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“If the coin be locked up in chests, it is the same thing with regard to prices, as if it were annihilated.” David Hume — Of Money
As I had stated before, as a matter of simple accounting, you make the math work out fairly easily to where consumption would have to fall a cumulative total of $84 million dollars. But introduce savings vehicles, which you can not assume away. How is this idle money being horded? There are a quite a few options, I’ll detail three:
Money Market Account: What if our idle millionaire holds his money in an MMA, earning (say) the 10yr Treasury rate of interest, which is then reinvested in Treasuries? The IRS takes his money, and the government spends it on goods and services. Does this reduce consumption future consumption while not affecting idle millionaire’s position? Yes-ish, but only to the extent that the risk-free real interest rate rises, and causes a fall in investment. You could get to a wash in this situation, though…if the government is investing the money at a higher ROI (i.e. it takes the money and invests in a project that cures all cancers with a single pill*).
An Index Fund: Now say our idle millionaire has his money in broad index fund, earing the average rate of return (5%), which is then reinvested back into the fund. The IRS takes his $84 million, and spends it. What the IRS has done here is to reduce the long-run stock of capital in the economy by some amount. IF the government can find a higher ROI than the entire basket of companies that idle millionaire held, then in the long run, there is no fall in consumption. However, that is a tall order, and unlikely to happen. Thus, I falls, and over a period C falls by ~G. Giving an answer that could be close to Landsburg’s result. This is because at the margin S ≘ I.
Mattress: Finally, lets say that our idle millionaire stuffs his mattress full of $84 million. His preference for sleeping on mattresses full of money non-withstanding, what our millionaire has done is reduce the stock of currency. This is the assumption that leads to the phrase “money is not wealth”. Indeed, money is not wealth! But the key is that our guy has already reduced long-run consumption by at least $84 million! This is because S ≠ I in this scenario. Hume explains this in the above quote. So, say the IRS steals his money, and simply keeps it in the mattress for IRS agent Joe to sleep on during lunch? The net effect is nothing happens, because consumption has already been reduced. What if the government spends it on stocks of a company which immediately goes bankrupt? Then society has lost. But if the government simply transfers $1 to 84 million people, then consumption will rise by…~$84 million.
However, this is not optimal. The optimal solution, given that the monetary authority is aware of our guy’s mattress, is to increase the money supply by $84 million. As Leigh Caldwell said in a Twitter conversation (the question was “What Would [Scott] Sumner Do?”):
@leighblue: well, I think he’d say that first the Fed should be printing a new $84m if it knows about the mattress; to be withdrawn when the guy takes his money out of the mattress. NGDP futures in theory would make this happen automatically.
In the real world, our millionaire, Mr. Kendrick, probably owns a basket of assets that includes Treasuries, stocks, corporate bonds, real assets, and currency. In the real world, the government may be hard pressed to tax Mr. Kendrick in a way that is welfare enhancing in the aggregate (even at less than full employment). Not saying that it couldn’t, just saying that it would be uphill battle.
P.S. I still firmly stand behind my “club goods” critique of this problem, although I’m assuming that Landsburg would disagree.
P.P.S. You can object that I’m overestimating the investment efficiency of the private sector over the public sector.
P.P.P.S. You’ll notice that I used investment above quite liberally. It is extremely hard to think of situations where the government is strictly consuming income, besides deadweight loss of transfer. It is also very hard to think of situations where individuals are strictly consuming income, which is a technical point that caused Garett Jones a lot of flack recently. Hence, money does not equal wealth.
The FINAL P.S. (I swear!): Paul Krugman posted a rebuttal to Landsburg’s problem that I think is misunderstood by many looking for contradictions (including my favorite blogger). PK’s hypothetical model assumes that government > no government. So if G is at 0, then any other state of affairs is welfare enhancing. Take your stand on the political spectrum on this one (mine is far to the…I guess right?…from Krugman’s, if you were wondering), but this is the model. The idea is that C (and I) in a world without a financed government would be drastically lower than C (and I) in a world where government steals Kendrick’s money, so by taxing Kendrick, the government (as an institution) is providing a higher level of C (and I) and would otherwise prevail under a situation where G = 0.
Extreme, I know. But the point is that government starts from the disadvantage of a priori deadweight loss. More realistically, you could say that government takes $84 million and invests in a technology which is capable of educating children and young adults much more efficiently than our current arrangement. As an aside, in this scenario, the Treasury issuing $84 million in new Treasury notes, and the Fed buying them with $84 million in newly minted currency would make this situation a wash.
I don’t think he is. I enjoyed his book, “The Big Questions”, and I even made a set of desktop images for him, which (if you’d like) I can send you the full sized images and you can use them for free if you enjoy them (p.s. I also do design work)!
The only thing I find wrong is the fact that you can’t do economics from accounting identities. If you could, then Steven’s basic model would be correct, as a matter of arithmetic, and a matter of reality. To my mind, that is where you stop.
Start with GDP: Y = C + G + I + Nx. I think we can probably disregard Nx to make the model easier. In this case, consumption is constant, as the assumption is that our idle millionaire consumes zero at $84 million, and you can’t consume less than zero (even when dead!). In this case, we’ll hold C constant at $100. Now say G is currently 0, but the government sees a nice pile of money, maybe $84 million, sitting around in a bank account. Well, that money isn’t just sitting there, S (savings) is related to I in our GDP model! So assuming a quick 1:1 relationship between S and I, what the government is doing, in order consume $84 is reducing investment by $84. Assuming there is some sort of relationship between I and C, than in future periods, C will have to be reduced by a cumulative total of $84.
Of course, none of that is literally true. As I (and Noah) said before, doing economics from accounting identities leads to patently absurd conclusions. There are no concrete relationships between savings and investment. They are both dependent variables. Neither is there a concrete relationship between I and C. Both depend on other economic variables, as well. But, zero-sum accounting would get you this result.
But I think there is a deeper fallacy that Landsburg’s experiment falls into, and that is the myth of government as consumer. It is very common to hear in right-wing (usually non-economist) circles that the private sector produces wealth, and that the government produces nothing, it only consumes wealth that is generated in the private sector. The fact is that the state produces the exact same amount of wealth as the market. That is none at all.
The fact is people produce wealth, and people consume wealth. The state and the market are simply institutions which people have arranged to coordinate production and consumption. The socialist calculation debate was not regarding how the state stole wealth from the market, it was regarding the limitations of the state as an institution for coordinating economic activity. Corporations in-and-of themselves do not produce any wealth, either. The organization of a corporation is wealth enhancing, but that is only to the point that it is more efficient than other such arrangements that bring people together to produce and consume.
Per James Buchanan’s excellent analysis [JSTOR] of the political economy, the (tax and spend*) state is largely concerned with providing club goods, that is: goods that are largely non-rival, and at least partially non-excludable. So to assume away transaction costs, deadweight loss, and the like…in this simple model, a society is choosing to purchase some goods as the “club of everyone”, instead of as individuals. Consumption increases when the government steals “idle millionaire’s” money, and doesn’t decrease at all (assuming no effect on I, or rather, that he government’s investment produced a form of capital to substitute for direct savings) because the types of goods provided by the “club of everyone” wouldn’t necessarily be purchased by the individual, but individuals are (presumably) wealthier for having them.
Brad DeLong is actually correct (and this fallacy is what he is pointing out in his post, although he doesn’t explicitly state it). “We” are the state. Arnold Kling is also correct, “lose the we”…the catch is that he just wants a different arrangement of the provision of club goods. Kling is re-stating Milton Friedman’s sentiment when he said (paraphrasing), “I’ve never seen a tax cut I didn’t like”. Friedman was stating a preference for institutional arrangements, not a statement about consumption.
Note: This isn’t an argument that allows the government to run roughshod over “idle millions” sitting around. Our capital stock does determine investment in the long run. Savings do have a role in the economy. In a hypothetical situation, if the government can get a higher ROI from stealing a millionaire’s money from under his mattress, then society is richer. But if not; if the government simply determines that government mattresses are where money goes, society is no worse off, and if the government consumes goods or invests the money in a ridiculous fashion, then society is worse off.
*I specifically point to the tax and spend state because the “tax to finance regulations” state is a completely different animal. And so you can see how you can get mislead by simple accounting identities!