Friday, October 2, 2009

Steve Keen Proves the People's Bailout Works Best

As I have been arguing all along, the only effective solution to debt deflation is cancellation of debt, and stimulus needs to go directly to the people, not to the banks. Perhaps Steve Keen cogitated over the comments I left on his blog, as he created a computer model to test the theory. Low and behold, his model proved the People's Bailout is correct: money given to banks is far less effective, even in theory, than money given directly to citizens.

As he puts it at his post’s-hard-being-a-bear-part-five-rescued/:

I’ve recently developed a genuinely monetary, credit-driven model of the economy, and one of its first insights is that Obama has been sold a pup on the right way to stimulate the economy: he would have got far more bang for his buck by giving the stimulus to the debtors rather than the creditors.

The model shows that you get far more “bang for your buck” by giving the money to firms, rather than banks. Unemployment falls in both case below the level that would have applied in the absence of the stimulus, but the reduction in unemployment is far greater when the firms get the stimulus, not the banks: unemployment peaks at over 18 percent without the stimulus, just over 13 percent with the stimulus going to the banks, but under 11 percent with the stimulus being given to the firms.

The time path of the recession is also greatly altered. The recession is shorter with the stimulus, but there’s actually a mini-boom in the middle of it with the firm-directed stimulus, versus a simply lower peak to unemployment with the bank-directed stimulus.

When a credit crunch strikes, the pipes pumping the bank reserves to the firms shrink dramatically, while the pipe going in the opposite direction expands, and all other pipes remain the same size.

If you then fill up the bank reserves reservoir—by the government pumping the extra $100 billion into it—that money will only trickle into the economy slowly. If however you put that money into the firms’ bank accounts, it would flow at an unchanged rate to the rest of the economy—the workers—while flowing more quickly to the banks as well, reducing debt levels.

So giving the stimulus to the debtors is a more potent way of reducing the impact of a credit crunch—the opposite of the advice given to Obama by his neoclassical advisers.

Obama has been sold a pup by neoclassical economics: not only did neoclassical theory help cause the crisis, by championing the growth of private debt and the asset bubbles it financed; it also is undermining efforts to reduce the severity of the crisis.

This is unfortunately the good news: the bad news is that this model only considers an economy undergoing a “credit crunch”, and not also one suffering from a serious debt overhang that only a direct reduction in debt can tackle. That is our actual problem, and while a stimulus will work for a while, the drag from debt-deleveraging is still present. The economy will therefore lapse back into recession soon after the stimulus is removed.


wraft said...

Steve Keen doesn't mention the possibility of the government printing fiat and mailing it to the households to pay off household debt. This is a solution advocated by Richard C. Cook who is a 'social credit' advocate. Cook recommends sending each US adult $1000/month and each family $750/month for children.

I have set up Keen's endogenous money model as a simple spreadsheet and studied the possibility of just printing counterfeit money and spending it at the household level. The money creation is at .05 to .10 of the GDP. The economy resumes its growth rate prior to the credit crunch and prices and wages don't skyrocket until near full employment is reached.

Justin said...

Thanks for the tip, I will read up on his theories and solutions.

wraft said...

You can study the endogenous money model of Keen with a debt overhang simply by creating an initial loan much greater than the firm's initial operating capital.

Prices and wages remain low for decades. Sort of like the Soviet Union, I suppose.