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Gaze Not Into The Abyss: The KfW, Mitchell, And Ramanan’s Misreading

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Posted on 11 March 2020 by Philip Pilkington Article of the Week from Fixing the Economists Ramanan is attacking the Chartalists again. And as usual he assumes a stupidity on their part that, well, what was that Nietzsche quote again? Battle not with monsters, lest ye become a monster, and if you gaze into the abyss, the abyss gazes also into you. Please share this article - Go to very top of page, right hand side, for social media buttons. I'm not going to spend very much time on this because it's just silliness. But we may as well nail it down for the record. Ramanan writes, In other words, Prof. Mitchell seems to present a story in which the German government is using KfW as a tool to have a higher budget deficit than what it shows in its own books but it is in

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posted on 11 March 2020

by Philip Pilkington

Article of the Week from Fixing the Economists

Ramanan is attacking the Chartalists again. And as usual he assumes a stupidity on their part that, well, what was that Nietzsche quote again?

Battle not with monsters, lest ye become a monster, and if you gaze into the abyss, the abyss gazes also into you.

Gaze Not Into The Abyss: The KfW, Mitchell, And Ramanan's Misreading


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I'm not going to spend very much time on this because it's just silliness. But we may as well nail it down for the record. Ramanan writes,

In other words, Prof. Mitchell seems to present a story in which the German government is using KfW as a tool to have a higher budget deficit than what it shows in its own books but it is in fact the opposite. This is because the combined entity KfW + Government of Germany has a lower deficit than the deficit of the government of Germany.

Eh, no. Mitchell was presenting a story in which the KfW** was engaged in extending credit to the private sector - just as Ramanan says. This then allows for an increase in aggregate demand without the government having to engage in deficit spending. Thus, Mitchell's story goes, economic activity is buttressed by the KfW so that the government doesn't have to do the heavy lifting. Mitchell states this clearly at the very beginning of the piece when he writes,

[The KfW] has since grown (and diversified) into one of the largest banks in Germany (taken its main business units into account) and pumps millions of Euros in the domestic economy and the export sector (via IPEX, its 100 per cent owned subsidiary) ... It is a major reason why the federal deficit has been reduced without scorching the German economy. (My Emphasis)

So, what's the problem with this? Simple. The KfW is, for all intents and purposes, a government institution. Mitchell writes,

The company is run by an Executive Board who are "appointed and dismissed" by the Board of Supervisory Directors (Article 6).

Guess who is the Chairman of the all-powerful Board of Supervisory Directors?

None other than our sudoku-playing Bundesfinanzminister (Federal Minister of Finance), Dr Wolfgang Schauble. The Board is packed with Federal government ministers, which is appropriate given the bank is state-owned.

Other features of the legal status of KfW:

1. It distributes no profits but allocates surpluses to reserves attributable to the shareholders (government) (Article 10).

2. It has the same status as the central bank with respect to taxes - that is, it doesn't pay them.

The Kfw is thus unambiguously a state institution and provides loans at lower than commercial rates because its bonds are considered of equal status to the German government's own debt-issues.

See the cheating here? The KfW, for all intents and purposes, is a government institution and has full government backing. The KfW is like a sort of shell company for extending credit that is effectively the same as if the government had to pay for these projects given that the board of the KfW is filled with government folks and the bonds are backed by the government. The trick is that this borrowing doesn't appear on the government balance sheet so, given a level of aggregate net expenditure equal to,

[Government Deficit + KfW Lending],

the Federal deficit is lower than it would otherwise be if the government had to foot the bill for all this expenditure.

Ramanan writes,

For Mitchell's claim on the deficit to be valid, KfW should be a net borrower each year of a big size. For the claim on the public debt, KfW's net indebtedness should be large. Unfortunately for Mitchell, KfW is a net lender to the private sector and the rest of the world sector in the flow sense and a net creditor in the stock sense.

It is clear that he has simply not understood Mitchell's argument. The lesson here? If you have an emotionally-charged gripe with some theory or other you should be all the more fastidious in trying to understand the argument of said theory before you criticise it. Otherwise there is ample chance that you will get carried away with yourself.

Anyway, I have no problem with what the KfW does per se. Nor, I think, does Mitchell. Government-backed development banks are an excellent means for providing aggregate net expenditure to the economy through government-directed lending without giving rise to government debts that cause hysteria among austerity hawks and politicians. Mitchell's point is that Germany is being hypocritical in this regard because they are calling for contraction in net expenditure in the periphery. I agree. They are.

Addendum: More misreading

As readers ca see from the comments section Ramanan came on here and began to put words in my mouth. He made multiple claims about what I was supposedly saying that I never, in fact, said. He now has added to his post with some strange arguments. I will deal with the two main points here. The first one is in response to me saying that if the KfW did not lend then the government would have to engage in expenditure to keep the level of output up. Ramanan responds,

First, the government would not have to "foot the bill for this expenditure" if it were to lend directly to the private sector on its books because the lending would not be "expenditure" but a loan by the government and it would be making a profit on it. The loan would not add to the budget balance even if the government were to directly lend.

Yes, this is also a possibility. The government could lend directly. This is another counter-factual. But it is highly unlikely to actually happen.

His second point,

Further Pilkington seems to assume that another counter-factual in this case is less borrowing by the private sector and hence lesser private expenditure. No! this counter factual is the private sector borrowing from other banks - i.e, private banks. Why would German firms find difficulty in borrowing if they happened to show their creditworthiness to KfW?

This indicates that Ramanan thinks that lending and spending by the private sector is not determined by institutional issues and is only determined by their desire to lend. I think this shows clearly Ramanan's weakness understanding institutional and political issues as they relate to economic issues. In short: I don't think that he fully grasps how industrial policy works. In actual fact, in such ventures the government and the private sector team up and engage in undertaking activities together. That is what appears to be happening here.


* This article was writtten in 2013.


** KfW is a German government owned development bank.


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