It’s easy to lose sight of the point of economics. Our civilization wide goal is to increase living standards for people, to make their lives easier and more enjoyable, to give people more quantity and higher quality real world goods, and allow people more leisure for the same amount of work.
This gets buried in the debates about economics. Our end goal is to increase real world living standards.
There were two articles this week which caught my eye on this topic. Matt Yglesias and Dani Roderick both had something to say about real living standards going up. First, Matt Y buries the lede in a post about a real loser:
“What matters for national prosperity is a) the availability and distribution of real resources and b) the capacity to mobilize those real resources. Public finance—the joint conduct of fiscal and monetary policy—is best seen as a tool of mobilization, rather than something to sweat in its own right.”
This is hard to remember in the talk about inflation, business cycles, investment, and the rest, but the only thing that really matters is national prosperity. Every thing else is secondary.
It really doesn’t matter what happens with the national debt, or with our monetary policy. These are tools we should use to get higher living standards.
The idea that Matt Y is talking about – that only real growth matters and everything else should be subordinate to achieving this goal – is known as Functional Finance. In functional finance, the major tools of government to influence the economy are used to get to full employment and a high level of demand.
There are 4 rules of functional finance:
1. The government shall maintain a reasonable level of demand at all times. If there is too little spending and, thus, excessive unemployment, the government shall reduce taxes or increase its own spending. If there is too much spending, the government shall prevent inflation by reducing its own expenditures or by increasing taxes.
2. By borrowing money when it wishes to raise the rate of interest and by lending money or repaying debt when it wishes to lower the rate of interest, the government shall maintain that rate of interest that induces the optimum amount of investment.
3. If either of the first two rules conflicts with the principles of ‘sound finance’ or of balancing the budget, or of limiting the national debt, so much the worse for these principles. The government press shall print any money that may be needed to carry out rules 1 and 2.
4. The government must establish policies which stabilize the price level and coordinate both the money supply rule and the aggregate total spending rule with this stable price level at the unemployment level it prefers.’
Compare these rules of functional finance to the dual mandate of the U.S. Federal Reserve:
“In 1977, Congress amended The Federal Reserve Act, stating the monetary policy objectives of the Federal Reserve as:
“The Board of Governors of the Federal Reserve System and the Federal Open Market Committee shall maintain long run growth of the monetary and credit aggregates commensurate with the economy’s long run potential to increase production, so as to promote effectively the goals of maximum employment, stable prices and moderate long-term interest rates.”
The dual mandate is to promote the goals of maximum employment and stable prices. This is not the same as maximizing real economic growth, or even the rules of functional finance. Additionally, many economists think the fed largely abandoned 1/2 of the dual mandate – that the fed abandoned the mandate of maximum employment for most of the last 30 years. Some Prominent economists are glad this is the case, and advocate for the goal of maximum employment to be abandoned explicitly.
Yet, these rules seem to be missing something. We know what works to make economies grow. Export Driven economies tend to do very well. Here is Dani Rodrick lamenting countries are de-industrializing too quickly.
Let’s be totally honest on how export driven economies work. These countries keep their currencies too weak, which gives their export markets an unfair advantage against products manufactured in the “host” country. They also set up a huge amount of informal barriers to imports, which make it difficult to penetrate their markets even if their currencies were fairly valued.
China has famously kept their currency too weak for many years with a strengthening target. Then, when a crisis hit, entirely froze the value of the Yuan against the USD. This pushed off price parity with the United States for almost 3 years.
Japan had to let their currency double in value during the 1980’s. In this chart, the Yen going down means the Yen is getting stronger. You can see the JPY/USD rate fell from roughly 250 to the 125-140 level, which means the Yen doubled in value.
Even with the yen doubling in value against the USD, Japan had a series of informal barriers which made it extremely difficult for any U.S. firms to export goods to Japan.
As a result, the trade balance between Japan and the United States remained about the same.
“The Plaza Accord was successful in reducing the U.S. trade deficitwith Western European nations but largely failed to fulfill its primary objective of alleviating the trade deficit with Japan. This deficit was due to structural conditions that were insensitive to monetary policy, specifically trade conditions.
Export driven growth isn’t just for developing countries. It’s pretty clear the reason Germany has done so well over the last decade is they were able to peg their entry into the Euro at a very favorable exchange rate. As a result, they were able to “outcompete” the rest of Europe in the larger European market. Really, Germany just has an under-vauled currency arrangement with other countries in Europe. No, it really does. This gives it a massive competitive advantage over other countries in the Euro.
If we look at the rules of functional finance, we don’t see anything which addresses export driven growth. We see rules about how to print more money, and hints about keeping credit at the appropriate levels. We see a rule on price stability.
But we do not see anything which addresses the foreign sector. This is a huge gap in thinking. Many people – including myself – think that much of the too-small stimulus ended up helping China more than the United States simply because China hoovered up business from the United States by pegging their exchange rate.
This has huge implications for functional finance style thinking. Balancing the amount of government spending and private credit becomes much more difficult when there are countries in the world which have an explicit policy of “stealing” demand from other countries through formally keeping their currency too weak and informally blocking exports.
I am glad Matt Y is thinking along the lines of functional finance. Yet, the rules of functional finance probably arent’ enough by themselves to push our economy into the very high growth positive equilibrium.