the IS-LM model. There are still many debates about whether or not this model successfully explain the real world economy. Of course, there is always a residual gap between what the prediction model estimates and what the real world phenomenon is in real. This is why the IS-LM model is a problem because of its complex tangle of a bunch of the equations. Especially in social science, when many mathematical equations are used and interlinked together, the total sum of the residuals tends to be significantly magnified, and the bias and the inconsistency of the model also tend to take place much often. Furthermore, these estimate mathematical models are not statistically tested as their formulas are merely based on the literature of economic theories. Therefore, it is really a natural fact that the IS-LM model often fails to fit into what really happens in real.

Even in the pure literature based economic theories and the logical economic theories also counter to the IS-LM model. This report introduces some significant counter-arguments against the IS-LM model as follows.


1. The Ricardian Equivalence


This theory implies that providing economic agents with extra income by the stimulus package does not successfully induce them to spend enough to stimulate their economy. When they prefer consuming/invest less and saving more at the present time to the extra consumption&investment, the extra income available by the tax cut and/or the government expenditure rather causes the negative impact on economy than the positive impact. The cost incurred by the tax cut and/or the government expenditure at the present time period has to be paid back in the future. As the economic stimulus becomes unsuccessful due to their preference of spending less than expected, the tax revenue in the future time period is lowered meanwhile the cost remains.

Those who disagree with the Ricardian Equilibrium argue that there are many economic agents with the low income insufficient to satisfy their needs and wants during the recessionary period so that they happily spend their extra income provided by the stimulus package to stimulate economy.

However, their extra income spent for consumption/investment is eventually transferred to owners of the means of production who produce the consumptions and own the assets invested. These owners will rather want to shift their income earnt from their capital investment to their assets in this downward market to either saving in their bank account or investing more active foreign markets.

When an economy become at the point that even these owners of the means of production become deprived enough to cling to the extra income provided by the stimulus package, the national government is less likely to be able to issue their bonds to incur the debt as the bond credibility is substantially lowered.


2. Liquidity Trap


The stimulus package by the monetary policy channel still does not work due to the liquidity trap. As mentioned in the Ricardian Equivalence, economic agents tend to be reluctant to spend their extra income available during the recession. Even the monetary policy is less likely to incur the cost like the previously mentioned fiscal policy channel, the result is identical to the previously mentioned scenario.

This phenomenon is explained as the liquidity trap. As shown in the graph above, although the extra money supply becomes available to transform to the extra income available for economic agents to spend, the effect is substantially low or even nothing under a very low liquidity level i.e. the investment motive is very low. The little effect on the interest rate reveals little impact of the money supply increase on economy. This means that the factors determining the interest rate such as the price indices, the business activity rate, and the value of this money currency in the foreign currency exchange market hardly changed by this monetary policy.

On the other hand, this interest rate shown in this LM graph merely implies the central bank interest rate, and this only partially affect on the banks' interest rate setting for their borrowers. The rest of this report explains the effect on these interest rates. The IS-LM model neglects explaining the following factors because the IS-LM model assumes all these factors are positively correlated to what it indicates in the model. Nonetheless, the more real economy is obviously different from this false assumption.


3. Under the Banking Monopoly in case of Risk Neutral


The supporters of the IS-LM model assume that their margin rate tends to be always positively correlated to the central bank interest rate so that the final interest rate for both investment and saving is always controlled by the central bank interest rate affected by the fiscal and monetary policy.

The IS-LM model is based on the assumption that all or majority of private banks and the other financial institutes are under the perfectly competitive market. By contrast, the real world economic situation is even not close to this assumption and actually far away from it. They are in the less competitive market due to the nature of the financial industry and market.

The interest rate is the price of money rent and borrowed. So, the private banks and the other financial institutes need to add the extra rate on the central bank interest rate after borrowing from the central bank to rend their money to their customers in order to compensate for the renders' service cost and reward.

Also, in a market economy, the characteristics and the quality of the financial service is heterogeneous to each other, and the demand is severely affected by their geographical situations e.g. access to customers and clients (both quantitative and qualitative), cultural attitudes toward finance, and the infrastructure for obtaining information and technology available there.

On the top of the service quality issue, the service users are difficult to change their service providers often as much as the mainstream economists assume due to the contract binding them together and the transaction cost to close and open their bank accounts. So, these service users are more likely to be bound to their already contracted financial services.

All in all, the market nature is far more monopolistic owing to these aspects. Then, the interest rates are set at the quantity of money invested where the marginal revenue becomes equal to the cost which is the interest payment for savers for this case. So, the quantity invested is lower than the quantity at the investment and saving intersection, and the interest rate charge for borrowing is always significantly way higher than the interest rate payment for savers.

The interest rate payment for savers may be affected by rise of the central bank interest rate increase but not often by fall of the central bank interest rate unless the market is very competitive. These financial service providers take advantage of this situation so that the interest rate payment for savers often tend to be notably lower than the interest rate charge to borrowers.

The following charts explain the different situations to set the final interest rates.

3.1. When the Central Bank Interest Rate is high


When the central bank interest rate is high, then the interest rate paid to savers is adjusted to be equal to the central bank interest rate.

The quantity of money invested is adjusted to the point where the marginal revenue from the return from investment intersects with the central bank interest rate, and then the interest rate charged for investment becomes higher as the central bank interest rate becomes higher.


3.2. When the Central Bank Interest Rate is low


When the central bank interest rate is low enough to be able to split from the investors' profit margin, then no change of both interest rates tends to take place as shown in the graph above.

This aspect completely contradicts what the IS-LM model assumes. As the market is less competitive, the monopoly power is stronger enough to maintain their high interest charge for investment payment unchanged.


3.3. The extreme case: The Central Bank Interest Rate is either zero or minus



In this extreme case which seems to occur frequently under the world economic crisis period nowadays, many central banks of this world have set their interest rate notably close to zero. Even some claim that they should set the rate zero.

Nonetheless, as shown in the previously mentioned mechanisms, the previously mentioned interest rate setting under the low liquidity, the money supply offered by the central bank with a sizably low interest rate hardly stimulates economy.

The interest payment for savers cannot be set below zero because they will no longer save in these banks or any other financial institutes setting such a negative interest rate.


4. Risk Taking Patterns

On the top of the gap between the interest rates, the IS-LM model over-simplifies the investment pattern influenced by the psychological characteristics of banks, investors, and other financial administrators.

What should be concerned is that the interest rate setting based on the investment volume is not always counter-cyclical to the business cycle, and not all economic agents are risk neutral as many mainstream macro-economists tend to assume.

The following examples are based on the situation of the fiscal and monetary policy is tightened to repress the economic boom or the recession repressing the aggregate income level.

The Y_t denotes the aggregate income invested to economy by these investors, and X_t denotes the investment safety (A higher value indicates the lower investment risk).


4.1 Risk Neutral: The IS-LM Curve assumes all agents are as such


This is the way which the risk neutral agents regularly react to the business cycle downturn causing the aggregate income shrinking.

They simply reduce the investment volume, and passively react to the investment risk change.

The IS-LM model may work as long as all the economic agents act as such.


4.2. Risk Averse


The risk averse economic agents put priority on their investment safety to their nominal income gain from their investment volume.

When their investment opportunity becomes more limited, they tend to take this situation warning of losing their business opportunity and potential collapse of their investing clients.

Even in the case where the fiscal and monetary policy represses the booming economy, they imagine about the negative side effect of the over-expansion which the policy alerts, and then they prefer preparing for the worst case scenario.

In particular during the recession, more agents tend to become the risk averse because their perspective tends to be more pessimistic about the future.

All in all, the income downturn exaggerates the investment discouragement furthermore.


4.3. Risk Lover


What the mainstream macro-economists supporting the IS-LM model ignores is this psychological characteristics of economic agents the risk loving attitude toward investment.

When the macroeconomic level of the aggregate income goes down during either the policy tightening or the recession, these risk loving investors start investing more in order to compensate for their loss by the downturn. Even though their action notably increases, they tend to be willing to invest a lot for increase the nominal investment return furthermore.

Their prior objective is to maximise the gross income growth despite the high risk reducing the average expected investment return. So, they will either maintain the current investment volume or even increase the volume in spite both the investment risk, the high central bank interest rate, and the high tax and/or the less government expenditure.

In particular during the economic bubble, an euphoria severely affects people's mind enough to lose their rationality. So, they often tend to become the risk lovers while the economic bubble.



5. Risk Premium in case of the Perfect Competition

Even in the Perfect Competition Model fails in the real investment mechanism because it ignores the interest rate influenced by the risk premium of investment. When renders invest, they add the extra interest rate charge on the top of the risk free interest rate which the mainstream economists supporting the IS-LM model use in the macroeconomic model.

The graph indicates the interest rate setting of a bank under the monopoly:

Under the monopoly or a less competitive market, these firms simply takes the cost incurred by the investment risk by spiriting the expense from their profit.

By contrast, in the perfect competition, it is very complicated to explain with only the saving=investment curves so that the graph will be a overly complicated mess if it attempts to explain the risk premium rate setting under the perfect competition.

So, this analysis introduces the cost denoted as C, which indicates the cost of attracting savers, the interest payment to the central bank, and then the risk premium all together.

The graph below sets the saving motive and the central bank interest rate as rigid so that takes account of only the investment motive and the risk premium.


In this case, the interest rate is not guaranteed to be counter-cyclical to the business cycle, and it can be acyclical or even possibly pro-cyclical to the business cycle.

Some economists argue that the risk premium factor may affect the investment cost more than the other factors such as the central bank interest rate, the saving ratio, and the aggregate income/productivity level.

So, the final interest rate influencing the investment volume may rather rise during the recession because the risk premium rises meanwhile the rate may fall due to the lower risk premium during the stable or booming period.