Supply Side Economics

http://www.washtimes.com/commentary/20050723-092114-4549r.htm

Among other Nobel Laureates, Ed Prescott (2004) emphasizes the effect of labor taxes on work incentives. Bob Lucas (1995) emphasizes tax incentives to invest in physical capital. James Heckman (2000) and Gary Becker (1992) emphasize how progressive tax rates weaken incentives to invest in schooling and on-the-job training. And the optimal tax theory of James Mirrlees (1996) and Joe Stiglitz (2001) emphasizes both social welfare and tax-revenue (Laffer Curve) gains from low marginal tax rates on highly skilled individuals.

Errores de los keynesianos

http://wanniski.com/searchbase/growth1.htm

Los candidatos prometen lo que ningún presidente puede dar... Mayor crecimiento económico - Solow

"The candidates are promising what no President can deliver," said Robert M. Solow of the Massachusetts Institute of Technology, a Nobel laureate in economics.

John F. Kennedy (demócrata), por recomendación de Robert Mundell, aplica teorías de "Supply Side Economics".

Supply Side Economics

http://www.polyconomics.com/1930s.pdf

Los impuestos de los 1930s crearon la Gran Depresión y no la Reserva Federal. La falacia de Friedman.

Jude Wanniski, junto con Robert Mundell y Arthur Laffer, pueden ser considerados los padres del "Supply Side Economics", la teoría económica que se aplicó explícitamemte por primera vez durante el gobierno DEMOCRATA de John F. Kennedy. Luego la aplicó Ronald Reagan, convirtiéndose en el presidente más popular de los tiempos recientes, y recientemente la aplicó George W. Bush. Hasta donde llega mi conocimiento, don Oscar Arias, con su énfasis en incentivar la producción, es también un gran Supply Sider. Hasta donde sé don Oscar rebajó los impuestos sobre la renta de 50% a 30% y tuvo mucho que ver en la creación del régimen de zonas francas. No es de extrañar que don Oscar sea 

El "Supply Side Economics"

El papel del dinero y el oro en la gran contracción de los 1930s.

Nathan K. Lewis.

Más de un millar de economistas y varios gobiernos extranjeros protestaron por la implementación de la ley de aranceles Smoot-Howley. En sus discursos de campaña política Frankiln Delano Roosevelt culpó a la ley Smooth-Howley y a los aumentos de impuestos de la contracción.

El secretario de relaciones exteriores, Cordell Hull, centró sus esfuerzos en los aranceles. Los industriales británicos acusaron a los impuestos de la contracción y la caída del gobierno de Bruening, en Alemania, se atribuye a los aumentos de impuestos.

En realidad solamente se pueden hacer dos acusaciones a los bancos centrales. 

Hoy, el BIS (Bank of International Settlements) requiere un capital de 8%. En otras palabras. 100% dividido entre 8% es 12.5. Por cada dólar en capital, los bancos prestan $12.50. El apalancamiento es 12.5 a 1.

Se creó la reserva federal precisamente para que no ocurriera esa crisis de falta de dinero.

En la crisis de 1907, los bancos eran solventes, pero no encontraban dinero para pagar a los depositantes. En la crisis de 1930, los bancos tenían dinero, pero corrían el riesgo de convertirse en insolventes. Muchos bancos quedaron legalmente en bancarrota, como resultado fueron liquidados.

Los precios cayeron dramáticamente entre 1929 y 1933 en varias naciones. Otros argumentan que los países estaba en una enorme, "venta de cierre de negocio" que cubre todo el país.

Si los depósitos de los bancos son considerados dinero, al "desaparecer" dichos depósitos, desaparece el dinero. Es la quiebra de los bancos quien lleva a la contracción monetaria, no es la contracción monetaria quien lleva a la quiebra de los bancos. Esa es la falacia de Friedman

Los actos expansionarios de Benjamín Strong en 1928 produjeron solamente pequeños movimientos en los tipos de cambio. 

El resultado de la deflación fue recesión pero también de altas tasas impositivas impuestas durante la guerra que el gobierno británico no redujo después. Francia se pegó en 1926 y no sufrió efectos deflacionarios.

Una breve pero intensa recesión en los EE.UU. en 1921, acompañada de una dramática caida en los precios, se debió principalmente al ajuste de la economía al regresar a las condiciones de paz, pero fue exacerbada por el ajuste monetario.

No se está negando que las causas de la gran depresión fueron en parte monetarias y financieras. Hubo poca cooperación de los bancos centrales. Francia incitó la ruptura del sistema financiero austriaco con un retiro mayor de depósitos y Gran Bretaña ayudó poco a Austria en la crisis subsiguiente.

John Maynard Keynes argumentó que era necesaria una devaluación para resolver el problema de los salarios inflexibles y el trabajo organizado. Este es un argumento diferente de aquel que dice que un error monetario causó la depresión en sí. Estos argumentos justificaron la devaluación de 1933-34. La política se consideró un fracaso y Roosevelt no la intentó de nuevo.

La época del estándar de oro se caracterizó por pánicos financieros crónicos. Eso es cierto. 

Página 13. Los demás países hicieron los mismos aumentos de impuestos. Japón no aumentó impuestos y los efectos recesionarios fueron mucho más leves.

1779: Hiperinflación causada por la guerra de independcia EE.UU.

1793-1819: Período de altos precios relacionado con las guerras napoleónicas.

1860-1879 Regreso al estándar de oro.

http://www.wanniski.com/showarticle.asp?articleid=2803

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http://wanniski.com/defmonster.asp

Appearing originally in the American Spectator September-October 2001.

The Deflation Monster

By Jude Wanniski

In 1995, I predicted that inflation’s days were numbered. A year later I warned of a new, more exotic enemy—deflation.

Throughout the boom and bust of the late 1990s and the new millennium, I detailed this foe’s attacks as it stomped its way through Asia, Russia, Brazil and the U.S. farm and energy economies, and later as it crashed into Wall Street and Silicon Valley. Now it ravages global telecommunications companies and capsizes every Third World economy that counts its debt in dollars, from Argentina to Zimbabwe. [ojo] Nótese que acá implícitamente se admite la sobrevaloración del dólar frente al euro. En el 2002 el dólar caería frente al euro.

Chart del valor del oro.

http://www.sharelynx.com/chartstemp/AUBULLRUN.php

On January 7 [suponemos que se refiere al 2001, puesto que Bush fue electo a finales del 2000], I met with Dick Cheney in his transition office near the White House, to warn him that the Bush administration had inherited an economy with a rare disease curable neither by Federal Reserve interest rate cuts nor by the timorous and dilatory series of tax rate reductions then being proposed by his administration. [ojo]Daniel J. Mitchell señala que estos, los recortes del 2001, eran recortes de impuestos keynesianos, y que estaban destinados a tener poco efecto] Indeed, although cuts in tax rates are entirely positive for the economy, they contribute to deflation by spurring [estimular] the demand for money.

The problem, I told him, was a pure monetary disorder that would cause serious damage unless corrected. There was nothing he could do until the political establishment realized that conventional medicine would not work. In April, I gave the same warning to Treasury Secretary Paul O’Neill, and to Senator Trent Lott, who was then majority leader.

In late February [suponemos que se trata de abril del 2001] I advised my Wall Street clients that, until the problem was corrected, there would be no reason to buy equities. The adjustment to a monetary deflation takes time, but it is inexorable, forcing all nominal prices to fall—including the price of wages, assets, and all goods and services, even the price of haircuts.  One hundred percent wage reductions, also known as layoffs, are frequent.

Japan is in the twelfth year of a deflation, the yen having doubled in value over the last decade.  Equities there hit a 17-year low in mid-August, and only now are its political and economic leaders beginning to understand why interest rates cut close to zero percent have had no effect.

Money, in its simplest form, is non-interest bearing debt of the government. To acquire more money, economic actors give up “goods” or “assets,” which is why gold and sensitive commodity prices react first to changes in the demand for dollar liquidity.

Deflation—a significant undersupply of money relative to demand—is first signaled by a fall in sensitive commodity prices, which can change rapidly in highly liquid “spot” markets. Like inflation, it occurs when a central bank—in our case, the Fed—fails to match the supply and demand of money in the marketplace. In the absence of a reference point by which to gauge an under- or over-supply of money, the Fed has to guess.

The current deflationary process in the U.S. began in late 1996 when the dollar price of gold and all other commodities began to fall. In 1997-98, the pivotal price of oil plummeted from $25 to $10 per barrel. Over the next two years, petroleum exploration and investment in production and infrastructure ground to a halt. In one of many misleading signals whereby monetary ease and monetary tightness mimic each other, the sudden deflation-induced scarcity pushed the price to $35 per barrel in 2000. This, after the global economy had emerged from the Asian crisis against a backdrop of diminished crude supplies.

http://www.chartsrus.com/chart1.php?image=http://www.sharelynx.com/chartstemp/free/chartindCRUvoi.php?ticker=FUTCL

Deflation is especially destructive to debtors, who are committed to paying down their debt with more valuable dollars out of incomes that shrink because of declines in the prices of things they produce.

Since 1997, there has been a steady advance in bankruptcy rates, with a record 1.6 million filings in 1998. In 2000, more than $40 billion in corporate debt went unpaid, a record until this year. Corporate defaults increased to $58 billion in the first half of 2001, with the important telecommunications sector accounting for $16 billion.

The car leasing business is in turmoil. Bank of America will take a $1.25 billion charge in the third quarter to exit this business because of rapidly falling prices for used cars. Losses for General Motors, Ford, DaimlerChrysler, and other auto finance companies could total $18 billion over the next few years.

Financed with high-yield bonds, telecom companies like low-earth orbit satellite operator Globalstar and networks Viatel, Winstar, Teligent, and 360networks are bankrupt, and many of their compatriots building the new Internet infrastructure are teetering on the edge with stocks trading for just a few dollars and bonds trading for pennies on the dollar. New backers are hard to find. Even old (and new) economy stalwart Lucent Technologies struggles with a junk debt rating, for a stretch even contemplating default.

The raw number of bankruptcies is on the way to surpass 1998 this year and next as the process grinds on until it completes its adjustment by putting debt-laden companies out of business. New businesses then form with workers agreeing to accept lower nominal wages that have higher purchasing power, and bankrupt firms cease operations or reorganize under new debt structures, in either case leaving most of the original investors with little to show for the risks taken.

Deflation is not a beneficent return to normalcy after a long inflation but a wrenching process just as destructive to peace and prosperity. Nobel Laureate Robert Mundell’s definition is the most meaningful: inflation is a decline in the monetary standard. By this definition, inflation is not measured by rising price indices, nor is deflation measured by falling price indices. Deflation is not a statistic but a decline in the monetary standard. Just what does Mundell mean by this formulation, one that was the essence of classical economics, from Adam Smith to Karl Marx, and also of classical finance, from Alexander Hamilton to Andrew Mellon? To these great men, the central function of money was as a standard unit of account. The decline in a standard reflects not its rise or fall in value but its deteriorating stability, credibility, and constancy. To all the titans of classical theory and practice, that standard was golden, the “commodity money, par excellence,” as Marx wrote in his monumental Capital. Only when we fully grasp the importance of this definition of inflation or deflation will we be able to understand how to rid the world of these twin evils.

Monetary policy has always been most difficult for political leaders to understand, but never before has there been a greater need for it. As Mundell wrote 25 years ago, when the world was just entering the monetary problems that have haunted it since, “Contemporary understanding of the inflation issue is hardly better than it was several centuries ago, despite the sophistication of very large economic models involving great mathematical and statistical sophistication but very primitive economic understanding.” Because far more rare and insidious—often deceptively wrapped in the remnants of rising prices and money supplies—deflations are even more slippery to grasp or remedy.

People confuse deflations with contractions.  In a supply-side model, it is not consumers but producers of goods—those who supply them to the marketplace—who are the primary actors. They produce in order to exchange their output with producers of other goods and services. As I explained to Treasury Secretary O’Neill: if he is a producer of bread and I am a producer of wine, and we are planning to exchange our output with each other over a period of time, in a modern economy, this is done through the intermediation of banks and financial markets, not barter. A higher tax on producers of wine and producers of bread, or a higher tariff between domestic producers of one and foreign producers of another, will make some exchanges of goods unprofitable. Instead of being exchanged, they will pile up in inventories. This is a contraction, not a deflation. Prices will fall as the producers discount them in order to get them off the shelves, but this is normally a temporary condition, “an inventory recession.” As soon as the surpluses are liquidated, the rest of the economy bounces back at the old price structure.

The Great Depression was chiefly a contraction, not a deflation. It was not caused by the Federal Reserve making dollars scarce relative to gold, the proxy for all commodities. It was caused by tariff and tax shocks that erected barriers between domestic producers and between exporters and importers.

The Fed now has caused both a contraction and a deflation. By raising interest rates unnecessarily when long-term interest rates were already lower than short-term interest rates (remember the “inverted yield curve”), the Fed slowed the real economy, bringing about the contraction from the higher growth rates the economy had been enjoying. At the same time, by not supplying sufficient monetary reserves to meet the legitimate demand for money by American enterprises and households, the Fed also caused the deflation we see evidenced by the declining gold price.

The contraction part can be overcome by lowering short-term interest rates and more important, by cutting marginal income-tax rates and capital-gains levies. Affecting every personal and corporate decision and valuation in the economy, tax rates are the single most critical policy lever directly governing economic inputs and outputs.

Lower tax rates enhance the demand for liquidity; higher rates stifle it. However, within any fiscal environment, a deflation can only be rectified by having the Fed add sufficient liquidity. Otherwise, there will be a slow, grinding, downward adjustment of all dollar prices—the murky mirror image of the lurching, upward adjustment of all dollar prices that we knew as the inflation of the 1970s.

Inflations and deflations only can be understood as process phenomena. When President Franklin Roosevelt raised the dollar/gold price to $35 per ounce from $20.67 by executive order in 1934, the general price level took two decades to catch up with gold. This is because contracts had to unwind in a gradual inflationary spiral between capital and labor. When the debt structure of an economy is mature, it takes a long time for the process to be completed. The same is true of deflation.

Our honest attempts to produce bread and wine and exchange output with each other via financial intermediation will be messed up by either a deflation or an inflation. If our contract is such that I deliver O’Neill a loaf of bread every day, with the contract requiring him to deliver the wine all at once at the end of a year, the government must keep the dollar constant against a standard in that period, for if it deflates, O’Neill, who is in my debt, will be required to give me much more wine than he anticipated at the outset. If the dollar inflates, as his creditor, I will be forced to steadily increase the amount of bread I give him, and at the end of the year will have to be satisfied with much less wine.

Think back to the Savings and Loan crisis in the 1980s.  Even when prices had been stabilized after 15 years of inflation, debtors who borrowed a whole house were paying back just one-tenth of a house.  Today the S&Ls are thriving because homebuyers who borrowed one house must now pay back a house and a half. 

But the interests of creditors and debtors only diverge in the short term.  Over time, they are perfectly aligned. And in a world where the unit of account is floating against the real world of commodities and gold, inflations and deflations will be the rule, not the exception.

As wise a man as he is, Fed Chairman Alan Greenspan has not been wise enough to realize the problems he caused by ending the dollar inflation, only to preside over the dollar deflation that is now forcing down the general price level. It is as if he threw a cigarette butt into the brush back in November 1996, when the process began, and it has been burning its way through commodity producers ever since, but is now reaching up the mountain toward our production of intellectual goods and services. It is nice to be a commodity producer at the beginning of an inflationary process, when the prices for your output surge before wages, taxes, and capital costs can catch up. But the flames finally reach you, too, when the dollars you get for your commodity will no longer pay for the rising costs of labor, taxes, and capital needed to sustain the business (or farm).

In a deflation, it is nice to be an intellectual producer—producing goods and services out of your head, not out of the earth—and buying real estate and commodities at ever lower prices. But eventually all economic activity suffers from doubt and disinformation, panic and overshoot, when the monetary standard declines. [no comprendo]

This is the deflation monster now chewing away at the economy’s foundations.  It is so rare that few economic theorists were prepared for it. We cannot undo the damage that has been done, but we can prevent further deterioration as the deflation unfolds.

Gold remains the best signal of destructive monetary errors. Critics of this “barbarous relic,” as Keynes called it, will always be able to point to incidental turbulence in gold markets—from new leasing practices by central banks to changing marital dowries in India to new connective tissue on microchips—that is alleged to cripple gold as a monetary tocsin.  Yet no alternative has emerged. With by far the largest permanent stock relative to annual production, gold offers a market where more than 98 percent of the supply ever mined is still available to respond to monetary conditions, as opposed to the weather or the demand for tantalum or pork bellies. Thus among all commodities, gold is the most accurate sensor of monetary policy. When the Fed creates too little money, given the market demand, the dollar becomes scarce relative to gold and the price of gold declines, eventually rippling through the economy until there is a new, lower general price plateau.

Increased liquidity would act as a firebreak, devaluing the dollar against gold with a mini-inflation that takes the gold price to $325, the number suggested by Jack Kemp in late June when he wrote about deflation in The Wall Street Journal.  But just how much liquidity do we need? Interest rate cuts don’t seem to have worked. So how do we know?

When President Richard Nixon broke the dollar’s link to gold in 1971, a young Canadian economist, who 28 years later would be awarded the Nobel Prize in economics predicted a serious inflation soon would follow. Robert Mundell said at the time that “Mankind seemed determined to attempt one of its periodic experiments with a managed currency, but the experience would be so painful that by 1980 we will be returning to fixity.” The inflation of the 1970s certainly was painful, and a great burden to the Nixon presidency and the Ford and Carter presidencies that followed. In 1980, on Mundell’s schedule, Ronald Reagan, a lifelong advocate of a gold standard, was elected, publicly stating his belief that he knew of no nation that left gold and remained a great nation.

Based on mastery of classical economic theory that had long been discredited by the Great Depression, Mundell’s insight gave rise to “supply-side economics,” the term I coined in 1975 while a member of The Wall Street Journal’s editorial board.

Inflationary monetary policy caused the dollar to lose 75 percent of its purchasing power relative to gold by 1973, when its price climbed to $140 from $35 per ounce in 1971, and when OPEC quadrupled the oil price to $10 per barrel from $2.50. The commodity inflation followed, and then came the adjustment of the general price level, as nominal wages and profits eventually rose by a factor of 10 to match gold’s rise to $350 (after a peak of $850 in early 1980).

It would be 1999 before the Swedish Academy recognized Mundell’s contribution to monetary theory and awarded him the Nobel Prize in economic science.

What nobody understood at the time, including Nobel prizewinners past and present, was that the demand for dollar liquidity would change as the tax structure changed.

All economic activity can be affected by the tax wedge between producers. If the wedge is large, marginal economic transactions cease.  Hours worked, investments made, and risks taken all decline. Higher tax rates cause liquidity demand to shrink, and lower tax rates cause liquidity demand to rise. If the tax wedge is reduced, people work harder for a greater after-tax return, new enterprises spring up, and investors envision greater profits flowing to the firms they support. Production increases. Businesses, investors, and entrepreneurs require more money to liquefy the economy, now poised to expand.

In 1979-80, the Fed was pouring liquidity into the banks just as the inflation-swollen tax brackets and Jimmy Carter’s credit controls were sinking the demand for money. The Ms (the monetary aggregates) looked as if they were behaving, but the velocity of money—the rate at which money changes hands—was going through the roof and so was the price of gold, hitting $850 in midday trading on February 1, 1980.

When it became clearer that Ronald Reagan would defeat Carter and then cut tax rates substantially, the demand for liquidity rose, dollars became scarce as velocity fell, and the price of gold began a precipitous 18-month decline to $300 from $850. Focused on the money supply rather than the demand for money, however, the Fed was still fighting a decade-long inflation when deflation had suddenly become the problem.

The 1981-82 Reagan recession was the worst since the 1930s and almost destroyed the economy and his presidency. I called Fed Chairman Paul Volcker, on St. Patrick’s Day 1982 as I recall, practically begging him to ease monetary policy by buying bonds with newly created dollar liquidity. Gold was at $310. “You want me to inflate?” he asked incredulously. “No, I just want you to stop the deflation, or all the dollar debtors in the world will go bankrupt.”

The deflation ended by accident in the week of August 11, 1982, when Volcker was faced with a crisis in Mexico, which could not pay interest on its $80 billion in debt to U.S. banks. He had to tell the Reagan Treasury he could no longer worry about the money supply because he had to monetize $4 billion in Mexican peso bonds. The price of gold rose $56 that week and the financial markets skyrocketed—bonds, stocks, the S&P 500, with Nasdaq out front. Monetary policy had been twinned with tax policy, both going in the same direction. The Reagan boom had begun.

The experience should have persuaded policymakers even then that a floating unit of account could do deflationary as well as inflationary damage. Here we are again, though, puzzling at the odd behavior of the financial markets, debating whether the dollar is too strong or too weak, and not quite realizing how heavy a price is being paid by everyone on the planet for not having a fixed standard of value.

As economic expansion led to Reagan’s landslide re-election in 1984, James Baker III moved from the White House to the Treasury, swapping jobs with Donald Regan, the former chief of Merrill Lynch, who was less interested in financial reforms than in effective administration. The move was a good one, leading to the major Reagan tax reform of 1986 and a Baker initiative in early 1985 to inch toward a gold-linked standard. First there was the Plaza Accord, an agreement at the Plaza Hotel in New York City among the major finance ministers and central bankers that was intended to coordinate monetary policy in a way that would lead to a gold-linked system. It worked very well at the outset, with the dollar/gold price rising from $280 in early March to $330 three months later. Stocks and bonds reacted positively.

Plaza was followed by the Louvre Accord, which was intended to ease the world toward a formal system that would be automatic, in the sense that each bank would manage the supply and demand for its money without having to consult each other or the money markets. If a dollar or a Deutschmark or a yen had to abide by the reference point, their cross-exchange rates would not change, and there could be no argument about one or the other having a trade advantage. Nor could there be an inflation or a deflation of any currency linked to the basket. If A=Basket and B=Basket and C=Basket and D=Basket, then A=B=C=D.

I did not like the idea of a “basket” of commodities because the prices of the goods in the basket would change from one minute to the next, causing the unit to inflate or deflate. As the most monetary of all commodities, gold’s large stock relative to its flow protects it from such gyrations.

Still, I celebrated the Baker initiative because I knew it would have to lead eventually to a focus on gold as the key reference point for the world’s monetary authorities. Unfortunately, a month later, the initiative was completely washed away by the October stock-market Crash on Wall Street. Although the Crash of 1987 was due at least in part to the newly expressed view of Fed Chairman Greenspan that the dollar was overvalued, on the Wednesday before the Crash, I had spent an hour at Treasury with Secretary Baker, bringing the urgent message from Professor Mundell that the dollar must be protected at all costs, even by selling bullion from Fort Knox if that is what it took.

From the outset the monetary adjustments enshrined in the Plaza and Louvre Accords suffered from contrary tax and monetary signals from Washington. While lowering the top income tax rate from 44 percent to 28 percent, the Reagan Tax Reform Act of 1986 had included an increase in the capital-gains tax to 28 percent from 20 percent without protection against inflation. Inflation can push real capital-gains tax rates above 100 percent on long-held assets, as the tax shifts from real gains to spurious inflationary increases in valuation.

Affecting the value of every asset in the economy, the higher capital-gains rate was having a day-by-day impact on all marginal business decisions. The net effect was a steady decline in the demand for dollar liquidity that portended a new siege of inflation and real capital-gains taxes at confiscatory levels.

With the subversion of the monetary valuationss of the Louvre Accord, the markets did not waste time seeing the odds of economic growth sharply diminished. On October 19, the day of the Crash, I was invited on a network television panel with several other economists to discuss the day’s events and made the argument that the Crash did not mean recession ahead, but was rather a buying opportunity, because the one-day adjustment had completed the downward valuation process. There would be slower economic growth, but as long as no other errors were made, the Reagan tax cuts would continue the expansion. The others on the panel—chief economists at the New York banks—practically laughed out loud. They were persuaded that the Reagan “bubble” had burst and that recession lay ahead.

In the days that followed, Greenspan flooded the banks with liquidity, as if insufficient liquidity were the problem. After the markets turned around, the idea of linking the dollar to gold disappeared from public discourse, as the opponents of gold asked the question: if Greenspan had been tied to gold, wouldn’t he have been prevented from flooding the system with liquidity when the Crash occurred? The underlying assumption is that there may be times when a gold standard prevents politicians from doing something desirable and if Greenspan did not have this freedom of action, the market Crash might have turned into a serious recession. This reasoning admits no possibility that the Crash occurred because the steps being taken to stabilize the value of the dollar in real, commodity terms went up in smoke. 

There are of course myriad times in human history where the constancy of gold as a monetary unit did not prevent panics and crashes, recessions and depressions. It was Mundell in 1960 who first made the argument in this context, that if a government has two targets, it needs two “arrows” (policy instruments) to hit them. Monetary policy cannot hit both at once. If government wants stability of the general price level, with no inflation or deflation, it should use a monetary arrow to hit that target. If it wants economic expansion, it should use the fiscal arrow for that. The principle should boil down to “tight money and easy fiscal policy” in combination, to achieve non-inflationary growth. There was nothing necessarily “supply-side” about this formulation, and to be sure it was presented as an alternative to the policy mix proposed by James Tobin of  Yale, who was a member of President John F. Kennedy’s Council of Economic Advisors when Mundell was  at the International Monetary Fund in the early 1960s. Tobin recommended “easy money” to spur growth and “tight” fiscal policy, i.e., higher taxes, to contain inflation.

It was the Tobin policy mix that won, which inevitably led to the abrupt, formal break with gold in 1971 and a decade of stagflation. The slump was faintly disguised by rising prices in the U.S. But to the rest of the world, stuck with a catastrophically devalued hoard of dollar denominated bonds, the key event was the closing of the U.S. gold window and the rise of the price of gold from $35 to over $800.

As a result of this ferocious inflation, sweeping up oil, land, and other commodities, Germany and the rest of Europe would never again agree to an international monetary system designed like Bretton Woods. In 1944, when the U.S. owned two thirds of the monetary gold in the world, it seemed reasonable to Europeans to give the U.S. central control over the mechanism. The U.S. would keep the dollar/gold price constant and the Europeans would keep their currencies constant relative to the dollar. When Nixon suddenly devalued against gold, however, everyone else was left holding the bag, especially if they held special U.S. bonds in their monetary reserves instead of gold. In a new regime, we might expect the United States to get more say in its management than other member states, but not a monopoly power, which is what it had in the Bretton Woods system. I believe Mundell could design such a system between breakfast and lunch, as he has been thinking about it for decades.

Most economists, though, are paralyzed by that belief that the gold standard contributed to the Wall Street Crash of 1929 and the Great Depression that followed. The only contrary theory was the simple “bubble” idea put forward by Harvard’s John Kenneth Galbraith. But it is simplistic to say the market crashed because silly people bid it up in an outburst of irrational enthusiasm. The big markets in particular tend to incorporate the best information available. 

This recognition—learned at The Wall Street Journal at the same time I was learning about monetary policy from Mundell and fiscal policy from his protégé, Arthur Laffer—is what prompted my momentous discovery that the 1929 Crash was caused by the Smoot-Hawley Tariff Act of 1930. I made this discovery in March 1977 while researching my book, The Way the World Works. How could a 1930 piece of legislation cause a market crash in 1929? Easily, if in the last week of October 1929 the United States Senate is in the process of changing its mind on the tariff, from no to yes. While the issue would not be completely settled until June 1930 when President Herbert Hoover signed the act, the market had not waited around to sell. Granted, few people in the market knew why they were selling or why they were forced to sell. If they did, it would not have taken me 47 years to figure it out. It is like a tote board at a race track, where suddenly the odds change in favor or against a horse, and the players in the stands take all that into account without knowing on what information the bets had been placed.

To a Keynesian economist, the dire effects of a collapse in aggregate demand could have been offset by a cheaper dollar. This is exactly the argument made by the monetarists, Milton Friedman & Co., who note that one-third of the money supply vanished in the early years of the Depression as one-third of the banks went bankrupt. If Friedman et al have their causality right, the banks went belly up because the Federal Reserve did not print money fast enough.

However, when Roosevelt did try to get more money into the economy by devaluing the dollar in 1933-34 and making it illegal for Americans to own gold, the Great Depression only got worse. There was a bit of an inflation, as would have to happen when the dollar cheapens against gold. But all that did was cause nominal prices to rise and push workers and investors into the triply higher tax brackets that had been created by Hoover in 1930 and Roosevelt in 1933, long before the term “bracket creep” was coined.

Law,” says Professor Reuven Brenner, “is built on sand. Tradition is built on rock.” The McGill University economist in Montreal used the phrase to explain the endurance of gold as a standard of value. Even though governments decide they would rather manage without it, the ordinary people who make up the markets continue to use it as the best measure of the money their government provides for them. Where it may seem as if the price of gold swings up and down, what is actually swinging is the price of the dollar in terms of gold, first inflating, then deflating. Money, after all, is nothing more than a convenient IOU, a piece of paper or an electronic entry in a bank that can be passed around among workers, consumers, savers and investors as reminders of who owes how much in exchange for something else. When it changes in value as it passes from hand to hand, it causes confusion, which is why thousands of years ago people around the world began using gold—and here and there, silver—as the basic unit of account. Goods and services could be traded over long distances and long periods of time for delivery if the producers understood the values in terms of gold, or the currency chosen to represent gold as a circulating medium.

It was by trial and error that civilization wound up with gold, partly because it is rare, constituting only 5 parts per billion of the earth’s crust while silver is roughly 50 parts per billion. Better yet, it does not corrode or tarnish. It is also dense, so it does not take up much space, and it is soft, so it can be easily divided. We know pretty much where all the gold is and how much there is, about 130,000 metric tons, only enough to build one-third of the Washington Monument out of solid gold. It is the most monetary of all commodities, widely accepted in lieu of various paper currencies in exchange for local goods and services. It is hard to disrupt the world gold market by adding gold faster from gold mines, or withholding it, because its total stock is so enormous compared to annual production of less than 2,500 metric tons.

The most telling point is that the world market continues to price gold’s future value in terms of today’s value in the spot market, plus the interest rate on government bonds over the future period being examined. No other commodity on earth enjoys that respect for constancy and integrity over time. I learned all this from Fed Chairman  Greenspan, who explained it to the House Banking Committee several years ago when asked why gold was more important than other commodities as a monetary commodity.

Unfortunately, when the price of gold began its decline from $385 per ounce in 1996 to about $275 today, Greenspan decided it was not a useful signal of monetary deflation. To do so, he would have had to acknowledge errors in his personal decision to manage the economy for purposes other than price stability. He saw the stock market as being inflationary. Then he saw the decline in unemployment as being inflationary. Lastly, he identified the rise in corporate bond yields as a harbinger of inflation. Now, with seven interest rate cuts and no positive reaction from the commodity or financial markets, Greenspan cites “fast” M2 growth as a sign that policy has become stimulative.

An obsession with inflation can be counted upon to bring delation. In its first phase, producers of things that come out of the ground are the first to see their products fall in price, following gold’s lead. This is because gold only measures a unit of labor, not a unit of capital. A unit of labor is the same everywhere, in the poorest and the richest countries, with wages differing according to the capital added.[no entiendo por qué esto sería así] It was not entirely “inflationary,” after all, for the value of real estate in downtown Tokyo to rise sharply as it did in the 1980s. The rise in asset values was due to favorable capital-gains treatment for real property. When that tax treatment ended in 1990, the so-called real estate bubble burst.

In 1996, as Internet investment accelerated and the election results pointed to a tax cut in 1997, the price of gold began its decline.[o sea, aumentó la necesidad de dinero porque la inversión (y la producción) aumentaban. Por eso el oro empezó a caer]  Mostly blind to these developments, even misreading them as inflationary and deploring them as “irrational exuberance,” the Fed failed to supply the liquidity the market needed. Greenspan was worried about the mini-inflation he allowed when the Clinton tax increase of 1993 reduced the demand for liquidity, and the Fed did not remove the surplus by selling bonds. [Un aumento de impuestos produce inflación porque se necesita menos dinero para manejar la menor producción de bienes a la que lleva el aumento de impuestos]. Gold had averaged $350, more or less, since 1985. It rose to $385 in 1994 and stayed there, despite Greenspan’s efforts to squeeze out the inflation with higher interest rates. The classical economists could have told him, as did I, that he could only bring down the gold price by selling interest-bearing bonds from the Fed’s cache, withdrawing the liquidity. But gold had been so demonized by the demand-siders that Greenspan probably believed he would have been ridiculed for any gold-based move. So he hunkered down and hoped for the “best.”

The best, as I see it, is that the deflationary process has only been partially completed. It cannot be reversed unless someone the president respects picks up the phone and tells him there is no remedy except an inflation to readjust the gold price. With Greenspan now turning 75 and wishing to retire, the pieces may fall into place before year’s end. When it does, the gold price will either shoot up and stop at a point where the interests of debtors and creditors are in balance, or it may shoot up much higher, as it did when the deflations of 1982 and 1985 ended. Long-term interest rates are as high as they are, even in this deflation, because they have experienced this phenomenon before.

Inflation hawks, of course, will deny that deflation is possible while the CPI ekes up and various money supply indices bulge like mattresses in a banking crisis. The CPI was also registering “inflation” during the 1981-83 deflationary squeeze, as it is today. Then, the indices were still being driven up by the previous inflation and had not yet fully reacted to the dollar/gold price. Because contracts can take decades to unwind, this process is gradual. Only now are we beginning to see the “noise” created by the deflation-induced crude shortage removed from headline consumer and producer price indices.

Thirty years after going off gold, there is virtually no talk anywhere in the world of going back to it. We seem to have somehow gotten along without it after all. Or have we? Those who continue to believe a dollar/gold link is the only way the market can effectively tell the Federal Reserve how much money it needs are now prepared to argue that the world can no longer endure a floating standard of value. Jack Kemp, a leading Reaganaut of the 1980s and champion of gold and low tax rates, most recently reiterated that there really is no alternative to a gold anchor. He sees how gold would have prevented the accumulation of errors that now bedevil our economy—and that of the entire world, which looks to the United States dollar as the key currency. It is always the poorest people and the poorest countries that are most damaged by the absence of reliable standards of measure. The Third World would benefit most with a return to gold. But as the only superpower in a unipolar world, the United States is the only country in a realistic position to make the move.

Untitled Document

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http://dallasfed.org/research/ei/ei9602.html

Tax Reform An Opportunity to Increase Our Saving - Economic Insights - FRB Dallas

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http://www.usc.edu/org/InsightBusiness/340articles/fall2006/taxes.html

Los EUA necesitan abolir el impuesto a los dividendos y a las ganancias de capital. El aumento de capital hace más productivo al trabajo y por lo tanto la economía puede producir más bienes y servicios con la misma cantidad de trabajo.

El capital que determina la productividad es gravado como impuesto a los dividendos y a las ganancias de capital.

http://online.wsj.com/article_email/SB113780947395852687-lMyQjAxMDE2MzI3MzgyMDM5Wj.html

Capital Offense

As the Senate and House get back to work on the economy, their chief order of business now -- as it was 25 years ago this month, when Ronald Reagan was inaugurated as president -- is taxes. In particular, it is the Tax Reconciliation Bill that will emerge from Senate-House Conference in early February. At stake -- tax rates on the capital that determines American productivity and our workers' paychecks.

America is not competing for jobs with China. We are competing for capital. Double taxing dividend and capital gains income drives capital to China, where it earns higher after-tax returns. When that happens, American workers are left behind with falling productivity and uncompetitive companies.

Reducing or eliminating dividend and capital-gains tax rates keeps capital in America, where it makes workers productive and supports high incomes. Congress must act now to keep rates from increasing in 2008, by extending or eliminating dividend and capital gains taxes.

The 2003 cuts in both dividend and capital-gains tax rates was a substantial boost for the stock market and corporate boardrooms. The Dow Jones Industrial Average is up 32% since Dec. 31, 2002, one week before President Bush announced the 2003 tax cuts. The S&P 500 large-cap index is up 47%. Mid-caps are up 79%, and small-caps up 81%.

Overall, the value of U.S. equities increased $6 trillion (up 50% from $11.9 trillion to $17.9 trillion on Sept. 30, 2005) since the dividend tax cut first appeared in the headlines. Household net worth increased $12.1 trillion to $51.1 trillion over the same period, an increase of $40,631 for every person in America. These gains accrue to the 91 million Americans who own shares of stock directly or through mutual funds, and to more than 80 million private and government workers through their pension funds. Growth, profits, and investment spending also grew, and we have created 4.4 million jobs. Tax cuts were a major factor in producing these gains.

Dividend and capital-gains tax cuts are not trickle-down economics as claimed by opponents. They work by jolting asset markets, stock prices, and capital spending, and by altering business decisions about capital structure, dividend payout and capital deployment.

In December 2002, I prepared a report for a White House working group detailing how the dividend tax cut would impact the U.S. stock market through two different channels 1) recapitalizing the stock market and 2) restructuring corporate balance sheets.

Tax cuts initially impact asset prices by making investors recapitalize, or revalue, the equities of existing companies to reflect higher after-tax returns relative to interest-bearing securities, tangible assets like land and collectibles, and foreign assets. The return gap -- more than 100 basis points for the 2003 tax cuts -- makes investors sell relatively low-return assets, driving their prices down, and buy relatively high-return assets, driving those prices up, until after-tax returns have been driven together again. My estimates showed an initial positive impact on equity values of $560 billion to $938 billion, or 6% to 10%.

The restructuring impact of tax cuts on stock prices plays out over several years but is potentially several times larger than the initial price impact. The 2003 tax cuts were larger for dividend income (from 38.6% to 15%), than for capital gains income (20% to 15%); tax rates on interest income were unchanged. The positive impact on a stock's value will be greater the more profitable the company is, the greater percentage of equity rather than debt on its balance sheet, the greater its payout rate, and the greater its duration (a stock with a greater duration is more sensitive to changes in cost of capital).

In 2003, U.S. companies were poorly structured to benefit from the changes. Decades of high tax rates on dividends prompted managers to reinvest profits and hoard cash for acquisitions rather than pay out dividends regardless of the company's prospects. Meanwhile, deductible interest payments had encouraged managers to finance companies with debt instead of equity, which reduced profits and increased bankruptcy risk. According to the American Shareholders Association, the number of S&P 500 companies paying dividends fell from 469 in 1980 to 351 in 2002. By 2002 the S&P 900 large- and mid-cap companies paid out just 53% of profits, and financed companies with only 27% equity and 73% debt.

Once tax rates were cut in 2003, managers quickly learned they could profit from lower tax rates by restructuring balance sheets. Companies like Nextel issued equity to buy back debt. Other companies, like Microsoft, initiated new dividends and cleaned out their cash hoards through one-time special dividends. Most increased dividend payout ratios: Dividend payments received by shareholders have doubled since the tax cuts.

As companies, one by one, made these changes, their equity values increased further. But changing capital structure takes time, one reason I believe equities will enjoy strong returns for years if tax rates remain low.

We need permanent tax cuts, not temporary extensions, to fully realize these benefits. Managers do not make decisions about leverage and dividend payouts lightly; they will do so only if they believe tax rates will remain low. But Congress gives them temporary rate cuts and temporary extensions in order to comply with the bizarre Congressional budget scoring ritual.

Equities are a long-term investment. Based on our estimates, the duration of the S&P 500 is over 22 years. Each of the first five years of expected free cash flow determines only about 5% of the stock market's intrinsic value. That means 90% of the value of the stock market depends on expected after-tax profits after year two, the date when tax cuts are currently scheduled to expire. We need to make tax cuts permanent for them to be fully reflected in stock prices.

Congress could adopt the two-year extension in the House bill and keep the recovery strong and net worth growing. Better still, they could make current tax rates permanent, which would encourage managers to speed up restructuring activities, accelerate stock-market gains, reduce cost of capital and increase capital spending. Best, they should end double taxation by making both dividend and capital-gains tax rates permanently zero.

America enjoys the highest living standard in the world because American workers enjoy the use of the largest and most advanced stock of tools in the world. But tools are mobile, workers are not. While America continues to double-tax capital income through dividend and capital gains taxes, China, India, and other countries are aggressively competing for American capital with investor-friendly policies. When the capital leaves, the paycheck goes with it. We can't afford to let that happen.

Mr. Rutledge is chairman of Rutledge Capital and president of Mundell International University School of Business in Beijing.

Capital Offense - WSJ.com

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http://dallasfed.org/research/indepth/2001/id0104.html

Other factors slowing investment

How important is the investment slowdown? It is very significant because investment has played a key role in the long expansion of the 1990s. Indeed, since 1993, the contribution of equipment investment to GDP growth—the bars—has hovered around 1¼ percentage points, which is remarkable given the smaller and more short-lived boosts from equipment investment in earlier expansions to the pace of overall GDP growth—depicted by the line. Today, information technology comprises about half of equipment investment, and its growth has been so rapid, that this component accounted for nearly all of equipment investment's contribution to GDP growth last year! Thus, only comprising about 5 percent of GDP, high-tech investment directly accounted for roughly one-third of overall economic growth in recent years!

Most recently, equipment investment has posted two consecutive quarters of decline, with computer and software investment falling last quarter for the first time since the Gulf-War recession. Partly as a result, GDP growth—depicted by the line—has slowed sharply.

The Impact on Consumers
The growth slowdown has also slowed consumption through several channels. First, falling stock wealth has likely curtailed spending, especially since more people own stocks. Second and more importantly, the profit slowdown has affected peoples' expected labor income as layoff fears have sapped confidence and retail spending. Job concerns have also been compounded by the fact that many households are over-extended on debt. Let me elaborate on each of these factors.

Between 1994 and 1999 overall U.S. stock prices roughly tripled in value and helped boost household net worth a great deal, as household wealth rose from around 2½ times the size of disposable income to roughly 4¼ times the size of income. At the same time there was a sizable decline in the personal savings rate as many households felt less need to save for their retirement, future downturns, their children's education, or their heirs. Indeed if we correct the measured savings rate for technicalities regarding capital gains, there is a notable negative correlation between the savings rate and the wealth-to-income ratio. However, following the stock price gains of the late 1990s, overall stock prices, as measured by the Wilshire 5000, fell by roughly 25 percent between the first quarters of 2000 and 2001, with the value of equities directly and indirectly held by households falling by roughly 4 trillion dollars. This has raised concern that a negative stock market wealth effect could slow consumption spending considerably.

Some analysts have raised doubts about the stock wealth effect on consumption, pointing to instability, over different time periods, in estimates of its size. However, conventional models do not account for the increased share over time in the share of households owning stocks, partly because ownership data are not available on a regular basis needed for estimating models. As shown in Figure 7, stock ownership rates, the bars, have nearly doubled since the 1970s, owing to a rise in indirect ownership through mutual funds. This rise from about ¼ to ½ of households is associated with a huge decline in loads on equity mutual funds, the solid line, from nearly 8 percent of one's initial investment to 2½ percent. Loads have fallen owing to declines in computer processing costs and economies of scale in the very competitive mutual fund industry. The large drop in loads removed a big barrier to stock ownership for small investors, for whom mutual funds were the only feasible way to own a diversified portfolio of stocks. Unlike the infrequent ownership rate data, the load series that I have constructed is available on a frequent enough basis to estimate models.

Using mutual fund loads to proxy for the rise in stock ownership yields more reliable estimates of stock wealth effects which impact consumption to a modest degree over long periods of time. Reflecting the rise of stock ownership rates, my model estimates that this effect is stronger than a decade ago but is roughly 40 percent smaller than the estimates from many conventional models.

In viewing the impact of the recent 25 percent market correction, we should not forget that household stock wealth is still much higher than it was in the mid-1990s and that wealth effects have a more drawn-out and less abrupt impact on consumer spending than do income effects. According to my findings, the wealth gains posted between 1994 and 1999 bolstered consumption by roughly 3½ percentage points, but that the correction since then has cut this boost to around 2½ percentage points. Thus, despite the recent correction, the sizable stock wealth gains from the last half of the 1990s that still remain will likely continue to bolster consumer spending for some time. It's just that the correction will likely reduce the medium-term boost from earlier stock market gains to consumption by roughly 1 percent and the boost to GDP by 0.6 percent. This effect, while notable, is far smaller than many people fear.

Stock wealth effects on consumer spending

At the other extreme, some analysts dismiss the stock wealth effect, pointing to the fact that consumption held up well after the 1987 crash. However, 2001 differs from 1987 in three ways. First, stock prices rose over a five-year period, long enough to affect people's perceptions of long-run wealth and their spending. By contrast, stock prices surged and then fell within a one-year period in 1987. Thus, swings in stock prices back then were too short-lived to have much impact on spending. Second, a higher share of people own stocks today. Third, the 1987 crash largely reflected a short-lived swing in sentiment that was not linked to long-run expectations about the economy. By contrast, the rise of high tech had fueled the boom of the late 1990s, and thus, recent high-tech woes have hit both wealth and expected labor income.

This is evident in consumer confidence indexes from the Conference Board's survey of households. Overall confidence was very high in the late 1990s, before falling to more normal levels recently. Some of this drop owes to declining stock wealth. But much of it is linked to people's expectations of whether there will be more versus fewer jobs six months ahead, with a negative reading indicating that people expect there will be fewer jobs. These more pessimistic expectations were borne out in last month's employment report, marked by payroll declines and rising unemployment. Declining wealth and a worsening employment outlook, which stem from doubts about the sustainability of the high-tech boom, have eroded consumer confidence, inducing a sharp slowdown in retail sales growth.

High debt service burdens are another drag on consumption. Payments on mortgage and consumer debt as a share of disposable income have approached the highs reached in the 1980s. However, these Federal Reserve Board estimates ignore auto leases, which have become more popular. Using some crude assumptions, I have tried to estimate the impact of leases. My lease-adjusted figures indicate that debt burdens have risen faster and to new highs. Fortunately, these high debt burdens will likely be cushioned by the recent surge in mortgage refinancings.

Some Good Economic News
A surge in mortgage refinancings is not the only piece of good economic news. There are several positive economic factors that I believe will help the economy avoid recession. One important piece of good news is that the debt-service burden on non-financial corporations is not high, as indicated by the ratio of net interest payments to profits. The run-up of leverage in the 1980s had saddled companies with heavy debt payments a decade ago. This led many firms to restrain investment spending to pay down debt, slowing economic growth in the early 1990s. In contrast, overall debt burdens are much lower today, meaning that firms have relatively more borrowing capacity to fund investment in the face of a near-term slowing in cash flow. Some companies, however, are having difficulties, as reflected in rising defaults on junk bonds, particularly among telecom and health care firms. Nevertheless, overall corporate debt burdens seem manageable.

Another positive factor is that our banks are healthy and able to provide financing during a period of slow growth. As Jeff Gunther pointed out in his February presentation to this board, banks are better capitalized and far fewer banks are deemed to pose problems than a decade ago. Another positive is that the Fed has eased quickly and aggressively, which has limited further downward pressure on asset values and has sparked a surge in mortgage and bond refinancing activity. Also bolstering future household finances are likely tax cuts, which should help cushion the drag from declining stock wealth over the medium- to long-run. Another positive is that car sales recovered from their collapse of late 1999, with auto inventories returning toward more normal levels. Nevertheless, car makers have had to offer very large incentives, which they may not be able to maintain. Finally, the worst of the energy price increases seem past us and inflation is under control.

More good news

Despite a fluky inflation number from the latest GDP report, which likely reflects seasonal adjustment problems, year-over-year inflation rates have flattened out. Inflation, as tracked by the broadest measure of consumer prices, the PCE index—the blue line in Figure 13—fell in 1998 before turning up in 2000, largely reflecting swings in energy prices. Most recently, broad consumer inflation appears to be abating as the worst of energy price increases have been put behind us. Especially encouraging is that core consumer inflation, which excludes food and energy prices, has remained very tame, as shown by the red line.

From a long-term perspective, it is remarkable that U.S. inflation rates are slower than those when the expansion began. In addition, a future inflation gauge for the U.S. has declined so much this year that it has more than reversed increases posted in 1999 and 2000. Future inflation gauges for other major economies also indicate waning price pressures. Together, past and prospective inflation performance give the Fed and other major central banks credibility and substantial room for maneuver. In particular, monetary authorities can lower short-term rates to stave off a recession without rekindling fears of inflation that would push up long-term interest rates and prevent us from stimulating the economy.

What Should We Watch?

May 2001 - In Depth - FRB Dallas

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WSJ-¡Extraordinario! Jude Wanniski describe como Wall Street en 1929 fluctuó con las discusiones de la propuesta Smooth Howley, que llevaría al mayor aumento de aranceles de la historia: Cada vez que parecía que ley sería rechazada, los mercados repuntaban, cada vez que parecía que sería aprobada, los mercados caían: El derrumbe total ocurrió cuando los senadores opositores a Smoot Howley admitieron que ya no podían detener la ley.

El texto de Jude Wanniski que adjunto, publicado en el Wall Street Journal (WSJ), es simplemente uno de los textos más extraordinarios que jamás he leído. He leído incontables estudios sobre la Gran Depresión, todos me han parecido poco convincentes.

Wanniski señala que ni monetaristas (Friedman et al) ni keynesianos (Keynes et al) entendieron bien el derr

Primero se dieron "los increíbles 1920s". ¿Qué ocurrió allí? Una colosal disminución de impuestos: Después de la guerra, las tasas eran elevadísimas: Warren Harding obtuvo una victoria sin precendentes en ese momento, prometiendo recortar los enormes impuestos que se habían impuesto durante la guerra.

Wanniski explica como las noticias que más impactan a los mercados son los cambios en las políticas públicas: Los aumentos de impuestos pueden llevar a las empresas a la quiebra, las reducciones de impuestos pueden mejorar la situación de muchas.

Parece que lo que ocurre es que si el gobierno propone un aumento de impuestos, muchos empresarios llaman a expertos en el tema (gente de KPMG, por ejemplo), para que analice el impacto de la propuesta tributaria en las empresas.

Pues parece claro que en 1929 entre los empresarios reinaba la impresión de que la ley Smoot Howley, el mayor aumento de impuestos de aduana de la historia, sería una debacle para la economía estadounidense.  

Wanniski decribe cómo cuando la ley parecía ser aprobada, los mercados se derrumbaban. Inclusive habla del famoso 

P

Par

Si el gobierno por ejemplo propone un plan fiscal, algunos empresarios llaman a expertos contables (gente de KPMG, por ejemplo), para que evalúen el impacto de la ley. Parece que los análisis 

http://www.wanniski.com/showarticle.asp?articleid=4091

Wanniski.com

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La falacia keynesiana de la demanda agregada.

Esto es lo que he entendido de la teoría keynesiana que he estudiado en el libro Macroeconomía de Robert J. Barro.

La teoría keynesiana dice que los precios son "viscosos" a la baja, en otras palabras, que se mantienen largo tiempo sin reducirse. Parece muy difícil que eso sea así. Hace unos días Roy Jiménez envió a este foro un verdadero tratado, escrito por él, en donde explicaba cómo cambiaban los precios en la feria del agricultor de Tibás, dependiendo de varios factores como lluvia, partido de fútbol anunciado, etcétera.  También he visitado ferias del agricultor y, en mi humilde opinión, lo que Roy dice se apega totalmente a la realidad:  Así funcionan los precios, los precios se reducen y aumentan en cualquier mañana de feria del agricultor. Puede alegarse, por supuesto, que los precios en las ferias del agricultor bajan, pero que hay precios que no bajan. De acuerdo. Quisiera saber cuáles precios.

Friedman había señalado que las cantidades son físicas, generalmente no se pueden variar, pero los precios son acuerdos de voluntad, que se pueden variar en un santiamén: Si un tramero tiene 100 kilos de tomate a punto de podrirse, no puede transformarlos en procesadores de computadora, no le queda más que bajar el precio para que el tomate no se pudra. Si refrigera el tomate, el costo de refrigerarlo es muy elevado. Inclusive, cuando el precio es bajo, a veces los tomateros ni siquiera recogen la cosecha y la dejan que se pudra en las matas.

El tomatero puede, en un santiamén, bajar el precio que pide, pero no puede transformar los tomates en microprocesadores. Por eso, a menos que el gobierno le prohiba al tramero bajar los precios, algo que muchos gobiernos hacen, el tramero puede bajar los precios. 

Explico con un ejemplo concreto lo que entiendo que dice la teoría keynesiana. Supóngase que los neurocirujanos ganan $100 por hora y los trabajadores de la construcción ganan $5 por hora. Si a los trabajadores de la construcción se les ocurre aumentar su precio a $100 por hora, simplemente se van a quedar sin trabajo. Un trabajador de la construcción a $5 por hora puede conseguir trabajo para 50 horas semanales. A $100 por hora, tal vez 1 hora semanal, o media hora, o ninguna hora.

Si alguien tiene un tumor cerebral, va a conseguir dinero de cualquier manera, aunque se endeude para el resto de su vida, y va a pagar $100 por hora a un neurocirujano para que le extripe el tumor cerebral. Pero es evidente que si los trabajadores de la construcción cobran $100 por hora, lo que ocurriría es que, o bien la abrumadora mayoría acabamos viviendo en pocilgas, o bien acabamos construyendo nuestras propias casas. Pero que paguemos a todos los trabajadores $100 por hora, 50 horas cada semana, eso no va a ocurrir.

No va a ocurrie simplemente porque no existe el poder de compra para pagar 50 horas diarias a los trabajadores de la construcción a $100 por hora. Con costos se paga $100 por hora a los neurocirujanos. Si el kilo de arroz cuesta $5, una hora de trabajo de un trabajador de la construcción representa 1 kilo de arroz, una hora de trabajo de un neurocirujano representa 20 kilos de arroz. Si el asunto se ve de esa manera, pagar $100 por hora significa pagar 20 kilos de arroz por cada hora de trabajo de un constructor, en vez del kilo de arroz por hora que se paga antes de que los constructores aumentaran los precios ¿de dónde van a salir los millones de toneladas de arroz necesarios para pagar 20 kilos de arroz por cada hora de trabajo a los trabajadores de la construcción? Si el gobierno, a través de su gasto, quiere lograr que los trabajadores de la construcción ganen 20 kilos de arroz por hora, tiene que quitarle a alguien esos 19 kilos adicionales por hora. El gobierno no tiene una fuente mágica de arroz.

Esos trabajadores son "capacidad ociosa". Y esa capacidad ociosa por la simple y sencilla razón de que se les ocurre cobrar un precio exorbitante, insufragable, incosteable.

El gobierno puede imprimir dinero de la nada, de forma a degradar la moneda hasta que 1 kilo de arroz valga $100. De esa manera es posible pagar $100 a cada trabajador de la construcción. Pero se seguiría pagando 1 kilo de arroz por hora, y el neurocirujano ganaría algo así como $2000 por hora. Pero eso no es aumentar la "demanda agregada", eso es degradar la moneda hasta que los precios nominales disminuyan.

Pero el gobierno puede aumentar los incentivos para trabajar, de manera que la producción aumente por un tiempo. Si el gobierno imprime dinero, las personas se encuentran con más dinero en sus manos. El arrocero se va a encontrar con que aumenta la demanda de arroz. 

. Friedman describió el proceso: Si el gobierno empieza a imprimir más moneda, por un tiempo las personas creen que lo que producen vale más. El productor de arroz  

Entiendo que la teoría keynesiana alega que en ese caso es la "demanda agregada" la que determina el esfuerzo laboral: Si se aumenta la "demanda agregada", se puede poner a ¿todos? los trabajadores de la construcción a trabajar 50 horas semanales ganando $100 por hora.

La primera falacia es que no puede haber demanda sin oferta. Yo, muy gustoso, demando un jet privado, un Ferrari y un yate de $20 millones. Pero no tengo qué ofrecer a cambio de esos lujos asiáticos. Si llego a una venta de yates privados en mi Toyota 1991, los vendedores ni siquiera me van a atender. Se van a reír y van a decirse entre ellos  "este carajo es un limpio, ni perdamos el tiempo en atenderlo".

En otras palabras, yo no puedo demandar un yate de $20 millones porque no puedo ofrecer a cambio algo que vale $20 millones. No hay demanda sin oferta. Sí puedo demandar un kilo de arroz en la pulpería, porque tengo 700 colones en el bolsillo que el comerciante va a aceptar a cambio de un kilo de arroz.

 El problema del keynesianismo es ¿cómo se va a aumentar la demanda agregada para que sea posible pagar a los trabajadores de la construcción $100 por hora? 

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Paul Krugman miente para intentar ocultar el fracaso del keynesianismo y el triunfo del "Supply Side Economics" -  Donald Luskin

Los fracasos del keynesianismo son contundentes: 100 trillones de gasto keynesiano en el Japón, y el Japón se mantuvo en la recesión- depresión ocurrida después de los aumentos de impuestos. La recesión duró 66 meses (ver, de Rserva Federal de Dallas). Krugman dice que si se aplicaran las políticas que él pregona, el problema se habría resuelto. Pues, según Benjamín  Powell (ver http://www.mises.org/fullstory.aspx?control=1099 y Referencias), no solamente se aplicaron en el Japón las políticas que recomienda Krugman, además de otras políticas keynesianas, sino que, cuando se aplicaron las recomendaciones de Krugman, el Japón experimentó dos de los años más negativos de la década de los 1990s.

Krugman offers another policy solution. Because New Keynesians do not strictly prefer fiscal policy over monetary policy, Krugman recommends "unconventional monetary expansion, with the Bank of Japan buying dollars, euros, and long-term government bonds; it also involves accepting and indeed promoting mild inflation and a weak yen. I could explain why this would probably work, but what's the point? It's not about to happen" (Krugman 2001). Krugman should not think that this could not happen, because it is similar to what occurred from mid-1997 to mid-1998, and this approach did not work. During that period the BOJ's holding of commercial paper went from zero to $117 billion (Herbener 1999, p. 14).

The Ministry of Finance and BOJ both bought government bonds from private holders increasing the amount the government owned to $2.22 trillion, which is 53 percent of the market for government bonds, while at the same time promoting a weaker yen (Herbener 1999). The Japanese economy was not stimulated out of its recession but instead experienced the two most negative years of GDP growth in the decade.

Parece que Krugman no puede aceptar que los recortes de impuestos de Reagan fueron un éxito y, según Donald Luskin, Krugman ha llegado hasta a la mentira para tratar de ocultar el éxito de las políticas de Reagan, y el fracaso de las políticas keynesianas.

Por ejemplo, Krugman señala que Reagan no tuvo méritos, que el éxito de Reagan se debió simplemente a que la economía por sí sola salió de la recesión, porque la economía estaba tan mal antes de Reagan, que había mucho "campo para crecer". Pero, parece que el Sr Krugman ni siquiera es capaz de usar lógica elemental para darse cuenta de las consecuencias lógicas de las afirmaciones que hace, para quitar mérito a Reagan. Si eso es así, entonces los personajes idolatrados por Krugman, Keynes y Roosevelt, tampoco tuvieron ningún mérito en acabar con la gran depresión, porque la gran depresión fue sin duda una depresión muchísimo más grave que la que ocurrió antes del gobierno de Reagan, y entonces después de la gran depresión la economía tuvo todavía mucho más "campo para crecer". Pero las cosas van más lejos, si el segundo período de Clinton fue "milagroso", como señala Krugman, entonces no se puede alegar que el éxito en crecimiento después de los recortes de impuestos de Bush del 2003 se debió a que habia "mucho campo para crecer", puesto que precisamente se salía del "milagroso" período de Clinton. Por otra parte, los tengo cansados de tanto hablar de los recortes de impuestos de 1997 (segundo período de Clinton), y parece que éstos tampoco existen para Krugman.

Falta analizar otra afirmación de Krugman, que el Japón vive un "glut de ahorro". A primera vista, parece haber ocurrido que después de los brutales aumentos de impuestos a las ganancias de capital y otros impuestos en 1989, el capital empezó a huir del Japón hacia otros rumbos, por ejemplo a China. El superávit de cuenta corriente del Japón, la alta inversión extranjera directa de japoneses en China, después de los aumentos de impuestos, son consistentes con una huida de capital del Japón. La caída en el crecimiento de la producción japonesa es consistente con la idea de que el capital se fue del Japón, es el capital quien permite aumentar la producción, Alesina, Ardagna, Perotti y Scianterelli claramente señalan la estrecha relación entre inversión (formación de capital productivo) y producción. Pues Krugman habla de un "glut de ahorro" en el Japón.

Pienso que, al tratar de defender una teoría en bancarrota intelectual como el keynesianismo, el Sr Krugman queda en el ridículo ante mucha gente. 

Por otra parte, existen recortes de impuestos keynesianos, que buscan simplemente poner más dinero en los bolsillos de la gente (aumentar la "demanda agregada")  y recortes de impuestos de "Supply Side Economics", que lo que buscan es aumentar la producción al aumentar los incentivos para trabajar, llevando a las personas a producir más, y que además buscan convertir en rentables actividades que con impuestos más altos no serán rentables. En el 2001 en los EE.UU. se hicieron recortes de impuestos keynesianos, y en el 2003 se hicieron recortes de impuestos de "Supply Side Economics". Los primeros no lograron casi nada, los últimos fueron un éxito rotundo. Puede leerse más sobre el tema en 

Referencias

Artículo de Donald Luskin

http://www.nationalreview.com/nrof_luskin/kts200406141035.asp

Donald Luskin

June 14, 2004, 10:35 a.m.
That Old Hack Magic
Krugman goes mystical in his latest attack on the Reagan record.

Paul Krugman is living his worst nightmare. Last week, the world poured out its admiration for Ronald Reagan and his extraordinary economic record — forcing Krugman to attempt to explain away Reagan’s success. But how to do so? According to the economic theories Krugman teaches at Princeton, Reagan’s achievement should not have been possible. So dismissing Reaganomics in terms of science won’t work. How about professing economics as a cargo cult?

Reagan, it seems, deserves no credit for the courage, insight, and political skill he used to pull America out of a deadly tailspin. The tailspin itself deserves all the credit. Human action counts for nothing. Presidents are but twigs floating on the tides of economic fate.

Unfortunately for Krugman, this mystical interpretation of economic history has several inconvenient corollaries. We’d have to use it to discredit the economic achievement of Krugman’s idols Franklin D. Roosevelt and John Maynard Keynes. After all, in the Great Depression there was “plenty of room to grow.” And, of course, we’d have to let Krugman’s bête noir George W. Bush off the hook for the recession and jobless recovery that Krugman is always ranting about. After the Clinton “miracle” there just wasn’t “plenty of room to grow.”

True, Krugman’s fatalism should make the economy as easy to predict as when the moon is in the second house and Jupiter aligns with Mars. Indeed, in Friday’s column Krugman claims a victory for his favorite flavor of economic astrology. He writes that “it all played out just as ‘left-wing Keynesian economics’ predicted.”

But to anyone who knows even the slightest thing about the history of economics, this statement is a laughable lie. The truth is that the “stagflation” of the 1970s — the combination of high inflation and low economic growth — utterly confounded the Keynesian orthodoxy, which would have predicted that such a combination was utterly impossible. Then in the 1980s the Keynesian model predicted that the combination of falling interest rates and Reagan’s tax cuts should have created a massive stimulus to aggregate demand that would send inflation even higher. Yet inflation fell dramatically over the 1990s.

Honorary Krugman Truth Squad member Caroline Baum pointed me to a classic smoking-gun memo that tells us exactly what Krugman’s “’left-wing Keynesian economics’ predicted.” In November 1982, when Krugman was a staff economist in Reagan’s Council of Economic Advisors, he co-authored with Larry Summers (later to be Clinton’s Treasury secretary) a memo warning of a coming “inflation time bomb.” Krugman and Summers wrote, “It is reasonable to expect a significant reacceleration of inflation in the near future … A significant portion of the slowing of consumer price inflation since 1980 does not represent a reduction in the underlying rate.”

At that point inflation had fallen from a maximum of 14.6 percent in March 1980 to 4.5 percent. Its average for the rest of Reagan’s presidency was 3.5 percent. The “inflation time bomb” Krugman predicted didn’t go off. It still hasn’t.

With less-than-stellar predictions like that — based on “left-wing Keynesian economics” — Krugman didn’t last long at the Counsel of Economic Advisors. But did he fall, or was he pushed? All we know is that he has written of his time in Washington that “many powerful people prefer to take advice from those who make them feel comfortable rather than from those who will force them to think hard. … so I was not tempted to stay on in Washington.”

In Friday’s column Krugman not only lies about his own incorrect predictions — he lies about his ideological opponent’s entirely correct ones. He says that Reagan’s “supply-side advisers … promised, but failed to deliver, a sustained acceleration in economic growth.”

Let’s just look at the record. Using official National Bureau of Economic Research business-cycle dates (and not making up our own to flatter our case like Krugman does), the Reagan boom that began in November 1982 lasted 92 months — making it the second-longest expansion on record. But it didn’t stop there. After pausing for a brief recession of eight months, the economy took off again on an expansion that ended up lasting 120 months — an all-time record.

One way to see it is that Reagan set in motion a period of prosperity that lasted 220 months with only an eight-month break in the middle. Or you could even say it’s still going on. After another eight-month hiatus, the boom is back — inspired by the same combination of falling inflation and tax-cutting that marked the Reagan years (and that still utterly befuddles the precepts and predictions of “left-wing Keynesian economics”).

But in Friday’s column, Krugman specifically dismisses the idea that Reagan’s economic policies could have possibly contributed anything to the “Clinton-era miracle.” He didn’t say whether or not they contributed to the present Bush boom — because that’s a subject Krugman doesn’t like to draw attention to (although he admitted en passant in an article last week in the New York Times Magazine that “the recovery has finally started to look like the real thing”).

Considering that Krugman can only conceive of the prosperity during the Clinton administration as a causeless “miracle” — he even admitted in a television interview earlier this year that it occurred “for reasons we’re not clear about” — it seems illogical to be so sure that Reagan had nothing to do with it. A more scientific approach would be to quote Isaac Newton, the father of modern science, who said, “If I have seen further it is by standing upon the shoulders of giants.”

I’m certain Ronald Reagan would not have been hesitant to say that the era of tax-cutting began with the 1964 “Kennedy tax cuts,” which reduced the top individual income-tax rate from 91 percent to 70 percent and accelerated a boom that lasted even longer than the one ignited by Reagan’s tax cuts. So why would an honest liberal be hesitant to admit that Clinton not only built his period of prosperity on the foundation that Kennedy and Reagan had laid, but indeed borrowed their methods when it suited him? Yes, Clinton raised income taxes in 1993. But he cut taxes with the Tax Relief Act of 1997, including a sharp cut in the capital-gains tax. In his Friday column Krugman notes that Clinton’s “miracle” didn’t happen “until Bill Clinton’s second term,” yet he misses the obvious connection.

With Reagan’s accomplishments now more widely honored than ever, Bush’s economy booming, and Bush himself rising in the polls, Krugman is being revealed for what he really is: A frightened man unable to explain the phenomena in the world around him except as “magic” and “miracle”; a man now stripped even of his usual pretense of economic pseudo-science.

— Donald Luskin is chief investment officer of Trend Macrolytics LLC, an independent economics and investment-research firm. He welcomes your comments at don@trendmacro.com.

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Extracto de "Explaining Japan´s Recession", de Benjamin Powell.

http://www.mises.org/fullstory.aspx?control=1099

Explaining Japan's Recession

By Benjamin Powell

After decades of "miracle" economic growth since World War II, Japan's economy abruptly faltered in 1990 and has stagnated since. Why? Neither the Keynesian nor Monetarist explanations can provide an account. Only the Austrian theory of the business cycle provides the explanation.

An Overview of Japan's Economy 1985–2000

After the September 1985 Plaza Accord, the yen's appreciation hit the export sector hard, reducing economic growth from 4.4 percent in 1985 to 2.9 percent in 1986 (EIU 2001).1 The government attempted to offset the stronger yen by drastically easing monetary policy between January 1986 and February 1987. During this period, the Bank of Japan (BOJ) cut the discount rate in half from 5 percent to 2.5 percent. Following the economic stimulus, asset prices in the real estate and stock markets inflated, creating one of the biggest financial bubbles in history. The government responded by tightening monetary policy, raising rates five times, to 6 percent in 1989 and 1990. After these increases, the market collapsed.

The Nikkei stock market index fell more than 60 percent—from a high of 40,000 at the end of 1989 to under 15,000 by 1992. It rose somewhat during the mid-1990s on hopes that the economy would soon recover, but as the economic outlook continued to worsen, share prices again fell. The Nikkei fell below 12,000 by March 2001. Real estate prices also plummeted during the recession—by 80 percent from 1991 to 1998 (Herbener 1999).

Real GDP during the 1990s stagnated, rising only from 428,826 billion yen in 1990 to 469,480 billion yen by the end of 2000.2 Growth has been negative since 1998. The unemployment rate rose from 2.1 percent in 1991 to 4.7 percent at the end of 2000. Although the unemployment rate may seem low by international standards, the rise to 4.7 percent is significant in Japan, given the cultural and historical precedent of lifetime employment and given that it was never above 2.8 percent in the 1980s. The official unemployment rate is also biased downward because the Japanese government offers "employment adjustment subsidies" to companies that maintain employees as "window sitters" (Herbener 1999).

The Keynesian Explanation and Solution

In Keynesian macroeconomic theory, business cycle fluctuations are caused by aggregate demand collapsing. Consumption is regarded as relatively stable, so the weakening in aggregate demand is due to the declining investment. Keynes did not precisely explain why investment collapsed; instead he attributed it to "animal spirits" in the business community. If the 1980s asset bubble is ignored, and Japan's stock market is viewed between 1989 and 1992, a massive withdrawal of confidence occurred in the business community and investment collapsed, causing the Nikkei index to fall more than 60 percent. Because the investment decline is not attributed to something specific in Keynesian theory, the theory is difficult to refute. Nevertheless, in Japan, there has been a recession that has not corrected itself following a drop in investment.

In Keynesian theory, prices are "sticky" or rigid in the downward direction, so they do not adjust quickly to restore equilibrium. Although the economy might eventually restore its equilibrium, equilibrium is not inevitable. Even if price adjustments eventually restore equilibrium, Keynesians believe that the process requires too much time. According to Keynesians, to recover from recession, government must pursue active fiscal policies by lowering taxes and raising spending to increase aggregate demand and offset the fall in investment. Keynesians usually prefer increased government spending. Many of the policies in Japan fit the Keynesian prescription, but they have failed to bring the economy out of recession.

Between 1992 and 1995, Japan tried six spending programs totaling 65.5 trillion yen and cut income tax rates during 1994. In January 1998, Japan temporarily cut taxes again by 2 trillion yen. Then, in April of that year, the government unveiled a fiscal stimulus package worth more than 16.7 trillion yen, almost half of which was for public works. Again, in November 1998, another fiscal stimulus package worth 23.9 trillion yen was announced. A year later (November 1999), yet another fiscal stimulus package of 18 trillion yen was tried. Finally, in October 2000, Japan announced yet another fiscal stimulus package of 11 trillion yen. Overall during the 1990s, Japan tried 10 fiscal stimulus packages totaling more than 100 trillion yen, and each failed to cure the recession. What the spending programs have done, however, is put Japan's government in poor fiscal shape. The "on-budget" government spending has caused public debt to exceed 100 percent of GDP (highest in the G7), and even more debt is apparent when the "off-budget" sector is included.

The Keynesian framework permits a liquidity trap in which shifting the LM curve has no effect on aggregate demand. Keynesians can point to failed attempts by the Bank of Japan to reinflate in order to revive its economy (see monetarist section below) as evidence supporting their theory.

The Keynesian policy solution when the economy is in a liquidity trap is to have the government lend directly to businesses instead of creating liquidity in the banking system. Japan has the Fiscal Investment and Loan Programme (FILP), an off-budget branch of the Japanese government worth about 70 percent of the spending in the general-account budget. FILP gets most of its money from the post office savings accounts. Once they collect the money, the funds are allocated to borrowers through the Ministry of Finance Trust Fund Bureau and the bureau's various agencies. Much of this money is not allocated to the most efficient projects.

Politicians in the Liberal Democratic Party (LDP) run most of these government agencies. The Economist Intelligence Unit profile states that "FILP money is channeled toward traditional supporters of the LDP, such as those in the construction industry, and without proper consideration of the costs and benefits of specific projects" (EIU 2001, p. 30). Although this Keynesian approach of government direct-lending does avoid the reluctance of banks to lend, it does not aid economy recovery. Funds are not allocated according to market-based consumer preferences, but to the most politically connected businessmen. This leads to a higher cost of borrowing for those seeking private funds, further distorting the economy. Also, because the loans are often highly risky, Japan's fiscal condition deteriorates further. Once FILP and other "off-budget" debts are included, Japan's debt is estimated to exceed 200 percent of GDP (EIU 2001).

One prominent New Keynesian, Paul Krugman, recently recognized that,

Japan's postal savings system which channels money into public works projects that have little if any social payoff, is monumentally inefficient; so is the practice of rolling over the debts of companies that will never regain profitability and hence keeping capital employed producing what nobody wants. (Krugman 2001)

Krugman argues that this is not a problem as long as Japan is not producing at capacity. He says that to assert otherwise is erroneous because the focus on supply ignores the real problem: inadequate demand. Japan's problem, however, is not inadequate aggregate demand but a structure of production that does not meet consumers' particular demands. Producing things that nobody wants and propping up malinvestments cannot possibly help any economy. This policy is equivalent to the old Keynesian depression nostrum of paying people to dig holes and fill them. Neither policy will revive the economy because neither forces businesses to realign their structures of production to match consumer demands.

Krugman offers another policy solution. Because New Keynesians do not strictly prefer fiscal policy over monetary policy, Krugman recommends "unconventional monetary expansion, with the Bank of Japan buying dollars, euros, and long-term government bonds; it also involves accepting and indeed promoting mild inflation and a weak yen. I could explain why this would probably work, but what's the point? It's not about to happen" (Krugman 2001). Krugman should not think that this could not happen, because it is similar to what occurred from mid-1997 to mid-1998, and this approach did not work. During that period the BOJ's holding of commercial paper went from zero to $117 billion (Herbener 1999, p. 14).

The Ministry of Finance and BOJ both bought government bonds from private holders increasing the amount the government owned to $2.22 trillion, which is 53 percent of the market for government bonds, while at the same time promoting a weaker yen (Herbener 1999). The Japanese economy was not stimulated out of its recession but instead experienced the two most negative years of GDP growth in the decade.

Krugman's policy recommendations are a result of his belief that Japan is in a liquidity trap. Although Krugman recognizes the problems in Japan's banking system and thinks that the banks need to be reformed, he believes the failure of broad monetary aggregates to expand along with narrow aggregates is not due to the banking problems but is occurring because Japan is in a liquidity trap. Although he recognizes that current inflation is ineffective in a liquidity trap, he thinks the major obstacle is a credibility problem. If the central bank could credibly promise to continue to inflate in the future, Japan would be able to increase the aggregate demand and revive its economy. He recommends passing a law requiring the central bank to pursue at least 4 percent inflation rates for 15 years (Krugman 1998).3

Central banks, however, do not have a credibility problem when promising to inflate. The history of central banks is one of continual inflation of the money supply and erosion of their currency's purchasing power.4 Japan's government debt, in excess of 100 percent of GDP, makes any policy announcement to inflate all the more credible, because inflation reduces the burden of the debt that must be paid back. Indeed, given the history and incentives of central banks, the Japanese people should already rationally expect Japan to continue to inflate its money supply in the future, regardless of policy announcements.

Krugman's policy recommendations would only make Japan's problems worse. Any fiscal stimulus package only serves to maintain the existing structure of production against the preferences of consumers. Even worse, a policy of continual inflation only distorts the interest-rate signal from consumers to businesses and results in more malinvestments that will eventually have to be liquidated (see section on Austrian theory below).

While Keynesian theorists could plausibly point to evidence that the source of Japan's recession is consistent with their theory, many Keynesian policies have failed to revive Japan's economy. Massive spending and lending packages have been tried over the past decade. By focusing on aggregate demand, Keynesian theory overlooks Japan's real problem: a mismatch between the existing structure of production and consumers' specific demands. The Keynesian spending programs have not only failed to pull Japan out of its recession, but they have also placed the government in a weak fiscal position and distorted the economy further away from consumer preferences.

The Monetarist Explanation and Solution

The Monetarist School, like the Keynesian, has no trouble finding a cause for Japan's recession. Monetarists blame recessions on a contraction in the money supply or a slowdown in the growth rate. In 1987 the discount rate was lowered to 2.5 percent to stimulate domestic demand. An asset price bubble followed. To stop the bubble, the discount rate was raised five times, to 6 percent during 1989 and 1990, slowing lending, and the bubble burst. Since the monetary contraction, Japan's economy has been in a recession. Monetarists can argue that the BOJ contracted the monetary expansion too quickly and caused the economic slowdown, much like Milton Friedman's story in the Great Contraction regarding America's Great Depression.

Traditionally, monetarists have recommended reinflating after a monetary collapse to avoid a continuing depression. Monetarists recommend this because they have traditionally viewed the LM curve as relatively steeply sloped and the IS curve as flatter. This branch of monetarism has seen its policies implemented and fail in Japan.

Japan's expansionary monetary policy failed to achieve recovery. From a high of 6 percent, the discount rate has been lowered to 4.5 percent in 1991, 3.25 percent in 1992, 1.75 percent during 1993–1994, and 0.5 percent during 1995–2000. This dramatic easing of interest rates has not stimulated Japan's economy, but the failure of interest-rate easing is not necessarily a failure of monetary theory. Japan's banking system is widely regarded as in need of restructuring. Much of the stimulus that reduced rates could provide has not been realized because the banking community has been increasing its liquidity instead of increasing its lending. Many banks have bad loans with collateral now worth only 60–80 percent of their value when the loans were made. Some banks are merging, and others have been nationalized. Such problems have contributed to the ineffectiveness of monetary policy.

Some monetarists argue that interest rates should be ignored and that the money supply itself must be controlled. Milton Friedman has advocated a monetary rule of expanding the money supply at an annual rate of 3–4 percent. During the 1990s, the Japanese money supply grew steadily. M2 grew from 507,526 billion yen in 1991 to 629,664 billion yen in 2001, an increase of about 25 percent over the decade, or 2.5 percent a year. Monetarists who advocate a monetary rule would likely point out that Japan should have been following a monetary rule before the recession. The rapid expansion and then contraction of the money supply, the monetarists would claim, caused the asset bubble and its subsequent bursting.

Controlling the money supply can be difficult, especially in view of the condition of Japan's banking system. From mid-1997 to mid-1998 Japan increased its monetary base by 10 percent, but the broader monetary aggregates rose by only 3.5 percent (Herbener 1999). This is what Keynesians mistakenly call a liquidity trap. The lack of credit expansion, even after expansion of the monetary base, is not due to investors expecting that future interest rates will rise, but is instead caused by the enormous amount of bad debt in the banking system that makes banks unwilling to lend (Herbener 1999).

In Japan's recession not all monetarist approaches can be dismissed as a complete failure like Keynesian theory can. However, monetarist policies have not helped Japan out of recession.

The Austrian Explanation and Solution

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Puesto al día: 11 de diciembre del 2007