Unemployment Insurance and Spending: Bond Purchases are Reallocations from Other Saving

In his Economix piece this week, Casey Mulligan picks up on his theme from last week that unemployment insurance (UI) benefits may not boost spending in aggregate, since the money needed to pay benefits is withdrawn from other spending. He agrees with my earlier point that the money is not coming from current tax revenue, but rather from deficit financing, then says that:

"But that 'financing channel' still does not make the payments free from the perspective of today’s economy.

"Suppose the government has been borrowing the money to pay for unemployment benefits. It borrows money by selling bonds. The purchasers of those bonds have less to spend on something else."

Actually, most or all of the money that would be used to buy the bonds is a reallocation from other savings, at least at a time like the present when the economy is in a serious downturn. In effect, bond buyers will use either deposits or sales of other assets (e.g. stocks or bonds of private companies) to buy up government bonds. This has no direct effect on their consumption.

In other times this could lead to an increase in interest rates, which would discourage other spending to some extent, however this effect is likely to be trivial or altogether non-existent in the current environment. Banks have vast amounts of excess reserves sitting idle. The government's sale of bonds will likely pull in some of these excess reserves. If UI benefits are associated with a boost to growth, and therefore more total deposits, then the net amount of excess reserves in the system may decline slightly, but as long as we still have vast amounts excess reserves, the impact on the interest rate will be trivial, as will the impact on spending.

The extreme case can be seen when the Fed is the buyer of the bonds. In that case, there would actually be an increase in the excess reserves of the system as a result of the government's sale of bonds, and therefore no increase, and possibly even a decrease, in interest rates. In that case, the government spending is a pure gain to demand and to the economy.

In this scenario, safety net spending boosts growth and employment. It does not impose a cost on the rest of us. More generally, it makes sense to think of UI benefits and other safety net programs as being like other forms of insurance. We pay some price for it in the good times -- output is somewhat lower than it otherwise would be -- so that we can be protected in the bad times.

This means that in the bad times (e.g. your house burns down) insurance is unambiguously beneficial. Whether it is providing good value over the good and bad times taken together depends on the exact conditions of the policy.

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written by JSeydl, February 22, 2012 6:24 AM

It's amazing how Mulligan always seems to put things into full employment terms. He just assumes that whenever the government takes in money and spends more, it's going to crowd out activity in the private sector -- nevermind the fact that we had an $8 trillion housing bubble collapse, government bond yields are near all-time lows, and there is still widespread risk aversion and a relentless demand for liquid assets in the economy. It's pretty incredible.

Retired professor of economics
written by Richard Hattwick, February 22, 2012 7:34 AM

I'm glad you included the case of the Fed buyhing the bonds. You are one of the few knowledgeable bloggers who keeps pointing out this option ( along with the fact that interst paid on Treasury securities held by the Fed is paid back to the Treasury. I only wish that all major blogging economists would keep pointing out this option. Well done!

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written by JL, February 22, 2012 9:47 AM

Yeah, there is no "crowding out" in the financial markets. The credit money dog wags the base money tail. This is well documented. The only way crowding out occurs is in the asset markets, or the markets for labor or capital. We see this during WWII and during other periods of shortage. Aside from this, there is no textbook "loanable funds" market.

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written by Mcwop, February 22, 2012 3:19 PM

China and Japan are major buyers of our debt too.

Insurance payments or compensation for damages imposed?
written by Perplexed, February 22, 2012 4:19 PM

The entire controversy is a direct consequence of our "loser liberalism" approach to unemployment. Casey's view is based on the assumption that unemployment benefits are a cost to society of "supporting the unemployed." Most economists, the people that should be knowledgeable about how markets work, simply go along with this ruse. When viewed with a more honest approach to what is actually occurring, it becomes apparent that the unemployed are victims of market that denies them access in order to artificially support the prices of those left with access to the market.

Once we own up to the fact that mass unemployment is a direct result of the failure of our legal system to protect against a majority imposing it’s will on a powerless minority and put an end to this option, other solutions come to be seen quite differently than the “government handout” characterization implies.

If I bring 1,000 bushels of corn that meet quality specs. to the market and you refuse me access to the market and force me to allow the corn to degrade and decay, there are laws that will force you to pay my damages (everything I lost by not having access, including legal and collection costs) for denying me access to that market. If what I bring to the market is my labor, you can pay another worker a higher wage than I would require and refuse me access to the market, force me to allow my “skills to degrade,” and deny me access to any income at all. When I do work, you take part of my wages to fund “insurance" to cover losses that may be imposed on me by you’re denial of my access to the market. Somehow you have concocted a system where you can legally do this to me, but not to my neighbor who brings goods to the market instead of labor. Economists call this the effects of “sticky prices” to provide cover for what is really happening.

Recognizing that, in a Democracy, there is tremendous risk that a powerful majority will impose it’s will on a powerless minority, the Constitution and Bill of Rights were established to prevent abuses of this type; but no one challenges the right of an enormous majority (governments, producers, and employed workers) to impose the full costs of an output gap entirely on a small group of people willing to work who are powerless to secure access to this so called “market” and powerless to recover any of the damages they suffer. WE MUST CLOSE THIS LOOPHOLE AND FORCE A CHOICE BETWEEN OTHER ALTERNATIVES.

If the option of sticking the entire cost of an output gap on a small minority were not available, we’d have to choose between allowing an actual, open market for all labor (with its corresponding rapid price declines and deflation) or fully compensating those that are the victims of our choice to allow the market restrictions that delay wage declines. Those benefiting from not having free markets should be paying for the benefits they receive to the extent they impose costs on others; not receiving the benefits while imposing the full costs on a small minority. This is not a "cost" to society as Casey implies, its largely inadequate compensation to society's powerless victims for costs the majority imposes on them to provide benefits to that majority. Either it is a market, in which case it's open to all qualified bidders, or its something else. This ruse has gone on way too long at much too high a cost.

We can’t get a serious discussion of stimulus spending or proposals such as MMT because of the enormous conflicts of interest that are built into and protected by current policies and laws that circumvent Constitutional protections. If the costs of the output gap were truly born by those imposing it others, the entire conversation around what to do about it would change.

The “people” that should be buying “insurance” are those that are participants in this market manipulation, not their victims.

Bond issue creates credit
written by BT, February 26, 2012 2:21 AM

Bond issue plus government spending has the net effect of creating new credit (deposits) and new debt (the bond). This is important.

It means that there is no crowding out - unless the private sector is booming with its own credit creation and inflation is surging and creating pressure for an interest rate rise. No chance of crowding out in our balance sheet recession.

Unemployment Insurance and Spending: Bond Purchases are Reallocations from Other Saving

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