Daily Archives: February 12, 2014

Warren Mosler’s Department Store Analogy – An Extension

Warren Mosler suggests in his book ‘Seven Deadly Ionnocent Frauds Of Economic Policy’ that we should:

“Think of the economy as one big department store full of all the goods and services we all produce and offer for sale every year. We all get paid enough in wages and profits to buy everything in
that store, assuming we would spend all the money we earn and all the profits we make. (And if we borrow to spend, we can buy even more than there is in that store.) But when some of our money goes to pay taxes, we are left short of the spending power we need to buy all of what’s for sale in the
store. This gives government the “room” to buy what it wants so that when it spends what it wants, the combined spending of government and the rest of us isn’t too much for what’s for sale in the store. However, when the government taxes too much – relative to its spending – total spending isn’t enough to make sure everything in the store gets sold.”

It’s a good analogy and it’s interesting and instructive to take it a little further. Consumption has to balance production. Goods have to leave the store at the rate they arrive. If the store owner notices goods leave too quickly he’ll start to raise his prices to make extra profit while he can. If they leave too slowly he may drop his prices or he may just leave things on the shelf. Either way the suppliers of those unsold or unprofitable goods aren’t likely to get another order, on the terms necessary to keep those businesses going and the workers in those businesses employed.

Therefore, for all products to repeatedly clear everything must be sold at a sufficiently good price to pay all the suppliers, all the workers and generate enough profits to make it worthwhile for the investors. The government have spending power which they’ve made room for by taxation and they are a customer of the store. The workers, the suppliers, the investors are also key customers. They need to spend all their wages, receipts and profits. If anyone decides to save part of their wages or their profits there isn’t going to be enough spending power to buy everything which is for sale.

There’s a natural tendency to save everywhere. Be it for a holiday or retirement or whatever. Businesses will save their money too if they don’t see any immediate profit in re-investing it. Apple reportedly has a cash pile of $147 billion. Presumably they they think it’s too risky to use that money developing new products right now.

So what can be done? Germany, China , Switzerland etc solve their own problem by encouraging UK and other foreign customers to shop at their stores. In other words, they use exports to solve their own problem of overproduction. But of course not everyone can do that and it makes the problem worse for the UK and the US stores. (Not to mention the Greek one!). Not only are some goods unsold because their customers are saving rather than spending, some are unsold because their customers have gone elsewhere.

So what else can be done? Yes, that’s where Governments come in with their deficit spending. Governments of countries like the US and the UK who are net importers have to deficit spend not only to enable their own citizens and companies to net save they also have to deficit spend to cover their trade or current account imbalance. Greece is in the unhappy position of not being able to do that, at least not anywhere near to the extent needed to fix its problem.

Countries like the US and the UK have become the World’s bankers. They sell treasury securities to cover their deficit spending. Apple probably don’t actually have $147 billion of real US dollars. Incidentally, real US dollars are just the IOUs of the US government. They can write out as many as they like. Apple probably have most of their $147 billion as commercial bank IOUs which are not at all the same thing. That bank will have used Apple’s money to buy US treasury securities which will have then been spent back into the US economy.

Deficit spending shouldn’t be overdone of course. If too much demand is created inflationary problems will arise.

Many make not like it, but that’s the way the system works. It’s obviously not possible to discuss any government deficit in isolation. It can’t be substantially reduced by just cutting spending and increasing taxation. If any politician promises and tries to do that, they’ll certainly fail.

They may crash the economy in the attempt though. So its probably not a good idea to let them try!

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