Stimulus Without Letting Double Entry

Book-keeping Taketh It Away - Fear of Double Dip Recession

HD Vinod is a professor of economics and director of the Institute for Ethics and Economic Policy at Fordham University, New York. He received his Ph.D. in economics from Harvard University, has worked at Bell Laboratories for many years, and has been an expert witness in major antitrust trials. He has published over a hundred articles in top journals in econometrics and statistics, including Econometrica, Journal of Econometrics, Journal of the American Statistical Association,Management Science, American Economic Review, Review of Economics and Statistics,International Economic Review,Journal of Economic Literature,Journal of Business, and Journal of Advertising Research. He has edited special issues and refereed many journals. In 1992 he was elected Vice-President of Indian Econometrics Society and edited a special issue of JQE on CR Rao's Contribution to Economertrics. In 1996, he was named a fellow of the Journal of Econometrics. Maharashtra Foundation honored him for outstanding social service in 1998. Vinod coauthored a 1981 research monograph on regression methods and a 2005 Wiley monograph, "Preparing for the worst: Incorporating downside risk in stock market investing." He co-edited volume 11 of the Handbook of Statistics with C. R. Rao, the famous statistician. Vinod manages a worldwide anti-corruption project described at: www.fordham.edu/economics/vinod.

Double entry book-keeping (DEBK) is responsible for failures of both monetary and fiscal policies in both America and Japan, trapped by the zero lower bound (ZLB) on interest rates, or the liquidity trap. This essay is based on my academic paper available at: http://ssrn.com/abstract=1916361. I show that, under DEBK, whatever stimulus the government give it also take away." Hence we need a single entry net stimulus explained below.

DEBK, invented by Venice merchants in the 13th century, requires that every stimulus dollar from a tax cut or government spending (credit entry giveth) is matched by a dollar of `debit' entry (taketh away). American public and businesses correctly worry that any debit entry leading to new debt will have to be serviced," with the added burden of interest payments in the future. In the absence of any net stimulus, many US corporations are holding huge cash reserves, some of it abroad, but they do not spend it by hiring people.

Since interest rates cannot go below zero, the monetary policy has no ammunition to ght recessions and get out of the ZLB trap. Bank of Japan (BOJ) invented quantitative easing, which was copied by the Federal Reserve (Fed) as QE1 and QE2. This increases the money supply by rejiggering holdings of Treasury securities to reduce the short-term interest rates. QE stimulus increases the money supply (giveth), but the public knows that DEBK will eventually take it away, by having to decrease money supply at a later date, dollar for dollar.
In short, sophisticated market participants know that DEBK means there can be no net stimulus, even if hundreds of billions of dollars are involved in tax cuts, government spending or QE.

Since about 1990, Japan has been mired in near-zero economic growth hurting the world economic growth. The twenty plus years of sad experience of BOJ proves that any stimulus within the con nes of DEBK is no net stimulus at all. We have shown why it does not and cannot work.
Instead of increasing domestic demand, Japan exported her problems to the US, while maintaining high domestic employment. Until recently, American consumers willingly participated by spending binges which provided an engine for world growth. Inevitably, the spending and importing binges have created serious imbalances. More recently, China has joined her Asian neighbor by pursuing export-driven high domestic employment, while ignoring the imbalances arising from artificially propping up the US dollar. 

Recently published minutes of the August 9 meeting of Fed bankers shows rare dissent and a clear sense of helplessness. However, no one seems to recognize that DEBK is the real culprit. Once we understand the enemy, our solution must suspend the DEBK and create a net stimulus by spending and tax cuts of, say one trillion dollars. Since DEBK is not in the US Constitution, it can and should be disobeyed. Decades long Japan-style permanent recession is too high a price to pay for a mere nicety.

If President Obama and Ben Bernanke jointly announce a single entry net stimulus, it will be a bold move, somewhat similar to Nixon's cancellation in 1971 of direct convertibility of the United States dollar to gold. Nixon had a short drama of wage and price controls to sell his unilateral cancellation of Bretton Woods. Obama and Bernanke would need to convince that the net stimulus will cure the imbalances. That is, US consumers will save more and import less, while reducing mismanagement, waste and conflicts of interest" in several key sectors.

Among macroeconomic problems, President Carter faced high inflation and stagnation. It needed the then Fed chairman Paul Volcker to impose 20% per year federal funds rate in June 1981 to break the back of inflationary expectations. By comparison, my net stimulus is almost painless. It will cause some devaluation of the dollar creating angry creditors (China, Japan, etc) and hurt sectors that depend on imports. It will also encourage rising gold prices, and price inflation in the US. This is a small price to reduce unemployment and get the US economy growing again.

My net stimulus solution would have been and still remains mostly painless for Mr. Noda of Japan. The pain of depreciation in the value of Yen is exactly what Japan has wanted all along. Instead, Mr. Noda promises

cutting the Japanese spending and debt, decidedly wrong policies.