MMT stabilization policy — some comments & critiques
— Abba Lerner (1943)
First, I want to make clear that the critiques I’ll offer below are not intended to discredit or dismiss MMT. As I’ve said before, I think MMT offers a coherent and important perspective on fiscal and monetary issues that ought to be understood, on its own terms rather than in dismissive caricature, by anyone serious about macroeconomics. MMT is not “true”, but then no theory is “true”. We ultimately judge theories by how useful they are, both in making sense of “the data” we already know and in offering guidance for policy going forward. In my opinion MMT is one of the most useful perspectives in thinking about fiscal and monetary questions.
However, it is still just a perspective. Enthusiasts sometimes present MMT in a manner that’s too complete and hermetically sealed. While some MMT theorizing is based on “double entry accounting” or “obvious, unarguable facts”, when MMT adherents offer non-trivial conclusions, they rely upon assumptions about human behavior that are in fact contestable. I continue to place non-zero weight on theories of government insolvency that MMT-ers have persuaded me are, in a sense, incoherent. Life is complicated, and even absurd prophesies can prove self-fulfilling.
This will be a long post. I’ll discuss each of the seven points I outlined in my summary of MMT stabilization policy. Then I’ll offer some general comments. Before you continue, you should understand the point of view being examined. Please read my previous post first. Or much better yet, read Chapter 1 (Tymoigne and Wray) and Chapter 5 (Tcherneva) of A handbook of alternative monetary economics (ed. Arestis & Sawyer). These essays offer a polished, concise introduction to the MMT perspective. Then spend some time with the “mandatory” or “101” readings on Warren Mosler and Bill Mitchell’s websites.
The summary points from my previous post are repeated below in bold. New comments then follow. I am critiquing my own distillation of MMT stabilization policy, so there is the danger I have set up straw men. If I have, I apologize and look forward to being set straight in the comments. As usual, almost nothing I say will be original. Many of the points I’ll make have been made better by others, for example, in the comments to the previous post, which are extraordinarily good. At a Kauffman Foundation blogger convention last week, I discussed MMT informally but at some length with David Beckworth, Megan McArdle, Mish, and Mark Thoma. My comments will undoubtedly be informed by those conversations.
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The central macroeconomic policy instrument available to governments is regulating the flow of “net financial assets” to and from the private sector. The government creates private sector assets by issuing money or bonds in exchange for current goods or services, or else for nothing at all via simple transfers. Governments destroy private sector financial assets via taxation. MMT-ers tend to view financial asset swaps, whereunder the government issues money or debt to buy financial assets already held by the private sector (“conventional monetary policy”) as second order and less effective, although they might acknowledge some impact.
While the flow of net private sector financial assets does strike me as an important and powerful tool for macroeconomic policy, it is not a uniquely effective tool. Changes in the relative price of financial assets (the object of conventional monetary policy) and in the distribution of financial assets can also powerfully affect behavior, and there are costs and benefits associated with each lever. What is the justification for focusing almost exclusively on managing the level of “net financial assets”?
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A government that borrows in its own currency cannot be insolvent in the same way as private businesses. That is, such a government will never face a sharp threshold where it cannot meet promised payments, leading to a socially unanimous or even legal declaration of insolvency and an almost certain run on its liabilities.
It is unassailably true that a government cannot be forced into insolvency for want of capacity to pay in its own currency. But a government might find itself politically or institutionally unable to meet an obligation despite access to the printing press, and there might be a sharp run on government obligations even without the focal point of formal insolvency that usually occasions private sector runs. It strikes me as an open question the degree to which protection from formal insolvency protects government obligations from disruptive races to redeem. Point #7 below strikes me as stronger protection.
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However, the value of money and government claims in real terms is absolutely variable. Governments do and properly should manage their flow of obligations with an eye to supporting that value, among other competing objectives (such as, especially, full employment).
I think almost no one would argue with this point.
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The real value of money and government debt is not reliably related to any theory of government balance sheets. In particular, the stock of outstanding government obligations is largely irrelevant. The value of government obligations is a function of financial flows.Government claims will retain their value so long as the private and foreign sectors wish to expand their holdings of those claims at the current price level, that is so long as agents are willing to sacrifice real goods and services today to reduce their indebtedness, improve their financial position, or stimulate their export sectors. The value of government claims will come under pressure when agents, on net, seek to increase indebtedness or redeem existing claims for real goods and services.
This is a place where MMT-ers, quite rightly, call out conventional economists on adherence to dogma ill-supported by the data. Empirically, the relationship between government balance sheet quantities and either the price level or private/foreign willingness to absorb government claims is weak. Conventional economists intone seriously about our growing debt-to-GDP, and discuss solvency criteria that no one believes as though they were real. (I don’t think any sensible person believes indebted governments will ever run surpluses of present value greater than the accumulated stock of public debt. Yet that is the party line solvency criterion. [Update: See below]) Theories of the public balance sheet that have proven unreliable continue to be endorsed to avoid inconsistency in the edifice of neoclassical finance. It is true, in extreme cases, that governments that experience hyperinflations go through periods of high indebtedness relative to GDP, but what is cause and what is effect there is murky.
Macroeconomic theory is often stupid about debt. Common models impose a “no Ponzi condition” that is absurd not only for governments, but also for private firms. All firms and governments eventually end, and when they do, they usually leave substantial claims unsatisfied. Agents lend to corporations and governments not because they believe the debt will be paid down, but because they believe the almost certain eventual default or debasement of claims is unlikely to happen within their investment time horizon. In the real world, governments and corporations balance actual gains from the transfer component of increased borrowing against increased hazard that the end will come quickly and potential “distress costs”. Typically, governments and firms find these costs easy to manage as long as indebtedness grows no faster that “size” (whether measured in terms of revenue or asset values). While it is risky to “lever up” — to increase debt faster than size — many firms and governments do so successfully. We have no reliable criteria of maximum leverage even for firms, let alone for governments. Governments are special. Their core asset is their taxing power. Their liabilities, whether notionally bonds or money, are best understood as preferred equity rather than debt. They face very diffuse liquidity constraints.
All of that said, I think MMT-ers sometimes err in the opposite direction. They are right that ultimately it is flows (actual or desired) between private agents in aggregate and governments that determine the value of government obligations. But the whole purpose of balance sheet analysis, in the private sector and the public sector, is to predict future flows. That conventional theories of public balance sheets are foundationally stupid and overstate the hazards associated with large stocks of outstanding debt doesn’t invalidate the intuition that flow volatility is likely to be proportional to the outstanding stock of government claims. Suppose, because of a sunspot, private holders of government claims get nervous and try to redeem them for current goods. If the net stock of claims in private sector hands is small, it takes very little taxation to offset that flow. If the net stock of government claims is large, than the desired flows might be massive, and governments might be faced with unappetizing choices between taxation or accommodating inflation. There is little evidence that increasing the stock of government obligations, by itself, increases the likelihood that the private sector will seek (impossibly but disruptively) to divest itself of those claims. But there are undoubtedly fluctuations in the private sector’s enthusiasm for holding money and government debt, and it strikes me as implausible that the difficulty of managing those fluctuations is entirely unrelated to outstanding stock of those claims.
Also, although MMT-ers are typically regarded as “left” economists, I think they underplay the distributional costs that attend expanding the stock of government obligations. Government obligations, like all financial assets, are disproportionately held by the wealthy. If the government did not accommodate the private sector’s demand for net financial assets, preferring different policy levers to stabilize the economy, wealthy people might be forced to store wealth in the form of claims on real resources, and would have to oversee the organization of those resources into value-sustaining projects. A large stock of “risk-free” financial assets allows people wishing to carry wealth forward to shirk their duty to steward resources carefully and bear the consequences of investment failure. Thus, the availability of government obligations simultaneously degrades the quality of real investment (by disincentivizing supervision) and magnifies the distributional injustice that attends failures of aggregate investment by shifting the burden of those shocks onto risk investors and workers. In theory, governments can mitigate this injustice by careful transfers and expenditures ex post, and that might be the right policy, but in practice those who disproportionately hold existing government obligations disproportionately hold political power, and resist the issue of new obligations which might put dilute the value of existing claims. In practice, a large stock of government claims serves as the lifeboat through which prior wealth inequality carries itself into the future. Absent an accommodative stock of government obligations, recessions would be crucibles that separate the deserving from the undeserving rich, and would thin the ranks of the rich generally. Recessions should be periods that decrease inequality, but the availability of default-risk free claims whose purchasing power is politically protected inverts the dynamic.
MMT-ers are right, I think, to argue that, for fiat-money issuers who borrow in their own currency, conventional government solvency criteria are false. They are right to argue that such governments have a great deal more latitude to issue money and debt than conventional theories suggest. But that shouldn’t be taken as license to defend carelessness in the distribution of new claims, or to treat expansions of money or debt as entirely cost-free. To be fair, this is a bit of a straw man. Serious MMT-ers think about distributional issues and quality of expenditure, and don’t claim that deficits should be “carelessly” expanded. But in the heat of current policy debates, rhetoric about “deficit terrorists” and money being nothing more than spreadsheet entries unhelpfully obscures that. At its best, a deep point of MMT is that the absence of short-term fiscal constraints creates space for government to craft policy that focuses on the productivity of the real economy. If the mobilization of real resources is wise, fiscal maneuvers will be rendered sustainable ex post. If the real economy will be mismanaged or let to languish and decay, no amount of “fiscal discipline” will save us. The version of MMT that I like best is, oddly, wedded to an almost Austrian sensibility about real investment.
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The “solvency” of a government is best understood as its capacity over time to manage the economy in a manner that avoids net outflows. “Net outflows” here means attempts by nongovernment actors in aggregate to redeem government paper for current goods and services.
I agree entirely. I think this is the best definition of government solvency.
The MMT-sympathetic Traders Crucible objects, however, to my use of the word “solvency” here, even with the scare quotes. After all, what currency issuing governments must concern themselves with is not insolvency per its dictionary definition (an inability to pay debts), but something quite different, a decay in the value of its claims in terms of real goods and services. Here’s TC:
[T]he impossibility of insolvency does not mean the fiat currency will have value. A government might be fully solvent even with a worthless currency… This distinction between insolvency and debasement is at the heart of MMT…
Why is the Traders Crucible going nuts…about the difference between insolvency and debasement?
Well, we can directly observe the debasement of a currency in an economy through the inflation rate. We can directly observe the process of debasement and loss of value of the currency through inflation. We cannot directly observe the risk of insolvency — it must be inferred from bond price action… the resulting process is one of guesswork, misstatements, boneheaded plans, wild specualtion, and dumbassery, because there is no way to observe the risk of insolvency directly even though it is one of the ideas that govern our spending. …[B]y removing the fear of insolvency, we can more directly observe the risk of debasement… [W]e don’t need to rely on the bond market to “give us signals” about the potential loss of access to their club to determine if we need to lower spending, or raise spending. We can just witness inflation and unemployment and make decisions on these two variables, instead of the three variables of unemployment, inflation, and insolvency… This is a much simpler task, and is perhaps the core strength of the MMT paradigm.
This is an important point, but contestable. We know with some confidence that the threat of traditional insolvency can lead to powerful and unpredictable runs and a lot of turbulence in the value of private claims. I’m glad to concede that, at the margin, absence of a sharp solvency threshold reduces the likelihood of such events. But does the lack of a sharp solvency threshold eliminate the possibility of sudden stops, Wile E. Coyote moments, etc? Can we be confident that, absent the danger of outright default, any debasement of fiat claims would take the form of an observable spiral, which would start slowly and thereby offer time to apply a policy antidote? Would we in fact observe and recognize the signs, and would they be different than, for example, a 500% increase in the price of gold in the span of a few years and recurring bouts of commodity inflation? Are employment pressure and labor costs the sole true and perfectly reliable indicators of debasement hazard?
One can make a strong case that increases in labor costs are in fact the sine qua non of uncontrollable inflation, that absent labor income to “ratify” price rises, inflation in inherently self-limiting. But you can make other cases too. Perhaps transfers and deficit spending can substitute for wage power, bidding up commodity prices and the capital share of income even while wages are held back by the reserve army of the unemployed. I’m not sure about any of these stories. But my experience as a trader in capital markets makes me wary of accounts that suggest sharp swoons in the price of any asset cannot happen, or would definitely be preceded by warning signs that would permit one to get out early.
So, I’ll to acknowledge TC’s objection as important and potentially valid, but defend my positing of an MMT “solvency” constraint, at least with scare quotes in place. I don’t think it’s reasonable for MMT-ers or anybody else to write off the possibility of sharp and unexpected changes in the value of a fiat currency. The possibility is dangerous enough that it should focus the mind in a precautionary way. If MMT policy advice is to be taken seriously, it must offer a some assurance of safety against that scenario. The absence of formal default hazard provides some assurance, but without Point #7 as a backstop, not enough.
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Avoiding net outflows is easy in times like the present, when i) low quality and difficult to service debt in the private sector leaves many agents eager to reduce indebtedness and increase their holdings of financial assets; ii) there has been little inflation or devaluation in the recent past; and iii) resource utilization is slack, as evidenced especially by high unemployment. Avoiding net outflows is more difficult when private sector agents’ balance sheets are healthy, or when agents come to expect inflation or devaluation, or when real resources (especially humans) are fully employed.
I think this point is unobjectionable.
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However, a sovereign government can always create demand for its money and debt via its coercive ability to tax. That is, if optimistic agents with strong balance sheets start up a spending spree, or if gold bugs fearful of devaluation ditch government paper for commodities, a government can reverse those flows by forcing private agents to surrender real goods and services for the money they will owe in taxes.
On the one hand, I consider this point is one of MMT’s deepest insights, and its secret weapon. So long as a government’s taxing power is strong, so long as it is capable of persuading individuals to surrender highly valued real goods and services for the ability to escape liabilities imposed by fiat, exercise of that taxing power creates a floor beneath which the value of a currency, in real goods and services, cannot fall.
However, relying too overtly on taxation to give value to a currency strikes me as dangerous and potentially counterproductive. A government’s taxing power is limited and socially costly. Governments must maintain a patina of legitimacy so that people pay taxes “voluntarily” or else they must intrusively or even brutally force compliance. In a decent society, it’s perfectly possible that governments will find it politically impossible to tax at the level consistent with price stability goals. A wise, MMT-savvy government would try very hard to regulate the issue of government obligations over time in a way that avoids the need for sharp fiscal shifts in order to stabilize the price level. Avoiding the need for sharp contractions later on might imply slower issue of obligations than would be short-term optimal during recessions. But once you acknowledge this kind of forward-looking dynamic, MMT starts to sound very conventional. We start having to trade off the short-term benefits of fiscal demand stimulation with long-term “exit costs”.
Two other points are worth making here:
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Even though, in principal, taxation could be used to regulate economic activity and put value underneath the currency, the institutions that would be necessary to do this successfully are simply not in place in existing democratic polities.
Within the MMT community, smart people have given a great deal of thought to institutional forms under which which fiscal policy might be used to regulate activity. As far as I know, they have mostly converged upon the institution of a “job guarantee (JG)” or an “employer of last resort (ELR)”, whereunder the size and wage of a “buffer stock” of public labor would become the economic instrument of macro stabilization. This is an ambitious idea, both politically and technically. Not only must one develop appropriate policies for stabilizing the economy on the fiscal side (i.e. the equivalent of a Taylor Rule for ELR wage levels), but one must also plan and implement real-world projects for a variable-sized pool of (hopefully) transient workers. These projects should usefully employ and develop the productive capacity of ELR participants, while remaining distinct from and and not interfering with the ordinary private and public sector workforces. (As I understand the proposal, ELR employees would be distinct from other public employees, in that they’d be paid a standard, low but livable, package of wages and benefits. ELR employment would always be viewed as a backstop that individuals would be encouraged to transition out of, rather than as permanent employment.)
I’m interested in and sympathetic to the project of designing a government-guaranteed full employment policy that would be complementary to a vibrant private sector and that would anchor rather than disrupt macroeconomic stability goals. But however richly MMT-ers have outlined such an institution in theory, we are very far from implementing such a thing in practice. MMT-ers participate actively in current fiscal policy debates, arguing that “sovereign” governments have sufficient space to let fiscal concerns be secondary to resource utilization goals given their power to tax. Yet the power to tax is next to worthless if we do not have well understood and broadly legitimate means of exercising it in a timely manner.
Taking a page from status quo macro management — that is, from the world of central banks — the least costly way to meet macro stabilization goals is to maintain credible expectations among the general public that tax policy will in fact be managed with sufficient dexterity and force that those stabilization goals are rarely tested. Existing fiscal institutions are mostly quasidemocratic legislatures that act in sporadic and highly politicized bursts. Their policy ventures typically mix interventions on the liability side of the public balance sheet with ad hoc changes to programs on the asset side that are often difficult to reverse. These institutions seem poorly suited to the task of credibly managing expectations and ensuring, in high-frequency real time, an appropriate fiscal stance. Promoting fiscal license in actual policy while the institutions that would render such license sustainable do not exist strikes me as reckless. When participating in practical debates about fiscal policy, it would be better if MMT-ers would bundle their support for “fiscally loose” stabilization policy with advocacy of institutional changes that could be plausibly implemented in time to matter and that could ensure support of the value of government claims, should that become necessary.
Some MMT-ers (Warren Mosler and Winterspeak come to mind) have proposed less ambitious institutions than an employer of last resort program, specifically using the level of existing payroll taxes as the instrument of discretionary macro policy. A government can stimulate by reducing the level of payroll taxes (and thereby increasing the flow of net financial assets to the public sector in a manner that directly encourages job formation), and could fight inflation by raising payroll taxes, rather directly reducing wages and putting pressure on employment. Macro policy by unemployment is detestable, despite its long, proud tradition at the Federal Reserve. If it can be made practical, I’d much rather we work out an effective ELR program. But ELR is not an achievable option in the time frame of the current business cycle. Delegating management of the level of the payroll tax to a “technocratic, independent” institution, whether the existing central bank or some new entity, is practically achievable on a short time frame (although the politics would be rough). Perhaps there are better easy-to-implement means of conducting credible, high-frequency macro policy. I’ve no special attachment to payroll taxes as an instrument. (I’d prefer that we use transfers as an instrument.) Whatever the specifics, relying on ad hoc interventions by Congress to thread the needle between inflation and underemployment strikes me as unlikely to work out.
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This is a technical point that would usually apply mostly to small, open economies, but that arguably applies to the United States today. Taxation can support the value of government claims, when priced in domestically produced goods and services. Taxation cannot support the foreign exchange value of a fiat currency, except to the degree that foreigners desire to purchase domestically produced goods and require expensive domestic currency to do so. A country that runs a large current account deficit owing to decisions by foreign governments to accumulate its currency and that faces competitive export markets cannot rely on taxation to support its currency, should foreign governments revise their policy of accumulation. For a country like the United States which is structurally “short” tradables, one may view the possibility of a difficult-to-counter fall in the value of the currency as a good thing or a bad thing. People like Dean Baker and Paul Krugman argue that a weaker dollar is exactly what the US needs to eliminate the structural gap in tradables production and spur domestic demand. People like Warren Mosler argue that a very weak dollar would be a bad thing, an adverse terms-of-trade shock and a loss of opportunity to trade cheap nominal claims for valuable real resources. Regardless of how you view the event, the taxing power of the government will not be able to undo it.
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Therefore, a government’s “solvency constraint” is not a function of any accounting relationship or theories about the present value of future surpluses. A government’s solvency constraint ultimately lies in its political capacity to levy and and enforce the payment of taxes.
I think this is true, a deep and powerful way to think about public finance. Note that a government’s “political capacity to levy and and enforce payment of taxes” depends first and foremost on the quality of the real economy it superintends. The value that a government is capable of taxing if necessary to sustain the value of its obligations increases with the value produced overall. A government that wishes to be solvent should first and foremost interact with the polity in a manner that promotes productivity. Secondly, the political capacity to levy taxes depends upon either the legitimacy of or the coercive power of the state. A government that wishes to sustain the value of its obligations must either gain the consent of those it would tax or maintain an infrastructure of compulsion. In theory, either choice could be effective, although along with the libertarians, I like to imagine excessively coercive regimes are inconsistent with overall productivity, so that legitimacy is a government’s best bet. The two strategies are not mutually exclusive — a government could be sufficiently legitimate as to be capable of taxing some fraction of the population without resistance and sufficiently coercive as to force the other fraction to pay up. That probably describes the best we can hope for in real governments.
I’ll end with a few miscellaneous comments:
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I’d like to see more attention paid to quality-of-expenditure concerns. That is, if a stable economy requires continuing government deficits to accommodate growing private sector’s demand for financial surplus, then the government must actually make choices about how to spend or transfer money into the economy. These choices will undoubtedly shape the evolution of the real economy, for better or for worse. Should we rely on legislators to make direct public investment choices? Should we put funds in the hands of individuals and then allow consumer preferences and private capital markets to shape the economy? How? Via tax cuts? A job guarantee? Direct transfers? Perhaps the government should delegate management of public funds to financial intermediaries, and rely upon banking professionals to find high value investments? While MMT focuses mostly on the liability side of the public balance sheet, many critics fear that ever increasing public outlays imply increased centralization of economic decisionmaking that will lead to low quality choices. Whether that is true depends entirely on institutional and political choices. These concerns can be and should be specifically addressed.
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MMT-ers sometimes blur the distinction between “private sector net savings”, which is necessarily backed by public sector deficits or an external surplus, and household savings, which need not be. In doing so, MMT-ers rhetorically attach the positive normative valence associated with “saving” to deficit spending by government. This is dirty pool, and counterproductive. The vast majority of household savings is and ought to be backed by claims on real investment, mediated by the liabilities (debt and equity) of firms. There is no need whatsoever for governments to run deficits to support household saving. When household savings increases, an offsetting negative financial position among firms represents increase in the amount or value of invested assets, and is usually a good thing. Household savings is mostly a proxy for real investment, while “private sector net financial assets” refers to a mutual insurance program arranged by the state. It is a category error to confuse the two. Yet in online debates, the confusion is frequent. Saving backed by new investment requires no accommodation by the state. It discredits MMT when enthusiasts claim otherwise, sometimes quite aggressively and inevitably punctuated by the phrase “to the penny”.
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In general, the MMT community would be well served by adopting a more civil and patient tone when communicating its ideas. I’ve had several conversations with people who have proved quite open to the substance, but who cringe at the name MMT, having been attacked and ridiculed by MMT proponents after making some ordinary and conventional point. Much of what is great about MMT is that it persuasively challenges a lot of ordinary and conventional views. But people who cling to those views, even famous economists who perhaps “ought to” know better, are mostly smart people who simply have not yet been persuaded. Neither ridicule nor patronizing lectures are likely to help.
My complaint is a bit unfair. The MMT community has been sinned against far more than it has sinned, especially within the economics profession. Whether you ultimately agree with them or not, the MMT-ers have developed a compelling perspective and have done a lot of quality work that has pretty much been ignored by the high-prestige mainstream. But a sense of grievance may be legitimate and still be counterproductive.
The internet is a fractious place. Many MMT-ers are civil and patient, and devote enormous energy to carefully and respectfully explaining their views. There’s no way to police other peoples’ manners. Still, even by the standards of the blogosphere, MMT-ers have a reputation as an unusually prickly bunch. That might not be helpful in terms of gaining broader acceptance of the ideas.
Anyway, that was a lot. I hope that it’s not entirely useless. Despite my complaints and critiques, learning about MMT has added enormously to my thinking about economics. In practical terms, I think that MMT offers the most promising toolkit for crafting a desperately needed replacement of status quo central banking.
With that, I’ll shut up. Feel free to be as nasty as you wanna be in the comments.
Update: The always great Nick Rowe calls me out:
(I don’t think any sensible person believes indebted governments will ever run surpluses of present value greater than the accumulated stock of public debt. Yet that is the party line solvency criterion.)
No, that’s not the party line. In fact, the party line would say that is impossible. The party line says that the *expected* present value of *primary* surpluses (plus seigniorage, if that’s not included) is *equal to* the existing debt. That party line is perfectly consistent, in a growing economy, or in an economy with positive inflation, with perpetual deficits, as conventionally measured (i.e. non-primary, to include interest on debt). Basically, if Nominal GDP is growing at rate n%, then a government can run a conventional deficit of n% times the outstanding debt forever. (Because that means the debt will grow at the same rate as NGDP, so the debt/NGDP ratio stays constant over time.)
Rowe is right to call me out — my wording was sloppy. It was especially unforgivable that, in characterizing the conventional intertemporal goverment budget constraint, I omitted the modifier “primary” before surpluses.
But I was only sloppy, not mistaken. Rowe suggests that, when accurately characterized, the conventional intertemporal government budget constraint is something that sensible people actually believe. I cede no ground at all on this point. Rowe himself does not believe it. He gives himself a partial way out just in the part quoted above, when he writes “plus seigniorage, if that’s not included”. In most macro models, it is not included. There are two ways that you can incorporate seigniorage:
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You can treat seigniorage as a cost expected by borrowers and holders of money, in which case it is not disruptive to conventional models. It is equivalent to reducing the interest rate and taxing the value of real money balances, if those are in your model.
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You can treat seigniorage as a form of sporadic default. That is, you can claim that at some point the government will simply write down the real value of accumulated nominal debt, in practice by allowing debt or money growth without sufficient yield to prevent an increase in the price level.
The second view is disruptive of conventional models. Rowe may argue that we account for everything by the use of expectations rather than certain values in conventional models. That could be true, but broadly, it’s not. There are some models of default inspired by third-world debt crises, but outside of that, explosive growth in the price level and/or default are modeled are presumed or constrained not to occur. Monetary policy models are a partial exception, in that they derive conditions under which the constraint would hold, which then come to guide central bank policy. But in the limit, under standard equilibria in a decent country, it is assumed or derived that real primary surpluses will (in expectation) be generated in sufficient quantity to offset the real existing stock of debt. I view that as a very unlikely characterization for many existing governments.
Suppose that we do include the possibility of default. What happens? Rowe and I agree furiously on this:
Suppose there’s a 1% chance every year that a firm of government will disappear and default totally on its debt. The probability of default approaches 100% in the limit, going forward. But a risk-neutral investor will happily hold the debt with a 1% risk premium on the yield.
But what does this do to the intemporal government budget constraint? There is no constraint whatever in this characterization. Suppose that the government offers a 2% premium over investors’ cost of borrowing, and the probability of default is exogenously 1%. Then investors borrow and invest without limit! Obviously, we need to “close the model” somehow to make things realistic, but there are lots of ways to do so that violate any ordinary interpretation of the conventional intemporal government budget constraint.
I claim that realistic models, which incorporate consumers who face liquidity constraints and idiosyncratic risk in an economy subject to systematic risks of production shortfalls, do not conform to an intertemporal government budget constraint of remotely the conventional form. I’ve already described half of such a model here. I should add the other half, and write the math down in a way that economists can understand. The key insight is one that both quasimonetarists like Rowe and MMT-ers accept but rarely state explicitly — much of our motivation in “lending to the government” is not to capture growth, bit to self-insure against idiosyncratic risk. There is nothing novel about this — conventional treatments of the permanent income hypothesis characterize the conditions under which individuals will engage in precautionary saving. Redemption of precautionary savings in the form of money or government debt usually works not by government provision of goods and services when an individual faces shortfalls, but by virtue of transfers of real goods and services to those who face shortfalls from those experiencing surpluses. In other words, money and government debt are the medium by which we conduct a mutual insurance program. The stock of government debt then grows as a function of determinants of precautionary savings, which include income, but also risk preferences, the idiosyncratic risk that agents face, and the degree to which borrowing constraints bind. In all periods where the government does not default, participating in this insurance program is straightforwardly beneficial. The risk of rare government defaults, due to systematic shocks, may be insufficient to offset the benefits of participation in the mutual insurance program, and government debt need only be the least risky available medium, conditional on its use for insurance purposes, to rationally attract insurance-motivated lending. Under some circumstances (satiable preferences, steep reduction of incomes post-government-default combined with rationing based on prior savings, little relationship between the scale of insurance borrowing and the likelihood of default), I claim, it is reasonable to expect government debt to grow without bound. I consider these circumstances to be pretty realistic.
– MMT focuses (in my view) on the flow of net financial assets to the non government sector because that represents a flow of income and saving – as opposed to a central bank asset swap; and MMT views aggregate demand as income sensitive as opposed to money sensitive
– I’d say the stock of outstanding government obligations isn’t irrelevant, but problematic, in that it shouldn’t be fixed as a policy objective – it can’t be irrelevant if at the same time NFA is logically important, which it is according to MMT; MMT implies that the policy objective for NFA is a floating target as a function of emergent inflation
– Government obligations are largely held by financial institutions and pension funds; I don’t know what this has to do with “the wealthy” in a direct sense, at least in any sense that distinguishes a GO from any other financial asset; I’d say China and foreign central banks are a much bigger issue for such a focus than “the wealthy”, in terms of distribution issues
– I’m afraid I dislike your “net outflows” concept/definition in that I think it is stock/flow inconsistent. Aggregate redemption is not a private sector option (taxes are not a private sector option). Higher velocity of trade in or collateralization of government obligations is.
– NFA is negative equity for the government, which means an insolvent balance sheet according to the normal private sector measure of insolvency. If NFA is an important function, then conventionally measured insolvency for that balance sheet must be as well. Governments sustain and increase their negative equity with a continuing option to issue new reserves to the banking system, in return for cheques issued by government (or money otherwise credited) to the private sector. Bonds and currency are then options to diversify away from this “base case” of 100 per cent bank reserve monetary base.
– A solvent private sector entity delivers the medium of exchange in exchange for redeeming its liabilities. The government only redeems its liabilities (in total) by destroying the medium of exchange through taxation – which amounts to a transfer of positive equity from the private sector to government, as a calibration of its stock negative equity position. Which is to say that the definition of solvency and insolvency in the case of government should be changed (the definition of it – not the conditions for it) before it can be discussed – because it can’t be the same definition as applies to the private sector – unless you are quite comfortable with the discussion above, which I am.
– Using taxation to control inflation is the fundamental MMT transformation for a monetary policy that instead focuses on the price of money
– MMT doesn’t really blur NFA and national accounts saving; it nets out the latter by definition, which is particularly evident in the sector financial balances paradigm; the NFA approach could be viewed as marginalist – in the sense that implicit in isolating NFA as a quantum is the view that the non government sector is chronically a seeker of saving beyond the defined national accounts level
April 7th, 2011 at 10:11 am PDT
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I very much question the ability to tax. As taxes go up, evasion efforts increase, willingness to work (for taxable wages) decreases, and barter becomes more commonplace. People and companies can fairly easily move. Without a very firm ability to tax MMT becomes fairly hollow.
April 7th, 2011 at 10:25 am PDT
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[…] the rest here: interfluidity » MMT stabilization policy — some comments & critiques ← Embrace Default! » The Cobden Centre | Steve Baker […]
April 7th, 2011 at 10:50 am PDT
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Steve: Interesting to learn you discussed this with McArdle. I’ve tried and totally failed (and we’re buds!) Anyway — what were her reactions (if any?)
Also, I thought your ordering was interesting, as I think of MMT in exactly reverse order. Fiat currency is, at its heart, a manifestation of sovereign power. It derives directly from the ability to tax, and therefore, from a Sovereign’s monopoly on violence. I find your dichotomy between “legitimacy” vs “coercion” as being the axis that can extract tax laughably naive. I’m not writing my big check to uncle sam next week because I’m impressed by his “legitimacy”. It’s because I don’t want to go to gaol. But then I’ve never been a Protestant.
Also, to further burst your Protestant bubble, please do look at any third world country where sovereign power is weak. You will see your hearts desire come true — the rich, instead of hoarding the local paper — instead buy real assets to enable future consumption. Unfortunately those real assets are not new Internet companies or alternative wind farms, they are Gold, Land, and family owned conglomerates that they can pass on to their heirs. Not particularly valuable additions to the real economy!
I’m sure you can educate them on the error of their ways, or at least build a lucrative career in the attempt. Lord knows there is no shortage of western consultants telling those third worlders what to do.
April 7th, 2011 at 11:03 am PDT
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Is it fair to say, Steve, that what you mean by a “solvency” constraint is a sharp and unexpected increase in inflation?
It seems that way in point 4, where you say:
“Suppose, because of a sunspot, private holders of government claims get nervous and try to redeem them for current goods. If the net stock of claims in private sector hands is small, it takes very little taxation to offset that flow. If the net stock of government claims is large, than the desired flows might be massive, and governments might be faced with unappetizing choices between taxation or accommodating inflation.”
I thought, but wasn’t sure, that the above was an example of a “disruptive race to redeem [government obligations]”
As an aside: you have a conception of government “claims” that I don’t quite understand. In my (admitted) simplemindedness I often can’t parse some of the abstractions you use, so this could be one of those cases. And to make matters worse I’ve drunk the “entries on a spreadsheet” kool-aid, and so I really don’t understand what these claims/obligations can possible be, and what it can mean to “redeem” government claims (you can’t demand that the government exchange your bond for cash at your discretion (or maybe you can – I’m a musician, not a trader), you can’t use your savings to pre-pay fifty years of taxes (can you?), and any other “divesting” of stored government claims, i.e. currency, has a much simpler description: buying stuff).
But in any case, if the “solvency” constraint is simply the threat of unexpected and dramatic movements in the inflation rate, can you describe more concretely how that might happen (leaving aside sunspots causing an irresistible urge for private actors to dissave en masse)?
And if that’s not what the “solvency” constraint is, can you please explain what a “disruptive race to redeem” government obligations looks like, and hazard an answer to the open question you posed: to what degree will protection from formal insolvency protect government obligations from these disruptive races?
(This is my first comment, so I’d like to say that I get a lot of value from your posts, and I love how you combine intellectual heft with a humane sensitivity to rhetoric and communication – I passed your posts on “Endogenizing ideology” far and wide.)
April 7th, 2011 at 11:35 am PDT
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Best discussion ever! Thanks to our host and quality commenters…
April 7th, 2011 at 11:57 am PDT
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Hi Steve,
Nice overview. I like how you’ve attempted to generate a discussion rather than an attack and defend style approach. It’s much more conducive to productive debate. Anyhow, I’ve covered most of these topics on my site. You might be interested in my treatise on the subject (link below). I approach MMT from a (free) market practitioner’s perspective so it’s much more sympathetic to the austrian school. Although I am not an austrian I do sympathize with many of their beliefs – particularly when it comes to govt overstepping its boundaries. I do, however, recognize that some level of government intervention is not only necessary, but quite useful. So, I think I am straddling more of a middle ground when it comes to the Austrian vs. Keynesian debates that MMT often devolves into….
http://pragcap.com/resources/understanding-modern-monetary-system
Anyhow, my initial thoughts:
1. I prefer fiscal policy over monetary policy because of the channels through which they function. Monetary policy is most effective when it benefits the banking system. Our banking system is a system which produces little, but takes much. Yes, it is a vital component, but it is not the engine of economic growth.
The US economy is at an interesting juncture here as 30 years of monetary policy driven focus has resulted in a massively indebted household sector. I don’t have the time to get into the nitty gritty here, but I would argue that the flawed theories of the 70’s are largely to blame. A multitude of factors have resulted in an increased role of the Fed, explosion in the size of the banking sector and a shrinking middle class and imbalance in household balance sheets. The current predicament can be traced back several decades in my opinion. So, it’s not necessarily that fiscal policy is some holy grail (or that monetary policy is useless). It’s that monetary policy can be detrimental when it is relied upon too heavily. Fiscal policy, on the other hand, can be much more focused and precise in its efficiency of distribution – assuming it is applied effectively. The last 24 months certainly prove that fiscal policy can be allocated poorly. So it’s no holy grail…
2. This is a political constraint. Not an operational constraint. The level at which the public rejects the sovereign currency is hyperinflation. That is a very different phenomenon than inflation or even “high inflation” in my opinion. You might be interested in my thoughts on this subject: http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1799102
3. Yes.
4. The real value of money is in the underlying goods and services that that money can purchase. I like to think of the tax system as “the glue that binds”. Think of it like a partnership between govt and pvt sector. We all agree to use this common currency with the assumption that govt will properly regulate its supply in accordance with its demand. If either party breaks their part of the agreement the other party can reject the currency. I’ll copy and paste from my treatise:
The willingness of the consumers in the economy to use these notes is entirely dependent on the underlying value of the output and/or productivity, the government’s ability to be a good steward of the currency and the ability to enforce its usage….The government cannot force the “value” of its currency on its citizens. The value of these notes is ultimately determined by the goods and services that are produced by the citizens and the value that other citizens are willing to pay for these goods and services. Therefore, government has an incentive to promote productive output. Otherwise, they risk devaluing the currency and possibly threaten the stability of their currency system. Paying its citizens to sit at home doing nothing, buy cars they don’t need or purchase homes they can’t afford are unproductive forms of spending (sound familiar?). If government is corrupt in its spending and becomes an institution that is mismanaged and detracts from the private sector’s potential prosperity then it is only right that the citizens revolt, denounce the sovereign currency and demand change.
5. Again, I think we’re veering towards a hyperinflation discussion. See above.
6. Don’t necessarily disagree.
7. Again, I view the tax system as the glue that binds. A breakdown in the tax system results in hyperinflation and hyperinflation is the result of exogenous forces discussed in the paper above.
8. Yes. If the tax system collapses the gig is up.
Thanks again.
Best,
Cullen
April 7th, 2011 at 1:01 pm PDT
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thanks for the write up. i’ve only become familiar with mmt over the past six months. it’s clear to me mmt thinkers deserve a voice at the table, particular now
“Still, even by the standards of the blogosphere, MMT-ers have a reputation as an unusually prickly bunch.”
not really. compare these guys to other heterodox boosters like the austrians, and mmters are for the most part pretty accommodating and patient. part of the reason i gave them a chance…
April 7th, 2011 at 1:02 pm PDT
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:-)
“Modern Monetary Theory” is basically Neo-Chartalism in disguise.
Now I will leave aside “job-guarantee” aside which I think will just lead to more people sliding into the JG pool! ….
To be more correct, MMT is a securitization of ideas such as sectoral balances, endogenous money, stock-flow consistency (which is not ‘MMT’), and the tranche in focus – Chartalism. In other words, MMTers are “users” of the Aaa tranches rather than “issuers” :-) – using them somewhat less correctly to argue on how economies work and how they should work.
To me a criticism of MMT should directly focus on a criticism of Neochartalist ideas such as “State is not revenue constrained” and things we hear such as “sovereign” “Governments do not promise to convert its IOUs into anything else”, “nonconvertible currency” etc. Any other criticism is that of Keynesian demand management.
Unfortunately the starting premise itself is wrong! This is shown directly by looking at the IMF Articles of Agreement Article VIII, Section 4:
It clearly states what the State’s liability is. 177 or so of nations have signed the Article VIII, Section 4. I have posted the above in many places only to be met with denial of the Treaty. Its an important point because convertibility of currencies exists in various forms .. from official convertibility to current account convertibility (as above) t0 full capital account convertibility. To this extent, nations have sacrificed some sovereignty in order to interact with the outside world.
I do not know how in spite of the existence of such a Treaty, anyone could ever claim “non-convertibility”. Gigantic Goof!
The Keynesians in the 70s simply failed to understand what’s wrong with economies and their demand management recommendation didn’t work because governments were completely muddling with the foreign exchange markets and faced the balance of payments constraint. MMTers tend to think that this constraint is exotic. Why – because supposedly the state is not revenue constrained!
The Keynesians understood “Net Financial Assets” and all that and there is a lot of literature in the 70s which uses this terminology. Keynesians also used more sophisticated language than “net saving desires”.
The external sector is weak point of Chartalism. To the Chartalists, the global imbalance problem is “nonsense”. My debate in the blogosphere doesn’t even go beyond the simple points such as “listen okay – imports are not necessarily invoiced in your currency, in fact very few nations have this luxury” to currency problems. There is a definite innuendo that “current account deficits” are not a problem to thinking of them as “free lunch” and dancing.
The biggest goof is to think of indebtedness to foreigners (such as a large negative international investment position) in your own currency as “not debt”. Its a Profound Goof.
There are more goofs… such as ideas that the money multiplier worked in the Gold Standard .. or that … central banks controlled the money supply in other institutional setups. They didn’t!
April 7th, 2011 at 1:24 pm PDT
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In the article was written:
Governments are special. Their core asset is their taxing power.
A Government’s solvency constraint ultimately lies in its political capacity to levy and enforce the payment of taxes.
I wonder if the political capacity is related in any way to the percentage of the current budget which is borrowed money?
For example, I understand the current budget has to borrow 43 cents of every dollar it spends.
Thus, taxation supports 57% of our expenses.
Is there a point, say taxation supporting 30% of expenses, in which the political capacity is neutralized and the full faith and credit of the Government is weakened?
Don Levit
April 7th, 2011 at 1:41 pm PDT
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@ramanan
i’ve been following your musings on the imf rules pretty closely, and i don’t think you’ve convinced anyone that this is of huge relevance. why do you continue to parade it like you’ve found some silver bullet? hash it out on actual mmt blog before clouding up the debate elsewhere
nobody thinks that current account deficits are a free lunch. no one is denying that china can use its holding of dollars to purchase us goods *AT MARKET PRICES*. the relevance is the issue
April 7th, 2011 at 1:51 pm PDT
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studentee,
Its actually a minor point. The dance is a counterdance on “only thing we owe the Chinese is a bank statement”. The frequency of this counterdance is pretty low compared to the number of dance around “nonconvertibility”.
Your point that it is irrelevant is just an assertion. I don’t think they will be “convinced” given that there is a big deal made out of “nonconvertibility” – 10 years ?
Have also hashed it out on mmt blogs dear! Why do you worry ?
Now, come on there are statements from MMTers about “indefinite sustainability” so hardly a straw man there.
Plus do not know if you really understand how current account deficits hemorrhages demand. No the Chinese won’t spend the dollars so easily and become ever bigger creditors.
April 7th, 2011 at 2:14 pm PDT
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Thanks for a calm and rational analysis that poses useful questions.
There is one MMT proposition that you appear to have overlooked – zero rates.
The reason why the current system proliferates Net Financial Assets is that the government pays people to hold them. So unsurprisingly that is exactly what they do.
This payment then holds the currency exchange rate at a higher value than it otherwise would be – favouring foreign imports over domestic production.
So if you get rid of this government subsidy, then people are likely to hold less Net Financial Assets. They will spend the money in the current period, which generates taxation and keeps the amount of NFA held in the private sector low.
Fiscal policy has the power to destroy money, whereas monetary policy actually pays people to put money out of use temporarily – often non-domestic. And once you start paying you have to keep paying to prevent that money coming back into use.
Getting from where we are now to a system where holding money is not centrally subsidised is a challenge. However if you can get there then the distribution of NFA should be more equitable.
April 7th, 2011 at 2:14 pm PDT
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“There is no need whatsoever for governments to run deficits to support household saving.”
i don’t understand this. within the horizontal sector, all savings must be by definition matched by the dissavings of another entity, correct? so if the non-government sector in aggregate wishes to net save, the govt must spend in excess of taxation? or i guess what jkh said earlier…
there be a case where in the aggregate the non-government sector does not wish to net-save. but right now all the evidence is that it does
April 7th, 2011 at 2:30 pm PDT
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@ramanan
i worry because you don’t seem to be taking into account any criticisms of your argument vis-a-vis the imf treaty. it’s the same one you began with the first day you found it and announced victory on prof. mitchell’s blog. but unless someone wishes to address it here, i’ll drop it.
“…dear”
you shouldn’t do this, it’s a bad look
April 7th, 2011 at 2:36 pm PDT
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“you shouldn’t do this, it’s a bad look”
Don’t know what that means …
“i worry because you don’t seem to be taking into account any criticisms of your argument vis-a-vis the imf treaty.”
What criticisms? The Treaty exists. Period. (in spite of assertions since ages about “non-convertibility”). Convertibility is a big thing for international trade and the setup of the international monetary “non-system”.
April 7th, 2011 at 3:03 pm PDT
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Can someone (doesn’t have to be SRW) please explain the following:
“MMT-ers sometimes blur the distinction between “private sector net savings”, which is necessarily backed by public sector deficits or an external surplus, and household savings, which need not be. In doing so, MMT-ers rhetorically attach the positive normative valence associated with “saving” to deficit spending by government.”
I get that the government doesn’t need to deficit-spend in order for my shares/home/lemonade stand to have value; what I don’t get is the trickery involved in the balance sheet accounting.
April 7th, 2011 at 3:49 pm PDT
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“MMT-ers sometimes blur the distinction between “private sector net savings”, which is necessarily backed by public sector deficits or an external surplus, and household savings, which need not be…It is a category error to confuse the two. Yet in online debates, the confusion is frequent.”
^This.
Also, the difference between nominal expenditure and real GDP.
Also, you should have mentioned the Philips Curve! What is it exactly that the flow of NFA is supposed to, well, do? And how?
Finally, I disagree with you about the no Ponzi-game condition. It makes sense that in the limit govt debt goes to zero.
April 7th, 2011 at 3:51 pm PDT
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Rodger Mitchell’s version of MMT denies that taxes are the best way to influence inflation. He feels that money is like any other commodity in that the ‘price’ is determined solely by supply and demand. If government raises interest rates, the currency becomes more desirable and as such the available supply is effectively diminished. Basically the opposite of QE. Raise the reward for holding cash and you decrease the appeal of looking to trade it for real assets which is what inflation is.
April 7th, 2011 at 4:13 pm PDT
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Can someone (doesn’t have to be SRW) please explain the following:
“MMT-ers sometimes blur the distinction between “private sector net savings”, which is necessarily backed by public sector deficits or an external surplus, and household savings, which need not be. In doing so, MMT-ers rhetorically attach the positive normative valence associated with “saving” to deficit spending by government.”
I get that the government doesn’t need to deficit-spend in order for my shares/home/lemonade stand to have value; what I don’t get is the trickery involved in the balance sheet accounting.
His point isn’t about trickery, it’s about semantics. The accounting identities are blisteringly uncontroversial. The Private Sector’s net Government Obligations position is reciprocal to Public Sector’s net Government Obligations position. Calling these respective positions in Government Obligations “net private sector saving” or just “net saving” is perfectly accurate given the language used in sectoral accounting… and perfectly unhelpful. It is unhelpful because “saving” is used in other contexts to mean something much broader, i.e. “income not consumed.” This semantic confusion isn’t, I don’t think, merely benign.
When an MMTer talks about the Government preventing the private sector from “net saving” due to an insufficient quantity of Government Obligations issued (i.e. negative net public sector savings), it sounds to most listeners as if they are claiming that the private sector is being rendered unable to direct resources toward the future as opposed to the present. But of course the private sector can net direct resources to the future without the presence of any Government Obligations. Build a house or a factor instead of throwing a big party. MMTers may wish to argue that these attempts to secure future resources are, unlike “true” net savings (government obligations), risky, and thus shouldn’t be called savings. But that is hiding a functional argument in a semantic shell. It would be more helpful to clearly define net saving or even net financial assets as being different from other uses of the word saving by finding better vernacular, and then separately argue the relevance of how the private sector’s demand for lower risk future consumption in the form of Government Obligations differs from its demand for higher risk future consumption in terms of durable real assets.
April 7th, 2011 at 5:44 pm PDT
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The US has never faced the need to compel taxation in the face of strong resistance, but it has faced this challenge in the face of conscription, e.g., during the Vietnam era. This resistance did not affect US ability to man its military. If conscription is any indication, there is no reason to think that the US would be a position of not being able to enforce its ability to tax, especially in a surveillance state such as the US has grown to be. I doubt that any reasonably developed nation would be, unless the tax revolt was widespread and spontaneous, which would difficult to engineer given government government control of media and communications.
Losing the power to tax would essentially be the result of revolution or result in anarchy. While anything is possible, I would put the possibility of this very low. It is certainly not something that need figure in realistic calculations about policy as a monetary matter alone. This would take a general breakdown of the relationship of government and society that liberal democracy is designed to avoid at the ballot box.
Therefore, I don’t see much need to be concerned about “insolvency” owing to losing the power to tax in most countries today.
April 7th, 2011 at 6:30 pm PDT
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SRW: “I’d like to see more attention paid to quality-of-expenditure concerns…. Whether that is true depends entirely on institutional and political choices. These concerns can be and should be specifically addressed.”
MMT is a macro theory. These are policy questions. MMT’ers say that MMT as a macro theory show what the policy options and their consequences may be. The choice of options is political. Most MMT academicians have tended to avoid injecting politics into their professional work. It is generally no secret where they stand personally however.
There is a considerable argument about this on MMT blogs among righties and lefties that subscribe to the MMT view of macro. MMT as a macro theory is apolitical, although its basic approach to macro is in terms of achieving full employment (everyone willing and able to work has a job offer) and price stability, thought to be impossible by the mainstream without redefining unemployment to include a buffer of unemployed. MMT provides a buffer of employed and the JG wage functions as a price anchor.
April 7th, 2011 at 6:40 pm PDT
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Ramanan
That was an interesting and game changing clause you found from the IMF. I’m sure that was put in there in the first place so that nations in future will avoid the unbelievably skewed global trade imbalance we now have. How did we get here? The US completely ignored the threat of being asked to convert its debt in its trade partners’ currencies. How was it so cavalier about it? Because it was a military power? Or because the US knew that no nation on earth will cut off its nose to spite its face, and demand payment that it knows the US cannot and will never be able to pay?
Sure, pragmatically, that’s something that seems too far off to ever happen. But black swans have happened before…..
April 7th, 2011 at 7:34 pm PDT
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In my view, JKH has it right in #1 above. To understand this position it is helpful to realize that government as currency issuer is inverse to nongovernment as currency users. The “negative equity” of government (consolidated central bank and treasury) constitutes the net financial assets of nongovernment, since the liabilities corresponding to nongovernment NFA must lie with government. This is what “net” financial assets means.
Financial assets created endogenously (within nongovernment) have corresponding liabilities in nongovernment and net to zero, e.g., loans create deposits. However, government creation of nongovernment financial assets is exogenous (outside of nongovernment). Nongovernment can accumulate “net’ financial assets because the liability of the nongovernment financial assets that government creates with fiscal deficits lies with government.
Government then accepts its own liabilities in payment of obligations to it. Government taxes what it expends and any residual is nongovernment net financial assets. Government injects nongovernment NFA through fiscal deficits and withdraws them through taxation. Functional finance operates though by adjusting nongovernment NFA through injection and taxation iaw sectoral balances. That is to say, the government fiscal balance and the nongovernment balance (private domestic and external) must equal zero as an accounting identity. Desire to net save and net imports constitute demand leakage that must be offset with a fiscal deficit, or the economy will underperform.
SRW notes that fiscal deficits increase Treasury issuance under the current rule of no Treasury overdraft at the Fed; hence, provide interest to those holding tsys. MMT’ers point out that Treasury issuance is operationally unnecessary under the current monetary regime; thus, the interest constitutes a subsidy. Some recommend that this subsidy be eliminated by discontinuing bond issuance. If the Fed wishes to continue to set the overnight rate, it can do so by paying a support rate equal to the target rate it desires to set. Some MMT’ers also point out that the natural overnight rate is zero and that the Fed should set the overnight rate to zero.
Finally, MMT is more than descriptive of the monetary systen or a recommendation of using fiscal policy (functional finance) over monetary policy. It is an integration of the work of many previous economists, especially Keynes, Kalecki, Lerner, Minsky and Godley. MMT adds to this specific recommendations for achieving full employment with price stability, e.g., through the ELR. MMT needs to be approached as a comprehensive macro theory based on stock-flow consistent models that also entails range of policy options and their consequences.
April 7th, 2011 at 7:46 pm PDT
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What is the practical application of IMF Articles of Agreement Article VIII, Section 4: that affects MMT, which holds that the international monetary regime depends on floating exchange rates? How does this undermine or invalidate MMT? Please be specific.
Also remember what happened to the Bretton Woods Agreement on August 15, 1971, when Nixon nixed gold convertibility.
April 7th, 2011 at 7:51 pm PDT
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SRW
Great Post, I agree with all of your criticisms, both in kind and in degree.
What do you think of the zero rate proposal, as well as the bank regulation proposals — e.g. no market discipline on the liability side of bank balance sheets, etc.
April 7th, 2011 at 8:01 pm PDT
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JKH,
“MMT views aggregate demand as income sensitive as opposed to money sensitive”
I think that’s really the key point.
Vimothy,
“It makes sense that in the limit govt debt goes to zero.”
Why? It seems to me that the only reason is for mathematical tractability of some models.
Too bad for those models.
The only thing you really need is that, in the limit, Debt/GDP is bounded.
April 7th, 2011 at 8:06 pm PDT
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Tom
I think the IMF agreement authors understood the fiat nature of money, printed at will or necessity by the various trading nation-states. That’s why they had to put that clause in there, to keep a nation who understood the gig from taking advantage of nations that didn’t. What makes it astounding is not that it contradicts fiat money (the opposite, in fact) but that the implications of it being in the agreement were ignored by countries. Hopefully, it continues that way until a rebelancing is achieved, because this clause could be abused for geopolitical purposes.
April 7th, 2011 at 8:46 pm PDT
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SRW: 1. “While the flow of net private sector financial assets does strike me as an important and powerful tool for macroeconomic policy, it is not a uniquely effective tool. Changes in the relative price of financial assets (the object of conventional monetary policy) and in the distribution of financial assets can also powerfully affect behavior, and there are costs and benefits associated with each lever. What is the justification for focusing almost exclusively on managing the level of “net financial assets”?”
MMT puts the focus on exogenous money because it has largely been missed by the mainstream debate. The application of functional finance iaw the sectoral balance approach is not something others are talking about. Moreover, the debate is presently centered around monetary policy, which is turning out to be not only a blunt instrument, but one with unintended consequences unless the Fed is intent on blowing more bubbles.
MMT doesn’t deny the important of endogenous money. MMT is Minskian, and long before the crisis broke, MMT’ers were pointing out that financial instability was developing, based on Minskian analysis. MMT’ers, e.g., Warren Mosler and Randy Wray (with Bill Black), have been out in front proposing financial reforms and remedies. I don’t see that MMT’ers focus “almost exclusively” on the level of NFA, although that is one of their strong points. The emphasis likely seems exaggerated because no one eles seems to be aware of it and it is important policy-wise at this juncture with controversy centered on deficits and debt.
April 7th, 2011 at 8:46 pm PDT
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I agree with nearly everything except, “hat MMT offers the most promising toolkit for crafting a desperately needed replacement of status quo central banking.” I’m with Scott Sumner on guaranteeing a fixed-rate (probably 5%, which is the trend) nominal income path through the level-targeting of the NGDP forecast. The price level adjusts to complement real growth, and, I believe, aggregate (nominal) indebtedness should remain loosely bound to a steady correlation with aggregate production and resources, and not deviate substantially for an extended period of time during a credit-expansion fueled speculative bubble event.
As an aside, Calculated Risk has some great updated housing price charts here. It’s beginning to look like the average annual real-rate-of-return on housing for the nearly quarter century from 1988 to 2012 will be … Zero. From 1998 to 2006, many people genuinely believed that number to be 8-10%. As Tyler Cowen says, “We are not as rich as we thought we were going to be.” I sincerely wonder sometimes how much more is really required to explain what happened.
April 7th, 2011 at 8:52 pm PDT
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rogue, my view is that the clause is there for the developing world. It was never intended for developed nations. Developing nations have to hold foreign reserves to meet obligations. The USD is the reserve currency. I don’t think for a moment that the US government thinks its sovereignty is limited by this in the slightest, especially if Bretton Woods is any precedent.
I asked above what the implications are. Is China going to demand the US pay in yuan when they running a peg and need USD to defend it? Are other countries going to demand SDR’s when SDR’s are 44% USD?
April 7th, 2011 at 8:53 pm PDT
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“People like Dean Baker and Paul Krugman argue that a weaker dollar is exactly what the US needs to eliminate the structural gap in tradables production and spur domestic demand. People like Warren Mosler argue that a very weak dollar would be a bad thing, an adverse terms-of-trade shock and a loss of opportunity to trade cheap nominal claims for valuable real resources. ”
As a Mosler fan (who has even visited him in the Center of the Universe and drunk beer on his fishing boat), I’ll have to back him up here. It all depends whether you care more about some abstract numbers in a central bank spreadsheet, or in what your own (real, current) dollars can buy you.
When it comes right down to it the people who recommend cheaper dollars do so because they fear that if we don’t, there will someday be a reckoning – which would consist of the dollar getting cheaper. That’s like saying, “We’ll have to stop drinking when the beer runs out, so as a premptive action we should throw the cooler overboard!”
April 7th, 2011 at 8:56 pm PDT
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Steve,
A very lucid and fair critique. Like Cullen Roche, I’m a market practitioner AND an MMTer, so I tend to look at the ideas in those terms. Those who like to call MMTers utopian fail to recognize that much of what we describe is not theoretical but accurately defines monetary and fiscal operations. MMT is a description of the way a sovereign currency works. Love it or hate it, our sovereign government spends by crediting bank accounts. Over the past 20 years, MMT has investigated, analyzed, and documented the sordid operational details. We can lecture for hours on the balance sheet manipulations involving the Treasury, the Fed, the primary security dealers, the special depositories, and the regular private banks every time the Treasury buys a notepad from OfficeMax. few libertarians and Austrians now get this, although instead of acknowledging the scholarship behind the work, we are immediately attacked, which explains much of the consequent “incivility” in response.
There appears to be a fear that if we tell policymakers and the general public how things work, democratic processes will inevitably blow up the government’s budget as everyone demands that wine flow freely through the nation’s drinking fountains whilst workers retire from government jobs at age 28 on generous pensions provided at the public trough. And off we go to Zimbabwe land, with hyperinflation that destroys the currency and sucks the precious body fluids from our economy. We’ve addressed this point as well. When you so comprehensively mismanage the supply side of your economy as the Zimbabweans did the only way to avoid inflation is to severely contract real spending to match the new lower capacity. More people would have starved and died than already have if the Government had have cut back that severely.
But this disaster has nothing much to do with budget deficits as a means to ensure high levels of employment in a growing economy (where capacity grows over time) where the non-government sector also desires to save.
That said, I do think the Austrians in particular have a strong point in terms of highlighting the potential corruption in government, which undermines the MMT claim that government is the instrument best utilised to mobilize broader public purpose. That’s clearly not the case when you have a dysfunctional polity and I think it’s an area that we MMTers have to address more honestly (as Jamie Galbraith has, for example, in his book “The Predator State”).
I think the JG program or widespread tax cuts help to minimise the government’s discretionary room for targeting their crony supporters, but it’s insufficient and I think this is one potential weak link for us.
The other area is trade. We do emphasise that “imports are a benefit, and exports are a cost”, but ONLY IN THE CONTEXT OF A FULL EMPLOYMENT ECONOMY. It’s absurd talking about the benefits of imports when it is accompanied by huge job loss. Again, that’s a point we have to acknowledge and stress more often.
And, I think, finally, we sometimes conflate the descriptive with the normative: it’s important to acknowledge that a sovereign currency issuer such as the US is OPERATIONALLY unconstrained, but is LEGALLY constrained via things like the debt ceiling. We have to be careful to distinguish between the two, although I think both Bill Mitchell and Scott Fullwiler in particular have honestly addressed this issue.
Anyway, your two pieces were very cogent and fair and I want to compliment you for conducting this discussion in such a lucid and civilised manner. (And I look forward to meeting you at the Levy Conference next week in NYC)!
April 7th, 2011 at 8:59 pm PDT
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Tom
Just to be clear,I don’t think the IMF agreement undermines MMT or belief in fiat (quite the opposite) That is why the potentially dangerous implications I see of that clause being in the agreement are not exactly economic in nature, but geopolitical. Granted, geopolitics is outside what I usually track, so I can’t say for sure what could possibly make the Chinese suddenly abandon their peg,and suddenly demand the US to pay them back in yuan. But geopolitical moves and aims are much more broad than purely economic.
This is outside of MMT, has no bearing on what MMT says. But realizing that clause being there was interesting and astounding.
April 7th, 2011 at 9:26 pm PDT
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Hi SRW, TC here. Another classic post, btw.
I think we agree far more than we disagree on the the distinction between solvency and debasement. I have many of the same fears you list – I’ve also traded extensively so am familiar with discontinuous pricing of assets.
Instead using the term quote – solvency – quote, I’ll use “Discontinuous Debasement” and shorten it as DD. I know, I know, please bear with me. I consider the use of the words “solvency” and “insolvency” to be moral words. The use and mis-use of these two words is very important, because these words are used to make people believe something that isn’t true. This belief is then used to rationalize lower standards of living for most people. I won’t use “solvency”, not even in quotes. I read your “Endogenize ideology” carefully and took it very seriously.
Part of the reason my post repeats itself and seems like more of a rant rather is that this is a moral argument, and not just addressing a technical issue of debasement vs. insolvency. It isn’t a technical issue to me. I like it when people are richer, and I think more people understanding MMT would make the world a slightly richer place.
Please forgive me if I sound harsh though this piece. I am just working through some things here, and wanted to respond quickly. But I also want to keep the tone light! So please take any part of the tone here in the best possible manner.
Here some of the questions in point 5:
“Can we be confident that, absent the danger of outright default, any debasement of fiat claims would take the form of an observable spiral, which would start slowly and thereby offer time to apply a policy antidote? ”
Yes, I am very confident, with 3 constraints that the United States fulfills
“Would we in fact observe and recognize the signs, and would they be different than, for example, a 500% increase in the price of gold in the span of a few years and recurring bouts of commodity inflation?”
I do think we would observe the signs for the U.S. subject to the constraints, and they would be different than a 500% increase in gold.
“Are employment pressure and labor costs the sole true and perfectly reliable indicators of debasement hazard?”
I think yes, they are the most reliable we can observe.
To expand on the response to first question, I think we would find it easy to recognize the signs of debasement for the United States. It has to do with your identification of the “Secret Weapon” of MMT, and the insight as to the power of governments.
I’ll start out with your Point 8. We would see an observable spiral of debasement in time for a policy antidote with three additional criteria in place:
1. When there is a legitimate government;
2. With a large population or a large economy relative to the known world economy;
3. and has a low current inflation rate.
The starting point of MMT is the power for governments to enforce their will on the population. Your point 8 is about this political constraint on the acceptance of currency. I talk about it in one of my first posts. http://wp.me/p1b5Ih-14 Democratically elected governments don’t have to do much to enforce their will, because people agree to the will of the government.
MMT is the logical extension of political dominance to the issuance and control of the medium of exchange.
True metal money that is exchanged for real world goods at the point of sale is impractical for modern society. Think “I’d like to buy 100 Shares of Apple, please” and tell me you think pure commodity money can work. So paper money or computer money must be used, even if this is backed by gold stored somewhere.
For any practical money system to work – even one “backed” by gold – the government needs to be legitimate. Think of a U.S. dollar backed by 1 ounce of gold in a vault somewhere. If the government becomes illegitimate, any paper claims to that ounce of gold are worthless. Physical assets retain their “worth”, but paper claims to them do not. This goes for every physical asset. Paper claims to gold, cars, factories, buildings, and real estate become worthless. When the government becomes illegitimate, you own what you can carry, until some guys with guns take even that from you.
So, we are assuming that for any money system to be stable, the government backing it must be legitimate. Witness war zone transactions in local currency, ect.
This is your point 8, but maybe said in slightly different terms, I think.
When a population agrees to recognize the government and pay taxes, the legitimacy of the government isn’t really in question. How can this change overnight, or even in a few weeks or a few months? DD won’t happen due to a country suddenly deciding overnight the government is illegitimate. We’d see evidence of currency debasement in inflation rates for a long time before the problem would spiral out of control. The “political legitimacy” channel of DD is not a viable channel.
When the population or economy is small relative to the rest of the world, there is a real risk the users of that currency could decide to shift preferences and move out of that currency. This is mentioned in your point 7. The population of a small country could easily decide to change their minds in a few days and move to a currency with a larger base, even with a legitimate government.
But how about for large economies, or large populations? How can you shift preferences overnight from that currency to some other asset over a period of days or even months? More directly: What could the entire United States decide to use in the next 6 weeks as a legitimate medium of exchange? Answer: Nothing. There is nothing else but U.S. Dollars that can fill the role. I am exposing myself to the Black Swans here, but feel pretty confident. There is nothing in the world that could fill that role in a short amount of time. Ditto for Eurozone, and the Yen. I don’t see anything – anything – that is granular enough, common enough, valuable enough to take that place. Full, unopened 16 oz. bottles of Pepsi might be the only competition for the U.S. Dollar.
A DD is a dramatic overnight shift in savings demand preferences. I don’t buy it for a large country like the U.S…unless there is already existing relatively high (15%+) inflation combined with some political agreement.
The final criteria is that of low current inflation rate. I believe in DD to some extent – its possible that there could be a doubling, tripling or quadrupling of the inflation rate at any given time. I can see inflation going from 3% to 6% due to some massive change in savings preferences, or possibly even to 10% inflation. I cannot see going from 5% inflation to 50% inflation overnight in a large economy, barring cataclysm. There just isn’t a mechanism that would cause savings preferences to change this rapidly for a legitimate government with a large population and large economy that isn’t related to a freakishly large natural disaster.
However, at 18% inflation, we easily see a jump 50% over a few weeks – its believable that the current government could convince people to value their money much less. I seriously doubt this would happen, or that it could be sustained, but I can imagine it with a sufficiently large political push. But thats with 18% inflation. A jump from 7% inflation to 50% seems impossible to me. I do not see it happening without some very serious political event – which calls into question the legitimacy of the government in the first place.
With these three criteria in place, there little chance of a DD.
Next:
Is there is the chance of a DD due to something we don’t recognize or observe at the time? Well, we cannot recognize them at the time, as you point out, so why worry about them? We’ll clean up the mess after. That is how we learn, right?
As to how this inflation would look different than a 500% appreciation in gold or theoretically other assets, these assets can vary in value.
A moderate bull market in a asset that could fit in an olympic swimming pool and only held in any quantity by a tiny minority of humans is not a valid concern of a government that provides the daily medium of exchange for hundreds of millions of people and is the reserve currency of the entire planet. (ok, yes, “I collect spores, mold, and fungus”) Note that everyone that has enough money to worry about inflation eroding their paper wealth can easily hedge a majority of their inflation risk in gold or whatever asset they think will retain value. Nobody is stopping them today from doing this hedge. Freedom!
I address the reason to ignore short-run energy inflation and focus on core inflation here: http://wp.me/p1b5Ih-ga
Government monetary policy cannot do anything about short term swings in energy prices due to the inelastic nature of energy demand. Monetary policy large enough to impact energy prices in the short term would be massively destructive to the real economy. This applies to either direction in energy prices – up or down. We could try to raise energy prices, but that would result in serious DD if it was effective!
Long term energy prices should be a massive concern of the government because they relate to the real standard of living. But I suspect the answers to long term energy prices involve far more than monetary policy.
Consumer level food inflation is a legitimate concern of the government. Notice, that we have not seen much food inflation at the consumer level, despite a doubling of the cost of grains.
For both food and energy, the presence of long term speculators due to long-only commodity funds is a question that should be addressed far more widely. Lots to think about on those topics.
So, are employment and inflation the best currently-known reliable indicators of debasement? I’d say yes, given the constraints I lay out here, and which are met by the United States.
Now, I have some other issues with MMT – for example, I don’t think that the explanation of the 1970’s inflation is fully cogent.
But this is already long enough. Great Post, and thanks for going through this. I have been thinking and working on a MMT Taylor/McCallum rule for a while.
April 7th, 2011 at 9:39 pm PDT
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Nice analysis, TC, but I wonder why we are so absorbed in the “solvency” issue wrt MMT. Everyone recognizes that fiat currencies have advantages and disadvantages and that one of the disadvantages is debasement. Given certain conditions including “fiscal irresponsibility,” of course a fiat currency can implode. So what? Fixed rates have their advantages and disadvantages, too. But the fact is that the world is running on fiat currency at present and that is the system we have to deal with. The question is, what is the best approach to this.
The possibility of “solvency” or debasement is a red herring — a distraction. It certainly is not a good argument against the use of MMT principles in economic policy. This is the monetary system we have, whether one understands MMT or not. Stupidity is a risk of liberal democracy. If the people elect fools (not mentioning any names but you know who), they will have to suffer the consequences. But if they elect wise people who understand how the monetary system works (so far in very short supply) and how to deal with it, then the outcome can be expected to be better than otherwise.
The emphasis of MMT is not merely monetary anyway. As a macro theory it is concerned with real resources and making them available to those who desire them, considered from the vantage of aggregates (macro) rather than individuals (micro). Economics in general is about production (supply), distribution (markets in a market system), and consumption (demand). Money is chiefly a medium of exchange (transactions) and a unit of account (price). MMT enters at the level of transactions that are booked nominally but are journalled in terms of the stuff involved in the exchange, be this real or financial. But even financial assets are generally representative of something real. Shares represent a share in something. MMT is not “just” a monetary theory. It is a macro theory for achieving optimal national outcomes, such as sustainable use of resources, full employment, and price stability, based on balancing private and public interests — private desires (needs and wants) and public purpose.
A basic contention of MMT is that macro is an independent discipline within economics, rather than micro scaled up. This, in addition to its understanding of monetary operations and their implications, sets MMT apart from the mainstream. Why are we so concerned about “solvency” or even debasement wrt when that is the current debate about the current policy regime? The current policy regime does not seem to have good answers from this. MMT does, in terms of sectoral balances and functional finance, as well as its Minskian approach to endogenous money.
April 7th, 2011 at 10:50 pm PDT
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Probably the best critique of MMT I’ve seen.
I’d like to add a couple of points regarding taxation as a tool to control demand (point #7). Seems to me this needs to be implemented as an automatic stabilizer, something like inflation-adjusted rate out of control of the Congress. Anybody who objects saying that businesses cannot operate without knowing what their tax rate would be ignore that:
a) the same could be said about interest rates and yet businesses operate just fine. They hedge their IR risk thru derivatives and I am sure Wall Street will swiftly come up with tax derivatives if floating taxation were ever implemented.
b) tax rate is not constant today either. True, MMT tax adjustments could in theory be of greater magnitude than today’s variation, but I don’t think anybody claims that MMT can solve all the possible problems. If a very large fiscal adjustment is ever needed, then something very wrong must have happened before. If it is a natural disaster or a war, then other policies such as rationing and price controls might be necessary.
April 7th, 2011 at 10:57 pm PDT
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Steve:
Bravo – admirably done. Precisely the kind of thoughtful engagement with these ideas that is needed, and the effort you put into this is appreciated. I will leave only a few brief comments on first reflection and maybe circle back when I have more time.
On 1, agree there is much room to introduce portfolio balance approaches, where shifts in portfolio preferences and asset prices, relative and absolute, play a role in macrodynamics. You find more of this in Keynes, Minsky, Tobin, Boulding, Vickrey, Leijonhuvfud (indeed, I feel there are outlines of a portfolio based economics throughout these economists) but so far not well developed in MMT.
On 2, we see instances of currency substitution in economies, and we also see runs on currencies, so these need to be addressed, especially to apply MMT to emerging nations. The answer that higher taxes will increase demand for domestic currency and so break currency substituion or currency runs may downplay the political constraints on raising and enforcing taxes (think Bjorn Borg emigrating from Sweden, black markets, etc.). You bring this back up in point 7, and this is an important practical matter. It is also relevant to a question I think you raise later about what happens when a large share of your public debt is owned by foreign savers, which are harder to tax than domestic citizens. There is also the related question of the “exorbitant privilege” of nations with global reserve currency status. Trading partners can and do demand to be paid in other than the national currenct of their counterparties.
On 4, (and this is something I should ask Bill Mitchell about), Australia has run a chronic fiscal surplus for many years, as well as a chronic current account deficit, and yet the corresponding chronic domestic private sector deficit (“when agents, on net, seek to increase indebtedness” in your language) has not “led the value of government claim to come under pressure” (i.e. escalating inflation). How come? Also, as an aside here, perhaps rating agencies need to confess they are assessing inflation risk, not default risk, when they are grading the debt of sovereign nations.
Later in 4, you also integrate Cullen’s point that if taxes are a way of governments establishing a claim on real products produced by the private sector, then the private sector needs to have productive capacity, and so swimming all the way upstream, we must consider that if taxes play a role in giving money value, there has to be a productive real economy. It seems to be a simple point but also can get lost in tracing through the monetary/financial flows. A better job of integrating real economy elements, without going all Austrian, is important and sometimes falls too far to the side of these discussions. There is a risk of MMT falling into a neo-mercantilist account of economics, where wealth (tangible productive capacity) and claims on wealth (financial titles or monetary instruments)are confused. You touch on this again point 8, and admirably so. I also think tying government expenditures back to qualitative issues, which Pavlina treats, and Joan Robinson treated as well is important, with their influence on labor productivity being on of those qualitative issues.
On 7, the ELR is a fairly automatic policy tool and maybe you should dig deeper into descriptions of it. I don’t have handy references, but others will. There is a debate with Malcolm Sawyer I believe, or maybe Phil Arestis, which is worth pursuing regarding traditional fiscal stimlus vs ELR. Possible real world complications of ELR may need to be better thought out (patronage schemes, managing productivity, complexity of possible tasks given uncertain workforce size and experience, etc.) but this is a simple but powerful automatic stabilizer mechanism that deserves more attention than tax rate manipulation or transfer payments, which you currently seem to favor.
Under miscellaneous, regarding the smearing of household savings and net saving of the private sector, I agree people should be more careful or strive for more clarity here. Too many people think of saving as a stock rather than a flow, and too few people realize their has to be an income stream to save out of, which must be the counterpart of prior spending.
In theory, we could have a world without government or foreign trade where banks make loans that create deposits, the loans are used by firms to install tangible productive investment, and households save a portion of their incomes, which turn out to be equal to the external liabilities of the business sector. You will find such stories described in many of the endogenous money and Circuitiste papers of the ’80s and ’90s. Households can net save as a sector as long as business net deficit spends (invests in tangible productive investment more than it saves out of profit income in retained earnings). These then net to zero. The only loophole I can find is if some of those external liabilities of the business sector are equities, the current market value may exceed the book value at issuance. Unrealized capital gains of the household sector may not be matched by an equal liability of the business sector. But I have yet to think this all the way through, and obviously realizing those capital gains requires units that have already been able to net save money (or other acceptable means of settling the trade).
Anyway, please know your exercise was far from entirely useless, and keep going. Maybe these ideas won’t get accepted or implemented in our lifetimes (and maybe for good reason), but at least we can help shake these unconventional but powerful perspectives down as best we can, and then boil them down into accessible memes and pragmatic policy proposals for the next generation to run with. If that is all we achieve, the efforts to explore this new terrain will prove far from useless.
best,
Rob
April 7th, 2011 at 11:03 pm PDT
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For Ramanan:
The IMF treaty can be considered just a self imposed constraint, like debt issuance and debt ceiling (only even less practically enforceable) – this is no more a refutation of MMT than those two, don’t you think?
April 7th, 2011 at 11:09 pm PDT
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Still the best post ever. Non-judgmental, yet clear and concise. Including consideration of the comments to date, I think MMT comes out very well indeed. Not a single commenter has defended the conventional wisdom that government deficits are a significant issue. When I listen to NPR tomorrow, I will be unable to ascribe to it any credibility whatsoever…
April 8th, 2011 at 12:07 am PDT
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Rob P/anyone:
Do you really model the demand for money as a function of the tax rate…?
April 8th, 2011 at 1:44 am PDT
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“Also, although MMT-ers are typically regarded as “left” economists, I think they underplay the distributional costs that attend expanding the stock of government obligations.”
This is a strange remark given that prominent MMTers favor a 0% Fed funds rate, which given any inflation means a negative real rate on cash. Current Fed policy implicitly promises that investors in cash will more or less keep up with inflation.
On inflation: chronic inflation requires increasing income. A currency devaluation increases prices but not incomes (except for incomes which are linked to a price index). So they are totally different phenomenon even though both involve rising prices.
April 8th, 2011 at 3:23 am PDT
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[…] MMT stabilization policy — some comments & critiques Interfluidity. Steve Waldman being temperate and thoughtful on Modern Monetary Theory. […]
April 8th, 2011 at 5:39 am PDT
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Steve: “(I don’t think any sensible person believes indebted governments will ever run surpluses of present value greater than the accumulated stock of public debt. Yet that is the party line solvency criterion.)”
No, that’s not the party line. In fact, the party line would say that is impossible. The party line says that the *expected* present value of *primary* surpluses (plus seigniorage, if that’s not included) is *equal to* the existing debt. That party line is perfectly consistent, in a growing economy, or in an economy with positive inflation, with perpetual deficits, as conventionally measured (i.e. non-primary, to include interest on debt). Basically, if Nominal GDP is growing at rate n%, then a government can run a conventional deficit of n% times the outstanding debt forever. (Because that means the debt will grow at the same rate as NGDP, so the debt/NGDP ratio stays constant over time.
“Macroeconomic theory is often stupid about debt. Common models impose a “no Ponzi condition” that is absurd not only for governments, but also for private firms. All firms and governments eventually end, and when they do, they usually leave substantial claims unsatisfied.”
That’s not correct either. That’s where the *expected* part of the “expected present value of primary surpluses* comes in. Take a simple example. Suppose there’s a 1% chance every year that a firm of government will disappear and default totally on its debt. The probability of default approaches 100% in the limit, going forward. But a risk-neutral investor will happily hold the debt with a 1% risk premium on the yield.
Expectations of the future matter, for people’s willingness to hold assets, whether it’s money, government debt, or a real asset. An accounting framework that ignores people’s expectations of the future totally misses that point.
The real problem with the “no-Ponzi” condition is the assumption that the required yield on an asset exceed the growth rate of the entity issuing that asset. As in Samuelson’s (1958?) Exact Consumption Loan Model, we get a very different world if the rate of interest is less than the growth rate of the economy, so that Ponzi schemes are sustainable indefinitely. Because you can rollover the debt forever, borrowing to pay the interest, and the debt/GDP ratio still declines.
And, it’s precisely when you look at money where you see that no-ponzi assumption is clearly violated. For example, the Bank of Canada effectively “promises” a negative 2% real rate of interest on currency, but the real growth rate of GDP is positive. So money is a stable Ponzi scheme. And one of the problems with MMT is that, AFAIK, they assume money and debt are effectively the same while totally missing the very difference that is so central to their assertions about functional finance. If r>g for bonds, but r<g for money, then the budget constraint for money-finance is fundamentally different from the budget constraint for bond-finance.
They really need to look beyond the current period when doing their accounting. Then they might understand some of these issues.
But some of the things you say about MMT are insightful. Now I've dealt with these issues I will go back and read it more thoroughly.
April 8th, 2011 at 5:42 am PDT
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OK. One more: “Therefore, a government’s “solvency constraint” is not a function of any accounting relationship or theories about the present value of future surpluses. A government’s solvency constraint ultimately lies in its political capacity to levy and and enforce the payment of taxes.”
That is a false dichotomy. A government’s expected future political capacity to levy and enforce the payment of taxes is exactly one half of the expected present value of future surpluses. (The other half is of course the government’s expected future expenditure).
April 8th, 2011 at 5:51 am PDT
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Now let me be provocative. How many MMTers have read this post? Probably hundreds. Do MMTers always talk about how important it is to get the accounting right? Yes. Did a single MMTer notice your accounting mistakes above? If so, they said nothing. Has a single one of them actually sat down to work out the accounting for the intertemporal government budget constraint?
It’s not that hard guys. Write down the current period government budget constraint. Do the same for next period. Substitute the latter into the former. Repeat ad infinitum. What do you get? Something like EPV(G)-EPV(T) + current debt = EPV(debt at year infinity). Now think about the weird term on the RHS of that accounting identity. Then look up “L’Hopital’s Rule”.
April 8th, 2011 at 6:11 am PDT
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[…] MMT stabilization policy — some comments & critiques Interfluidity. Steve Waldman being temperate and thoughtful on Modern Monetary Theory. […]
April 8th, 2011 at 7:31 am PDT
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” If r>g for bonds, but r<g for money, then the budget constraint for money-finance is fundamentally different from the budget constraint for bond-finance."
Except r < g for both money and (intermediate term) bonds.
It's not that hard to look this stuff up. We have data on GDP and bond yields going back over a hundred years.
And in that case, the EPV(Taxes) = infinite, but EPV(debt at year infinity) is just a function what deficits you want to run. If you want to run deficits of 20% of GDP every year, then there will be a (finite) debt/GDP ratio in year infinity. For every cap on deficit/GDP spending, there will be a corresponding cap on Debt/GDP.
However, if the deficit/GDP ratio goes to infinity, then so will the debt/GDP ratio.
April 8th, 2011 at 7:44 am PDT
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the MMT label was a recent development that applied to my writings and discussions, beginning with Soft Currency Economics in the early 1990’s, followed by ‘Full Employment And Price Stability around 1995, and then followed by the paper ‘A General Analytical Framework for the Analysis of Currencies and Other Commodities’ which provide definitive responses to all of your points. Shortly after writing Soft Currency Economics I met the late Bill Vickery at a meeting of what I recall was called ‘Social Policy’ in NYC and was directed to who were called the Post Keynesian’s, where I discovered their internet based discussion group. There I met Bill Mitchell and Randy Wray, who have subsequently become the main academic proponents of what is now called MMT.
April 8th, 2011 at 7:56 am PDT
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@Nick Rowe
“Expectations of the future matter, for people’s willingness to hold assets, whether it’s money, government debt, or a real asset. An accounting framework that ignores people’s expectations of the future totally misses that point.” do you own a farm Nick? Because you seem to have a lot of straw men lying around. when has any MMT advocate ever uttered the words “expectations of the future don’t matter”? I haven’t heard anyone say that. In fact, if you actually open some of the academic text that MMT is based, you’ll find an incredible amount about expectations. Whether it’s Minsky’s books, or Godley’s 2006 textbook (where you spend most of the time explicitly modeling expectations) there is quite a lot on expectations of the future. But of course, actually reading or going through any of that wouldn’t be worth your time. That’s fine. But if you’re going to criticize MMT (and I’m sure there are things to criticize) it would be nice if you weren’t arguing from a place of ignorance. Simply because MMT people don’t accept your version of how expectations of the future affect the economy, doesn’t mean that MMT don’t think about them. Normally Nick, i enjoy your blog, even though it is very much in the mainstream. This however, was a somewhat nasty response.
April 8th, 2011 at 8:11 am PDT
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*doesn’t think
April 8th, 2011 at 8:12 am PDT
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RSJ: Yep. You have actually thought about this stuff. It all hinges on whether rg? If so, that’s what we need to understand, because the very nature of the intertemporal government budget constraint will depend on the level of debt. We jump from one regime to another, at some critical threshold. So we can only run a Ponzi scheme up to some finite value (like in Samuelson). Or maybe whether r>g depends on expected future T and G?
By the way, if anyone asks “what’s L’Hopital?” I hope you will field the question, to save me screwing it up ;-)
April 8th, 2011 at 8:22 am PDT
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Nick @ 46,
Scott Fullwiler has already addressed the IGBC in Interest Rates and Fiscal Sustainability (2006).
April 8th, 2011 at 8:25 am PDT
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Damn. My 8.22 comment didn’t post right. Let me try it again.
RSJ: Yep. You have actually thought about this stuff. It all hinges on whether r is bigger or less than g. Does the level of r depend on the debt/GDP ratio? If so, that’s what we need to understand, because the very nature of the intertemporal government budget constraint will depend on the level of debt. We jump from one regime to another, at some critical threshold. So we can only run a Ponzi scheme up to some finite value (like in Samuelson). Or maybe whether r>g depends on expected future T and G?
By the way, if anyone asks “what’s L’Hopital?” I hope you will field the question, to save me screwing it up ;-)
April 8th, 2011 at 8:27 am PDT
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Tom @ 53:
Thanks. good link. The first 10 or so pages of that paper make sense to me. Then, around page 14, he seems to ignore those first 10 pages, goes off on a tangent, and loses me totally. I really do wish he would write down some simple model so I could get the gist of what he is saying.
April 8th, 2011 at 8:47 am PDT
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I don’t *think* that whether r < g depends on the government debt level. But the wrinkle is that r is a risk-free rate, and whether you believe government debt is risk-free may well depend on the debt level, if the government is not a currency issuer, and for long run historical data, it hasn't been. I don't think you will find evidence that higher debt levels correspond to higher interest rates — not robust evidence, anyways. I think Scott F. wrote a nice survey on this topic.
But there are so many issues here. Post-industrial revolution rates are low — say early 1800s on. But then look at Dutch Finance, with their incredibly low rates and enormous state debt. In the 19th century, the French government kept defaulting on rentes, and yet there were plenty of buyers. One of the explanations I read was that no one trusted the private sector there. Certainly the asian tigers manage financial repression with low rates and not a lot of inflation, although they had their own asset valuation problems. Tell China that the government doesn't control real rates!
But about L'Hopital's rule, the story I heard is that he bought the rights to J. Bernoulli's mathematical discoveries in exchange for an an annual payment. Then he wrote his textbook.
Everyone wants an annuity.
April 8th, 2011 at 9:08 am PDT
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Nick @55
I passed it on to Scott.
April 8th, 2011 at 9:09 am PDT
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Nick . . . probably because somewhere around p. 14 the critique of the previous pages begins. :)
April 8th, 2011 at 9:10 am PDT
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The gist of it is two-fold
1. bonds vs. money doesn’t matter in terms of inflationary impact, aside from interest differentials.
2. interest on the national debt is a policy variable, not something set by mkts, at least for a currency issuer under flex fx.
April 8th, 2011 at 9:12 am PDT
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Scott: Yep. That’s part of it. But that’s not all of it. If you are saying something unfamiliar to your reader, you really need to give some sort of simple example, or model, or whatever, just to help the reader get the gist of it. It’s OK if that simple example is way over-simplified. You can always add in the complications later.
Here is my *guess* at what you are saying: you have some sort of Phillips Curve at the back of your mind that leaves out expected inflation. You are either ignoring the distinction between real and nominal interest rates, or you are assuming that AD does not depend on interest rates. Then you have the rate of interest set by monetary policy.
Again, that is a total guess. I am almost certainly attacking a straw man. But that’s what happens when I have to try to “reverse engineer” your model. (I am trying to guess at the assumptions you would need to make your conclusions correct, and I am very probably guessing wrong.) If you wrote down (in words or math, it doesn’t matter) say 3 equations: an AD function; a Phillips curve; and some sort of monetary policy interest rate setting rule, it would really help me (and others) understand what you are saying.
Nathan: yes, I do own a farm (sort of). You guessed right!
April 8th, 2011 at 9:26 am PDT
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RSJ@48 . . . exactly right on convergence if r<g. I showed that in one of the tables in the paper. and correct on historical rates, too.
April 8th, 2011 at 9:28 am PDT
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Nick,
The point of the paper is to talk about how rates on the national debt are actually set. It doesn’t matter if we are talking nominal or real in that case, since what matters is the rate relative to g. So, if you have nominal i, you compare it to nominal g. The only difference b/n that and real for both is to subtract inflation from both–and for the IGBC. And it’s the ex post rate of inflation that matters, not the ex ante expectation, for whether or not unbounded debt service actually occurs–Blanchard et al. were very clear on that. Overall, you want to say rates on the debt are set by markets. MMT’ers reject that. That’s it, since that one point makes all the difference in the world. No broader macro model is necessary for making that one point, which is all I was attempting.
April 8th, 2011 at 9:33 am PDT
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Some general comments
Regarding the IMF clause:
You have to buy your currency from your foriegn creditor, right? But at what price? If you have issued a lot of currency and your foriegn creditor has issued little, you will have to give up little in foriegn reserves to accumulate much of the currency you issued. That’s the thing with floating rates, they adjust the price accordingly. If China wanted to cash in their dollars, their trade surplus would disapear rather quickly. So they don’t seek to redeem.
Yes, black swans do happen and political events can have economic consequences. If we went to war with China (for the record, war is bad), I’m pretty sure that the credit balances the Chinese had accumulated in dollars on the Fed’s spreadsheet would dissapear pretty quickly. The Fed would “liberate” them as part of the war effort. But, the Chinese would stop sending us those imports. Tit for Tat. Given the ability of a tax-driven money issuer to “liberate” foriegn credit balances, I still don’t understand why foriegn governments like running trade surpluses. Makes me think they don’t know what they are doing or that the US runs the most powerful, lightest touch empire of all time.
Regarding MMT as a analytical approach:
MMT is great because it focuses on three important ideas almost entirely ignored by conventional economics: (1) endogenous money; (2) credit nature of money (it’s just a liability on someone else’s balance sheet, with high powered money being a liability on the government’s balance sheet); (3) consistent stock/flow analysis.
Yes, how the government spends is very important, but I don’t think anyone disagrees with this. The famous Keynes quote about paying people to bury bottles of money and then pay them to dig up that money was made because he was saying it is better than no spending at all. But once we all agree that a deficit is needed to refuel the economy with high powered money, we then have to choose whether we want the deficit to be run by trading the government’s balance sheet liabilities for labor or for debt. The Fed can buy private debt and that way the private markets decide what to buy, how much labor to use. Or the Treasury can decide what to buy, how much labor to use. This is a political choice and is about who is given the power to decide. But either way, if GDP is going to grow in $ terms, more dollars must be issued than are taken in by the Central bank and that means it will have to expand its balance sheet with either private or public debt.
The debates we have over this stuff in Washington and in most of the mainstream press are silly and MMT is trying to expose that. The framework is what matters because the framwork dictates the kind of discussions we have and the range of possible answers. The answers are political. Pretending the government is like a household is just a political tactic used to avoid having a real discussion about whether those holding certain kinds of assets (dollars or fixed dollar income contracts) should benefit over those seeking to sell labor. The political answer to that question has much more to do with the kind of society we want to live in and the kind of people we are than it does with finance or economics.
Solvency constraint, I think, is a misleading term. I agree with the issues raised in the post, but I think the term that should be used is sovreignty constraint. As discussed above, the issue is how the people will respond to government policy. In a functional democrocy, the people should generally be on board with government policy. And if they are not, they should be pretty well able to get that policy in line with their wishes. Long story short, I don’t think we have identified a constraint in an economic sense by discussing the government’s taxation limits. I think we have identified the limits of government power, which is a political constraint.
The real economic constraint is the production possibilities frontier because after we hit it we are then just talking about redistribution, whether between consumers or between consumption and investment or different kinds of investment. So, rounding out the circle, spending matters. But not for the reasons discussed in DC and that is why MMT is vital. Spending matters because there are real limits on what can be bought and sold when we reach the production possibilities frontier and even before that it is obviusly silly to consume or invest in things that provide less value in social or capacity expansion terms than some alternative. Yes, we must make our spending choices intelligently. However, there are no limits, per se, on the accounting entries, or their token form, for doing the transaction.
Great post. Thanks for it.
Best,
Art
April 8th, 2011 at 9:35 am PDT
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Scott @59 (I wrote my 60 before seeing your 59):
OK. That helps a bit. Actually, it helps a lot, but we are not quite there yet.
Let’s assume money and bonds are identical (same interest rate), just to keep it simple. Let’s assume the national debt (money+bonds) is like one big chequable savings account at the central bank, and the central bank can set whatever interest rate it likes on that savings account. That, I think, correctly represents your 1 and 2. (We both agree it’s an oversimplification, but that’s OK, at this stage.)
Now, does AD depend on that interest rate? Does it depend on real, nominal, or neither? Is expected inflation in the Phillips Curve?
Again, I’m not asking you for the absolute truth, just a simple example, that leaves out as much extraneous stuff as possible, leaving only the bare essentials.
April 8th, 2011 at 9:40 am PDT
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Scott @62: we are posting at the same time!
“So, if you have nominal i, you compare it to nominal g.” Agreed.
“Overall, you want to say rates on the debt are set by markets. MMT’ers reject that. That’s it, since that one point makes all the difference in the world. No broader macro model is necessary for making that one point, which is all I was attempting.”
This I think is where we might disagree. I think a borader macro model is necessary. Because, depending on what you assume about the AD function, and the Phillips Curve, (or whatever) your model might not have a solution. The interest rate might be overdetermined. In other words, your assumptions 1 and 2 might contradict your assumptions about the AD and PC.
We are now REALLY making progress. I understand you (at least I think/hope I do) much better now. But we are not quite there yet.
April 8th, 2011 at 9:56 am PDT
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Seems to me that MMT regards AD as a function of income and saving desire rather than rates, and they account for income in terms of sectoral balances. MMT’ers reject IS/LM.
April 8th, 2011 at 9:57 am PDT
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Nick,
Short on time. Warren Mosler sent this reply:
Let’s assume money and bonds are identical (same interest rate), just to keep it simple.
“ok”
Let’s assume the national debt (money+bonds) is like one big chequable savings account at the central bank, and the central bank can set whatever interest rate it likes on that savings account.
“Yes, called ‘central bank credits’ by cb’s that have actually done it this way, mainly in emerging markets before they ‘graduated’ to tsy secs mkts.”
That, I think, correctly represents your 1 and 2. (We both agree it’s an oversimplification, but that’s OK, at this stage.)
Now, does AD depend on that interest rate?
“Not much evidence it does, with much of the evidence coming from fixed exchange rate regimes that used rates to alter the fx rate, all of which doesn’t apply to your question.”
Does it depend on real, nominal, or neither? Is expected inflation in the Phillips Curve?
“As above, it’s not clear. There are three channels- the interest rate channels, the propensity channels, and the cost channels: interest rate channel- higher rates means higher govt (fiscal) spending on interest payments; propensity channels- in the private sector altering rates shifts income between savers and borrowers. it’s never clear which has the higher propensity to consume as a function of rates; cost channels- higher rates raises the cost of production.”
April 8th, 2011 at 10:00 am PDT
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MMT’ers ignore the history of fiat currencies – which is a turn-off. Treasury-Federal Reserve collaboration exists in its present state, because whenever in the past the FED’s responsibilities were subordinate to the Treasury’s, this country experienced intolerable rates of inflation. The Treasury-Federal Reserve Accord of 1951 is just such an example. There’s no reason to believe that eliminating the middleman will foster fiscal responsibility (rather the opposite). Currently, the government securities market (long-term rates), acts as a breaker (because of the built-in component of inflation expectatons inherent in the pricing of longer-dated securities). In contrast, the actual rates of inflation (MMTs breaker), presents itself ex post facto.
April 8th, 2011 at 10:04 am PDT
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“And it’s the ex post rate of inflation that matters, not the ex ante expectation”
If you think that Scott is right, then explain why PIMCO (one of the world’s largest bond buyers), just sold all of the government securities in its Total Return Fund.
April 8th, 2011 at 10:21 am PDT
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Scott @67: Yes! Now I understand you! (Tell Warren I love his cars BTW, but can’t afford one!)
How to build a very simple minimalist MMT model:
1. Start with a bog-standard New Keynesian model. Set the interest-elasticity of aggregate demand equal to zero. And tell the central bank to set the interest rate below the growth rate of GDP (both nominal or both real).
Or, 2. Start with a basic ISLM+PhillipsCurve model. Make the IS curve vertical. Tell the central bank to make the LM curve horizontal, at an interest rate below the growth rate.
Everything else is just an optional extra. The guts is right there.
I disagree, of course, but now (assuming I have understood your above posts correctly) I now understand what MMTers are saying.
And, if we take the MMT model, and re-introduce an effect of (real) interest rates in the IS curve, we get back to the standard model, where the central bank cannot set whatever (real) interest rate it wants in the long run without the economy imploding or exploding, because r is over-determined.
April 8th, 2011 at 10:21 am PDT
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“And tell the central bank to set the interest rate below the growth rate of GDP (both nominal or both real)”
Keynes’s liquidity preference curve & the demand for money are both false doctrines.
April 8th, 2011 at 10:23 am PDT
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The Fed/Treasury Accord was more about the Fed not being able to peg short term interest rates and government bond rates at the same time. It also has a lot to do with the ideaology of the folks running the Fed and the Treasury at the time.
The inflation rates in the 40s and 50s were mild, except for a few outlying years and those years had much more to do with real capcity issues (crop failures and war) than with quantity of money issues. Inflation and the quantity of money are not nearly as connected as coventinal wisdom thinks and the connection between the Fed’s powers and the control of inflation or unemployment or even the money supply is also pretty darn thin.
April 8th, 2011 at 10:23 am PDT
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Scott,
Yes, I think everyone agrees that (nominal) short term rates are a policy variable for a government. The issue is, can you set those rates to be whatever you want without causing inflation, either in consumer goods or capital goods? If you believe that loans create deposits, then interest rates have to be the opportunity cost of seizing real resources — note “seizing” — as one of the tenets here is that savings is not a pre-requisite for borrowing. There is an involuntary aspect to this, and only interest rates are left as a tool to make sure that the right price is paid to seize resources.
Then there isn’t going to be a lot of freedom to both keep government interest payments low while preventing misallocation of resources in the private sector. And I think the spirit of functional finance should be not to focus on government interest payments, but to set rates at an appropriate level to reflect that opportunity cost. And in this sense, markets *should* set rates, at least to the degree that you believe that markets are also trying to determine the right opportunity cost for seizing resources. Now maybe the markets are wrong — they are often crazy — but on average, over long periods, they will get it right. Over long periods, you want the markets to set rates, and not government. Even if this means that, in practice, the government sets the rates, sees excess debt growth and realizes that it is handing out freebies to borrowers, so it raises the rates until there are no more freebies.
Assuming that you do that, then you need to show that government can always spend whenever it wants without worrying about increasing debt burdens. And the argument should be along the lines that if the private sector doesn’t want to hold that much paper, then they will sell it to buy goods, the output gap will close, tax revenues will increase, and the debt burden will diminish.
Then there is SRWs point that if the NFA are very large, and if the preference change is sharp, then it will take a while for this process to absorb all the unwanted savings. And in that time, you might get self-fulfilling prophecies, stagflation, etc.
But if you sell long maturity debt, then as inflation increases, the value of the debt drops more quickly than the value of money, so that the excess (nominal) savings are reduced more quickly as well. This would be another reason to sell longer maturity debt. How do you know that the effect of rate hikes is primarily by increasing demand for savings and decreasing demand for investment, and not by blowing those savings away via capital losses, thereby reducing savings to the level demanded? To the degree that the latter effect also contributes, then increasing IOR payments is not going to have the same effect on inflation as increasing FF in the current regime. Who knows, it might be the case that a very heavy debt level makes inflation difficult, as the smallest hint of it will cause such massive asset losses that households will increase savings demands again.
April 8th, 2011 at 10:26 am PDT
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… AD is, to a large part, government spending. Government spending is supported by government taxation. Government taxation requires people to sell goods and services either to the government or others in the private sector with the acceptable currency. Optimal tax/spending policy can lead to optimal AD.
Crowding out at ‘full employment’ places an upper limit on AD. Finite resources limit government taxing/spending to finite levels. Given many software resources are near infinite, government spending/taxing become near infinite as our economy shifts into unreal resources. :)
April 8th, 2011 at 10:27 am PDT
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“And, if we take the MMT model, and re-introduce an effect of (real) interest rates in the IS curve, we get back to the standard model, where the central bank cannot set whatever (real) interest rate it wants in the long run without the economy imploding or exploding, because r is over-determined.”
2 things . . .
1. Given that r<g on average during the past 65 years, why hasn't that happened?
2. Godley/Lavoie showed that the functional finance fiscal strategy is Ricardian, so it doesn't matter what the cb's strategy is, anyway (at least for that part of the model). It can be a Taylor rule, for instance.
April 8th, 2011 at 10:31 am PDT
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Just to add to my 69: And, given the vertical IS curve, the government must use fiscal policy to shift the IS and control AD, to prevent the economy imploding or exploding in the long run.
April 8th, 2011 at 10:37 am PDT
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…And one of the problems with MMT is that, AFAIK, they assume money and debt are effectively the same while totally missing the very difference that is so central to their assertions about functional finance. If r>g for bonds, but r<g for money, then the budget constraint for money-finance is fundamentally different from the budget constraint for bond-finance…
Dear Professor Rowe, I believe there is a discussion of that topic in the comment section of SRW’s last post.
http://www.interfluidity.com/v2/1300.html#comments
April 8th, 2011 at 10:37 am PDT
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Nick @76 . . . completely agree (!!).
April 8th, 2011 at 10:39 am PDT
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whoops, I see I’ve slept through the last 300 comments…
April 8th, 2011 at 10:39 am PDT
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Scott @75: You misunderstood what I meant by “imploding or exploding”. My fault, I wasn’t explicit. I meant imploding into accelerating deflation or exploding into accelerating inflation. I wasn’t talking about the long run government budget constraint (where r relative to g matters). I was talking about the long run Phillips Curve (where AD relative to Y* matters).
April 8th, 2011 at 10:41 am PDT
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“Even if this means that, in practice, the government sets the rates, sees excess debt growth and realizes that it is handing out freebies to borrowers, so it raises the rates until there are no more freebies.”
Unless there are other ways besides adjusting an overnight rate to slow the excess growth of pvt debt. Kregel, Tymoigne, Wray, and Black have done a good deal of research on this, and it’s as central as anything to MMT.
April 8th, 2011 at 10:44 am PDT
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flow5 @ 70, “If you think that Scott is right, then explain why PIMCO (one of the world’s largest bond buyers), just sold all of the government securities in its Total Return Fund.”
Tell me why Jeff Gundlach is on the other side of this trade. :)
April 8th, 2011 at 10:50 am PDT
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“Inflation and the quantity of money are not nearly as connected as coventinal wisdom thinks and the connection between the Fed’s powers and the control of inflation or unemployment or even the money supply is also pretty darn thin”
It is one of God’s miracles that the relationship between money flows (our means-of-payment money X’s its transactions rate-of-turnover) is so highly correlated to all transaction units (nominal gDp).
“one of the tenets here is that savings is not a pre-requisite for borrowing”
Exactly. From a systems viewpoint, commercial banks (DFIs), as contrasted to financial intermediaries: never loan out, and can’t loan out, existing deposits (saved or otherwise) including existing transaction deposits, or time deposits, or the owner’s equity, or any liability item.
When CBs grant loans to, or purchase securities from, the non-bank public, they acquire title to earning assets by initially, the creation of an equal volume of new money- (transaction deposits) –somewhere in the banking system. I.e., commercial bank deposits are the result of lending, not the other way around.
Savers (contrary to the premise underlying the DIDMCA in which CBs are assumed to be intermediaries and in competition with thrifts) never transfer their savings out of the banking system (unless they are hoarding currency). This applies to all investments made directly or indirectly through intermediaries.
Shifts from TDs to TRs within the CBs and the transfer of the ownership of these deposits to the thrifts involves a shift in the form of bank liabilities (from TD to TR) and a shift in the ownership of (existing) TRs (from savers to thrifts, et al). The utilization of these TRs by the thrifts has no effect on the volume of TRs held by the CBs, or the volume of their earnings assets. I.e., the non-banks are customers of the member, money creating, depository banks.
In the context of their lending operations it is only possible to reduce bank assets, and TRs, by retiring bank-held loans, e.g., for the saver-holder to use his funds for the payment of a bank loan, interest on a bank loan for the payment of a bank service, or for the purchase from their banks of any type of commercial bank security obligation, e.g., banks stocks, debentures, etc.
The financial intermediaries can lend no more (and in practice they lend less) than the volume of savings placed at their disposal; whereas the commercial banks, as a system, can make loans (if monetary policy permits and the opportunity is present) which amount to server times the initial excess reserves held.
Financial intermediaries (non-banks) lend existing money which has been saved, and all of these savings originate outside the intermediaries; whereas the CBs lend no existing deposits or savings; they always, as noted, create new money in the lending process.
Saved TRs that are transferred to the S&Ls, etc., are not transferred out of the CBs; only their ownership is transferred. The reverse process, which is called “disintermediation”, has the opposite effect: the intermediaries shrink in size, but the size of the CBs remains the same.
From a System’s standpoint, time deposits represent savings that have a velocity of zero. As long as savings are impounded within the commercial banking system, they are lost to investment or to any type of expenditure. The savings held in the commercial banks, in whatever deposit classification, can only be spent by their owners; they are not, and cannot, be spent by the banks.
From a system standpoint, TDs constitute an alteration of bank liabilities, their growth does not per se add to the “footings” of the consolidated balance sheet for the system. They obviously therefore are not a source of loan-funds for the banking system as a whole, and indeed their growth has no effect on the size or gross earnings of the banking system, except as their growth affects are transmitted through monetary policy.
Lending by the intermediaries is not accompanied by an increase in the volume of money, but is associated with an increase in the velocity, or turnover of existing money. Here investment equals savings (and velocity is evidence of the investment process), whereas in the case of the CB credit, investment does not equal savings, but is associated with an enlargement and turnover of new money (bank credit & the money stock).
The difference is the volume of savings held in the commercial banking system is idle, and lost to investment as long as it is held within the commercial banking system. Such a cessation of the circuit income and transactions velocity of funds, funds which constitute a prior cost of production, cannot but have recessionary effects in our highly interdependent pecuniary economy. Thus, the growth of time deposits shrinks aggregate demand and therefore produces adverse effects on GDP and the level of employment.
The CBs can force a contraction in the size of the S&L system, and create liquidity problems in the process, by outbidding the S&Ls for the public’s savings. This process is called “disintermediation” (an economist’s word for going broke). The reverse of this operation, as implied in the analysis above, cannot exist. Transferring saved TR or TD deposits through the S&Ls cannot reduce the size of the commercial banking system. Deposits are simply transferred from the saver to the S&L to the borrower, etc.
The drive by the commercial bankers to expand their savings accounts has a totally irrational motivation, since it has meant, from a system standpoint, competing for the opportunity to pay higher & higher interest rates on deposits that already exist in the commercial banking system.
The shift from demand to time deposits has converted spendable balances into stagnant money. This transfer added nothing to the Gross National Product, and nothing will be added so long as the funds are held in the form of time deposits. Shifts from transaction deposits, to time deposits, simply increases the aggregate costs to the banking system and adds nothing to the system’s income.
enough said, thus you might understand that MMT’s stock flow analysis is flawed too.
April 8th, 2011 at 10:54 am PDT
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Piggybacking on Tom, how did Tsy rates respond to PIMCO selling its holdings? Looks like I’m right.
April 8th, 2011 at 10:55 am PDT
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note “S&L’s” should be “non-banks”
April 8th, 2011 at 10:56 am PDT
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RSJ @ 73, “There is an involuntary aspect to this, and only interest rates are left as a tool to make sure that the right price is paid to seize resources. Then there isn’t going to be a lot of freedom to both keep government interest payments low while preventing misallocation of resources in the private sector.”
See Michael Pettis, Reforming the banks on banking models, rate setting, and malinvestment. To cut to the chase, scroll down to, “What do banks do?” If Pettis is correct, getting government out of the interest rate setting business and leaving credit analysis to bank that take capital risk is the way to go. This is the MMT position, too, as I get it — no bonds, set the overnight rate to zero, and let the private sector assume risk and determine rates accordingly.
April 8th, 2011 at 11:03 am PDT
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Tom@86 . . . right, aside from what I said in 81.
April 8th, 2011 at 11:06 am PDT
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Scott @ 81, 87,
Right, and MMT also emphasizes the importance of Minsky in bank regulation and oversight in order to reduce financial instability. For example,, see Warren Mosler’s for financial reform among other things and the voluminous work of Bill Black on cheating. MMT is on the case.
April 8th, 2011 at 11:14 am PDT
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Tom . . .that’s what I’m referring to.
April 8th, 2011 at 11:15 am PDT
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Nick is spot on: There’s a Philips Curve embedded in many MMT arguments, where we assume that the govt can increase NFA until the economy hits a full employment sweet spot, and then simply regulate the NFA flow relative to this relationship to achieve price level stability. But that there’s no reason to assume that the relationship is static or invariant to policy, as far as I can see, and plenty of reasons not to.
April 8th, 2011 at 11:51 am PDT
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Scott @ 89
Just wanted to make it abundantly clear, Scott. This is point is continually missed, as though MMT’ers hadn’t considered it before.
Most of the criticisms of MMT are based on reading isolated blog comments without undertaking a study of the MMT professional literature that deals with these issues in detail.
No wonder some MMT’ers get a bit testy when peppered with the same objections over and over when they have been answered already. If one made objections in the mainstream that were ignorant of the literature, or in any professional field, they would not be taken seriously enough to require an answer.
April 8th, 2011 at 12:02 pm PDT
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“It is one of God’s miracles that the relationship between money flows (our means-of-payment money X’s its transactions rate-of-turnover) is so highly correlated to all transaction units (nominal gDp).”
The flow of money, as you point out, is what creates nominal GDP (and real GDP). Quantity of money refers to a stock. The quantity can increase, as in depression and 2008, but flow can still decrease and deflation set in.
Moreover, there are scenerios where the quantity of money might be shrinking and at the same time inflation might be rampant. For example, if capacity collapses (say major natural disaster wipes out most agriculture yield in a country) and at same time government runs surplus. Demand might decrease in nominal terms because of the government budget surplus, but if the capacity shrink is big enough, the ratio of demand to supply might still create inflation.
April 8th, 2011 at 12:22 pm PDT
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“The flow of money, as you point out, is what creates nominal GDP (and real GDP).”
Nope. If anything, it’s the flow of real GDP that “creates” the flow of money.
April 8th, 2011 at 12:42 pm PDT
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vimothy @, not all economists accept “the Phillips curve” (there are different versions as you know), for different reasons.
Bill Mitchell writes on the Phillips curve in this post, for example, and Mitchell and Muysken devote Part 1, ch. 3 to it in Full Employment Abandoned (Elgar 2008). MMT’ers hold out the prospect of full employment (anyone willing and able to work has a job offer) and price stability based on the ELR as a price anchor.
From Warren Mosler’s review: “Regarding unemployment (aka the ‘output gap’ by today’s central bankers), it is readily acknowledge that inflation isn’t all that sensitive to changes in unemployment. In their words, “The good news is that the Phillips curve is flat. And the bad news is that the Phillips curve is flat.” The essence of what Bill proposes is that an employed labor bufferstock is a far superior price anchor than today’s labor bufferstock of unemployed. And this is one of those things that seems obvious and indeed is absolutely correct, yet entirely overlooked as a policy option.”
April 8th, 2011 at 12:49 pm PDT
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Not sure I understand. Are you saying that if I want to go out and buy a new jacket I will always find financing for it? Are you saying that lack access to money (whether token or credit) in a monetary economy does not create a barrier to the expression of demand?
April 8th, 2011 at 12:50 pm PDT
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Great post. You articulated many of my questions and concerns far better than I could. Thanks.
April 8th, 2011 at 12:55 pm PDT
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From Warren Mosler:
V: Nick is spot on: There’s a Philips Curve embedded in many MMT arguments, where we assume that the govt can increase NFA until the economy hits a full employment sweet spot, and then simply regulate the NFA flow relative to this relationship to achieve price level stability
WM: ok, some people have done that.
V: But that there’s no reason to assume that the relationship is static or invariant to policy, as far as I can see, and plenty of reasons not to.
WM: point? you’re free to say you don’t think we should make a fiscal adjustment now because you think inflation as you measure it might go up. but not because we could be the next Greece.
April 8th, 2011 at 2:24 pm PDT
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“There’s a Philips Curve embedded in many MMT arguments”
Obviously. We’re Post Keynesians. There’s a lot of literature on that. But, as Warren points out, it really isn’t relevant to MMT’s description of the monetary system, even as it’s obviously important in terms of policy advice. The overarching point is that whatever version of the Phillips Curve one uses, if the AD side of one’s preferred model model isn’t consistent with actual operations and actual accounting, it isn’t relevant. We generally prefer to put this into the context of the PK model, but not absolutely necessary.
April 8th, 2011 at 3:27 pm PDT
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Scott,
“Unless there are other ways besides adjusting an overnight rate to slow the excess growth of pvt debt.”
I don’t see how this can be efficient.
You are either paying a fair price or you are not paying a fair price. But what you pay is the interest rate.
The models that assume “prudent regulation” will overcome the price being too low are equivalent to rationing. You lower the price, but prevent people from purchasing too much because you ration quantity.
While I think we need good regulation, you can’t escape the distortionary effects of the price being too low. Even with rationing, you are creating transfers to those who borrow to those who do not. If people’s borrowing capacity is a function of their income, that means transfers from those with less income to those with more.
Tom,
You are saying that fixing a rate of zero is not fixing rates. We are in a post-Mayan world, in which zero is also considered a number.
April 8th, 2011 at 7:09 pm PDT
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RSJ, I did say “set” the rate to zero, but the Fed could also just let demand for reserves set the overnight rate figuring that the general conditions is excess reserves, which implies a rate of zero. It could provide unlimited liquidity with collateral at the discount window, too. The FRS is essentially a settlement system and the purpose of the Fed is to insure that the system is always liquid. If the FDIC is doing its job, insolvent banks are resolved immediately, so there is no overnight insolvency risk.
What I am saying is that the overnight rate on a risk-free asset is zero. See Warren’s paper, The Natural Rate is Zero.
Paying anything above that is manipulative, IMHO, basically a command system. I have zero confidence in government involvement with pricing risk or anticipating inflation in terms of expectations. See that Pettis article I cited in #86. Countries that backstop their financial system create moral hazard and malinvestment, which eventually ends badly.
These are my tentative conclusion from gleaned from reading, but you obviously know a lot more about this than I do from practical experience. What is your view about this?
April 8th, 2011 at 7:34 pm PDT
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Tom,
Borrowing at a rate allows you to take a real resource, make use of it, and then sell it, repaying the difference between purchase price and sales price, plus interest.
Holding the purchase price fixed, the interest rate paid is the fee you pay for taking that resource away from its current owner.
To borrow overnight is to take the resource for one day. It cannot be the case that you can take resources for one day for free.
The price matters, and it is non-zero.
April 8th, 2011 at 8:18 pm PDT
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Flow5 (68):
I’m honestly finding this claim bizarre but perhaps I’m missing something. As fair as I am aware, There’s an enormous amount of literature discussing the history of money from an MMT perspective, with quite a few dealing with the history of fiat currencies specifically. I’d wager that every 1 out of 10 papers by Wray is on this topic.
Even though he isn’t an MMT’er I know Goodhart has also explored this topic as well (he terms it cartalism)which I believe is consistent with a lot of what Wray and others have argued.
Nick Rowe (69):
I’m just a student, so don’t shoot me, hoping you could clarify the following:
When you state:
“Start with a basic ISLM+PhillipsCurve model. Make the IS curve vertical. Tell the central bank to make the LM curve horizontal, at an interest rate below the growth rate”
By assuming a horizontal LM curve are you assuming a special case (liquidity trap) or are you suggesting a general case where the LM curve is equivalent to an MP curve (Romer. If the former, then I don’t think that the model is a reasonable equivalent to MMT, (as you are aware) simply because MMT following the Post Keynesian tradition argues that central banks cannot control monetary aggregates without causing severe instability in the payments system. Central banks can only set the price and accommodate the demand for reserves are that price.
Apart from that when I learnt ISLM there was a lot in there that I don’t believe is consistent with MMT and Post Keynesian economics (e.g. Walras law, financial crowding out, etc.)but perhaps this is due to only learning it in an undergraduate setting.
April 8th, 2011 at 9:12 pm PDT
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RSJ, what if the Fed doesn’t set the rate to zero and lets the banks determine the overnight rate on the basis of their own estimation if price matters and is not zero? It seems to me that the sole function of the Fed is to provide liquidity for settlement, not intrude in rates. Otherwise, we have a command system, with the price of money determined by a small group of unelected and unaccountable technocrats. To me that seems anti-democratic and anti-capitalistic.
April 8th, 2011 at 9:20 pm PDT
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Tom,
“RSJ, what if the Fed doesn’t set the rate to zero and lets the banks determine the overnight rate on the basis of their own estimation if price matters and is not zero? It seems to me that the sole function of the Fed is to provide liquidity for settlement, not intrude in rates”
Nope. The OIR is the intersection of vertical and horizontal money. If there was no inside money — say everyone held an account at the central bank, which was the only bank, and this bank did not make loans. To borrow, you needed to go to the bond market. In that case, the government would not need to set any interest rates. Interest rates could “float”.
But as soon as the central bank starts lending money out to households, then it needs to set a rate (obviously).
Now replace “households” in the above with “banks”.
As soon as the central bank lends money to banks, then it needs to set a rate, and that rate will affect the rate at which banks in turn lend to households.
Now you cannot say that if the rate at which the central bank lends to banks is zero, then the government is not in the rate setting business. It is in this business, and moreover if this rate is too low, then you are causing real transfers to occur from the rest of the economy to those who borrow. Moreover you are distorting the relative prices of goods that cannot be borrowed against (e.g. consumption goods) versus goods that can be borrowed against (capital goods).
Again, as end-user borrowing capacity is constrained by income, you are transferring real resources from those with less income to those with more. These are all real distortions that occur when the borrowing rate is too low, with equivalent real distortions when it is too high.
You cannot fix these distortions by imposing quotas on how much each borrower can borrow. That may limit the damage, but there is still damage. But telling someone that they can only obtain 10 freebies instead of an unlimited amount of freebies is not the same as eliminating the freebies.
April 8th, 2011 at 9:44 pm PDT
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RSJ, I take it then that you disagree that the natural rate is zero and conclude that MMT’ers, e.g., Warren Mosler, are wrong abou this.
April 8th, 2011 at 10:02 pm PDT
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Devil’s advocate:
The natural rate dynamic depends on the existence of excess reserves.
The Fed can pay any rate it wants on excess reserves.
0 is just another rate.
It’s a choice.
April 8th, 2011 at 10:21 pm PDT
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Yes, I think they are wrong about this, and also about the notion that banks should not be subject to market discipline on the liability side of their balance sheet. Or that government should pick up the tab for any credit losses in excess of those predicted by FDIC models.
Banks need to compete for deposits by offering competitive deposit rates to households, and if households do not wish to hold deposits, this competition will force banks sell bonds to households instead of deposits. That allows households to have some control over the types of claims on banks that they wish to hold, rather than forcing deposits down their throats in order secure maximum seignorage for the financial sector.
In general, there are enormous rents being diverted to banks as a result of Mosler’s proposals, and enormous rents diverted to borrowers in general as a result of the zero rate proposal. And the irony is that these rents are being advocated in the guise of standing up to the financial sector.
I was hoping that some of these issues would also be addressed in this critical review.
April 8th, 2011 at 10:26 pm PDT
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“You cannot fix these distortions by imposing quotas on how much each borrower can borrow. That may limit the damage, but there is still damage. But telling someone that they can only obtain 10 freebies instead of an unlimited amount of freebies is not the same as eliminating the freebies.”
I believe CB lending amounts to freebies at any interest rate. Warren feels banks serve a public purpose and so are allocated the freebies for good purpose.
I disagree.
It makes much more sense from an optimal allocation perspective to distribute loaned reserves through quotas to all U.S. citizens as a way to increase opportunity to all citizens for entrepreneurship. This program would be run in a similar manner as the ELR program which is for those desiring jobs. Banks would then borrow needed reserves from U.S. citizens. As more reserves were needed by the banking system, more would be made available for U.S. citizens to borrow.
April 8th, 2011 at 10:30 pm PDT
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Thanks for clarification, RSJ. I look forward to these issues being debated somewhere if not here.
April 8th, 2011 at 10:31 pm PDT
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And, as an alternate proposal to highlight the distinction I was making, suppose that the central bank lends reserves at a rate of zero permanently to banks, however it imposes an asset tax on all non-central bank liabilities held by banks equal to its polity rate. Simultaneous to that, banks would be given credits for any interest payments that they make for their own borrowing (whether by providing deposits or selling commercial paper, bonds, etc.). The credits would only be applied to liabilities that are not payments to bank capital as set by regulators — dividends on common or preferred shares or interest payments on long term subordinated debt would be excluded from the credits.
Now the marginal cost of reserves is still zero, and yet lending rates will not fall below the policy level. Banks will not be able to earn money from borrowing short and lending long, but they will only earn money from credit analysis. The seignorage income that banks earn by supplying households with deposits would be turned over to the government and used for public purpose.
April 8th, 2011 at 10:41 pm PDT
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RSJ,
Banks don’t make profits because their costs are low. They make profits on the spread between the rate they charge and their costs. You haven’t demonstrated that under Mosler’s proposals banks will be able to charge a larger spread than otherwise. Absent that, there are no additional rents to banks.
Further, simply because the overnight rate is set at or near zero doesn’t mean there aren’t other ways to raise banks’ costs, such as raising capital charges for particular assets, or asset-based reserve requirements as Tom Palley has proposed, or any number of the many, many other possibilities that have been discussed. This is a better approach to controlling credit growth than expecting markets to do it–as Minsky always explained, and has been recently repeated for the nth time, markets price risk countercyclically, which is the exact opposite of what you want if you’re really going to control excessive credit growth.
I do sympathize on the point you made regarding households and bank deposits–which is why I’m not on board with the “no bonds” proposal of my MMT colleagues. I would prefer to keep short to medium term bills/bonds so that households don’t have to use banks as an intermediary every time they want to invest default-risk-free.
April 8th, 2011 at 10:43 pm PDT
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Scott, I wasn’t saying that banks make profits just because their (government imposed) costs are low. But we do know that the public is willing to hold large amounts — MZM — at basically zero rate. And going on up the yield, there is generally a profit to be made from maturity transformation.
Therefore *given* that their private sector costs are going to be too low, the government set costs need to be higher, to prevent rents from being earned.
I completely agree that there are many other ways to impose those costs on banks. You do not need to do it with FF. You can do it with taxes and fees, etc.
But however you do it, the result will be equivalent to charging a higher interest rate. You will not be able to have two rates, one for government bond interest payments that is low, and another rate that sets bank costs that are high. Any taxes or capital charges imposed on banks will drive up the government bond rates as if you had raised FF. A policy of raising or lowering marginal costs of banks is an interest rate policy.
I also completely agree that market set rates are pro-cyclical, and that there is a _cyclical_ role for government to manage rates, just as there is a role for government to manage income (demand).
But that does not mean that rates should be permanently set to be above or below the market rate over the whole cycle.
April 8th, 2011 at 11:21 pm PDT
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“I would prefer to keep short to medium term bills/bonds so that households don’t have to use banks as an intermediary every time they want to invest default-risk-free.”
Very simple fix for that – allow Treasury Direct to offer cash accounts paying the FF rate.
April 8th, 2011 at 11:31 pm PDT
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The Bank Run We Knew So Little About
By GRETCHEN MORGENSON
http://www.nytimes.com/2011/04/03/business/03gret.html
——————————-
How a big US bank laundered billions from Mexico’s murderous drug gangs
http://www.guardian.co.uk/world/2011/apr/03/us-bank-mexico-drug-gangs
It would be good to see how MMT deals with this real scenario regarding the credit crisis of 2008
April 9th, 2011 at 3:02 am PDT
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mdm 102: “By assuming a horizontal LM curve are you assuming a special case (liquidity trap) or are you suggesting a general case where the LM curve is equivalent to an MP curve (Romer.”
The latter. The central bank makes the money supply function perfectly interest-elastic. (In the ISLM model, the LM is horizontal if *either* the money demand *or* the money supply function is perfectly interest-elastic.)
In the standard ISLM, you can define a (real) “natural rate of interest” as the real interest rate at which the IS curve crosses “full employment” (aka the “natural rate of unemployment”, defined by the vertical Long Run Phillips Curve). In the MMT version, both savings and investment are perfectly interest-inelastic, so the IS curve is vertical (or near vertical), so the natural rate of interest is undefined. And this makes the AD curve vertical, with monetary policy unable to shift the AD curve. So you have to use fiscal policy to shift the vertical IS curve right or left, and hence shift the vertical AD curve right or left, to keep output at the natural rate of unemployment, and prevent accelerating inflation or deflation.
The ISLM model is useful for showing the differences between the MMT model and the standard model, but it’s not really necessary otherwise. The whole point of the ISLM model was to explore the interaction between the interest rate needed to get S=I (loanable funds) and the interest rate needed to get Md=Ms (liquidity preference). But if you are an MMTer who believes interest rates have little or no effect on Savings and Investment, you don’t need ISLM. You might as well revert to the simpler first year Keynesian Cross Income Expenditure model (45 degree line and AE curve).
The basic macro model behind MMT is the Keynesian Cross. Plus some sort of Phillips Curve. The central bank sets the nominal interest rate. But the interest rate has no macroeconomic significance. It’s just a weird way for the government to make transfer payments, so you might as well set it at 0%, and use regular fiscal policy to make taxes and transfers for macro and micro reasons. And since the central bank can set interest rates below the growth rate of GDP, if it wants, the government debt can be a giant Ponzi scheme where you never have to repay what you borrow. You can throw the Chartalist theory of fiat money into the mix too, but that part of MMT is independent of the rest of the macro model.
The above paragraph is not really a straw man. It’s a stick figure. Stick figures leave out a lot of the less important details, but are very useful. I think I have drawn it correctly.
April 9th, 2011 at 3:31 am PDT
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Nick, What if the nominal growth rate of GDP is negative? Since the CB cannot engineer negative nominal rates, can it find itself in a debt trap in which the gov’t will ulimately have to repay (and violate MMT theory), or voluntarily default?
Japan provides a potential real world example. The Ponzi scheme cannot last forever despite the best intentions of the BOJ.
April 9th, 2011 at 3:58 am PDT
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Forgot to say in my “stick figure” paragraph above: “…the government debt can be a giant Ponzi scheme where you never have to repay what you borrow *unless AD gets too big as a result of your past borrowing*.”
mdm 102: “Apart from that when I learnt ISLM there was a lot in there that I don’t believe is consistent with MMT and Post Keynesian economics (e.g. Walras law, financial crowding out, etc.)but perhaps this is due to only learning it in an undergraduate setting.”
There is financial crowding out in the ISLM model because the IS curve slopes down and the LM slopes up. So an increase in G increases r and decreases C and I. If you have a horizontal LM that never moves, an increase in G does not raise r. And if you have a vertical IS, even ir r did increase it would not crowd out C and I. So that’s why there’s no financial crowding out in MMT.
I don’t know the MMT position on Walras’ Law. Nearly all economists accept Walras’ Law (I’m one of the few who don’t). MMTers reject Say’s Law, but then so do 99% of economists, if you interpret Say’s Law strictly. So my guess is there’s no differences there.
April 9th, 2011 at 4:04 am PDT
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Nick Ricc 106 “Nick, What if the nominal growth rate of GDP is negative? Since the CB cannot engineer negative nominal rates, can it find itself in a debt trap in which the gov’t will ulimately have to repay (and violate MMT theory), or voluntarily default?”
Good point. Japan’s NGDP growth may become positive again in future? If real GDP growth were permanently negative, the MMTers would presumably have to argue that an aggressive enough fiscal policy could create sufficient inflation to make NGDP growth positive, so the Ponzi scheme could keep going. The question would then be: would they have to create so much debt to do this that they hit the wall before inflation gets high enough to remove the wall? Dunno.
April 9th, 2011 at 4:14 am PDT
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Right Nick R, but if the marginal propensity to save from the private sector is greater than the government’s ability to spend, (i.e. if every yen that the government spends induces the private sector to save more than one yen in some strange version of RE) then you will have creeping market socialism ultimately destroying (overwhelming) the private sector. Is this realistic? The Nikkei, after all, is down over 80% over the past 21 years during which Japan’s Debt/GDP has quadrupled.
While most MMTers are indifferent about this risk, they do not especially care about the health of the private sector, even if it (potentially) allocates resources more efficiently. That’s why I am post-MMT.
I’m usually Nick R. – Kyoto Japan, but I defer to the more intelligent Nick R.
April 9th, 2011 at 6:14 am PDT
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Nick Ricc,
“creeping market socialism ultimately destroying (overwhelming) the private sector.”
That’s an interesting concern, does not seem on the surface to be a desirable outcome… why doesnt the private sector over there then take some proactive measures at this point and ‘grow itself’ in order to defend against this?
Resp,
April 9th, 2011 at 7:39 am PDT
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For the third time, I’m noting that this is a fantastic discussion. I’d love to see further discussion on comment #112 (RSJ) above. Thanks to Scott, Tom, and RSJ in particular…
April 9th, 2011 at 12:21 pm PDT
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RSJ 112: “But that does not mean that rates should be permanently set to be above or below the market rate over the whole cycle.”
If you believe in MMT though (I don’t, but let’s pretend) there’s no such thing as a market rate of interest, independent of what the central bank sets. That follows from their assumption that Savings and Investment are both independent of the rate of interest. So if you draw the S and I curves in the loanable funds market, they are both vertical. So they can’t determine any concept of a market rate of interest. And income adjusts causing the S and I shift until the two curve lie exactly on top of each other. And the government’s job is to use fiscal policy to fill the gap between S and I at the natural rate of unemployment (“full employment”). And the rate of interest is determined purely by liquidity preference theory, with the central bank playing the lead role.
This is standard 1950’s British Keynesianism under extreme “elasticity pessimism”, as we used to call it.
April 9th, 2011 at 1:10 pm PDT
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And Warren Mosler is exactly right, BTW (within the context of the MMT model). The optimum nominal rate of interest for the central bank to set (on the overnight rate) will be (approximately) 0%. The rationale is exactly the same as Friedman’s argument in The Optimum Quantity of Money — any rate above 0% is a distorting tax on holding currency. I said “approximately” 0%, because you might want a small tax on currency to pay for the costs of printing, and to tax the illegal sector and tax dodgers etc. But Warren shouldn’t really call 0% the “natural” rate of interest, because that just confuses things. There is no natural rate of interest in MMT. It’s an underdetermined variable.
April 9th, 2011 at 1:31 pm PDT
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“No, that’s not the party line. In fact, the party line would say that is impossible. The party line says that the *expected* present value of *primary* surpluses (plus seigniorage, if that’s not included) is *equal to* the existing debt.”
There’s no such thing as expected present value at time zero relative to the calculation, unless you are very slow on the abacus. You mean present value of expected primary surpluses.
I think I prefer Steve’s obvious presumption of uncertainty to your error.
April 9th, 2011 at 1:55 pm PDT
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RSJ,
We appear to have been writing at the same time, so I didn’t see your #110. That’s the sort of thing I would be talking about in #111. As another example, Charles Goodhart proposed a cb lending facility much like Mosler’s but which limits the amount that can be borrowed at the cb’s target to some % of deposits or some traditional liquidity ratio, and thereafter the spread to the cb’s target grows at fixed intervals as additional thresholds are met.
Nick Rowe’s right regarding MMT and no “market rates,” though, as Warren explained in his response to Nick, it’s not necessarily the case that MMT sees aggregate spending as completely interest inelastic. That’s one example of why we cringe at such simple models–there are several channels, including the Minskyan links Warren didn’t even mention. That is, the rationale for not manipulating interest rates doesn’t rest on an assumption of (to use Nick’s framework) a vertical IS curve–instead, the rationale is that the effects of manipulating (short-term) interest rates are highly uncertain given multiple channels, and given our Minskyan background, frequently destabilizing. As I said, it’s very hard to put that into a simple IS-LM or similar framework.
April 9th, 2011 at 2:25 pm PDT
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Hit “enter” too soon.
Regarding my first paragraph in 125, I view the MMT position on cb ops as an attempt to avoid liquidity problem and to recognize that market disciplining of banks doesn’t work. As I noted above, markets usually price such risks countercyclically, which exacerbates credit growth cycles. But I see several of the other issues you are mentioning–e.g., bank spreads on assets vs. liabilities, slowing excessive credit growth–as separate from the more popularized MMT view of central bank strategy (i.e., fixed zero nominal overnight rate target, no bonds), and as such they are dealt with elsewhere in the literature.
Regarding my second paragraph, note that Mosler often describes interest rate effects on aggregates spending that would be more in line with an upward sloping IS curve (e.g., one can find in several places on his site where he suggests that Japan’s zero rate policy might be deflationary). So, again, the idea of a vertical IS as being a representative description of the MMT view of the world is a gross oversimplification.
April 9th, 2011 at 2:38 pm PDT
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anon 124; the disagreement between me and Steve was never about uncertainty. (And it has now been fully resolved via email, BTW).
An accountant would insist, I think, that the intertemporal government budget constraint must hold in each and every state of the world, so it should be actual values appearing throughout, not expected. But if we allow the risk of default, and if we are interested in people’s expectations of the future, we need an expectation in there somewhere.
There are two potential sources of uncertainty in the PV(S) calculation: future surpluses S; and the discount factors (interest rates) built into the PV formula. If future S is uncertain, but future interest rates are known with certainty, then PVE(S) is identical to EPV(S). But if future interest rates are not known with certainty, then you can only talk about EPV(S) as what people believe today.
I didn’t want to assume we know future interest rates, so I talked about the expected present value of surpluses. “Expected present value of surpluses” recognises more uncertainty than “present value of expected surpluses”.
Or maybe I have totally missed your point?
April 9th, 2011 at 2:39 pm PDT
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A variable interest rate policy is an artificial source of risk. With a fixed rate policy, the yield curve would be flatter (maybe even perfectly flat?)
April 9th, 2011 at 3:04 pm PDT
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The discount rates that apply to future cash flows are known from the current government yield curve. There is no uncertainty there as it pertains to a present value calculation at a point in time. The uncertainty lies in the size of the cash flows. Its the PV of expected cash flows.
Whether or not the discount rates plucked from the curve predict the path of future short rates is an entirely separate issue. That uncertainty is not captured in a PV calculation.
April 9th, 2011 at 3:15 pm PDT
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anon 129: yes, but if the government rolls over (refinances) some of its currently outstanding debt in future (as nearly all do), then we don’t know that those future interest rates will be.
I just realised what you were saying in your earlier comment, BTW. You thought I was saying E[PV](S), rather than E[PV(S)]. If I had been saying that, your point would have been right. But that’s not what I meant.
April 9th, 2011 at 3:28 pm PDT
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Future government refinancing contingencies are irrelevant to the present value calculation.
All required information is available from the current yield curve, including the implied zero coupon curve.
April 9th, 2011 at 3:32 pm PDT
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anon: what’s the longest market interest rate on government bonds? 30 years? My guess is that the debt for most countries will not all be paid off in the next 30 years. Surpluses 40 years from now are part of the equation.
April 9th, 2011 at 3:54 pm PDT
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My guess is that the debt for most countries will never be paid off, which puts the whole concept in (MMT) perspective.
Apart from that, 30 years is typically the most expensive point on the curve out to 30 years, with hypothetical points beyond even more expensive. Discount factors are sufficiently steep to make the PV contribution unimportant.
April 9th, 2011 at 4:09 pm PDT
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Folks:
Whatever happened to paying off the principle?
My grandfather had a wonderful saying:
What you owe, you owe.
What you own, you may not own.
That applies top all entities, in my opinion, even the U.S. Government.
Don Levit
April 9th, 2011 at 5:50 pm PDT
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a bit late to the party but just wanted to point out that the imf thingie from ramanan is irrelevant. the us can always give back yuan to the chinese in exchange for their dollars: just have treasury buy yuans in the market … duh.
ok yuan are not freely traded but it seems section 2deals with that. anything freely traded is not an issue.
grotesque argument
April 9th, 2011 at 5:52 pm PDT
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Scott,
I don’t see how you can believe that the market mis-pricres assets in a pro-cyclical way while also believing that CB should not alter rates counter-cyclically to account for this mis-pricing.
An interest rate reaction function is anything that affects borrowing rates. Increasing capital requirements during booms is an interest rate reaction function.
In that case, it’s misleading to say that you want rates to be zero. There is nothing wrong with wanting to ditch reserve pricing as a tool to manage lending rates. It’s a clumsy, archaic system built on the gold standard where coins were rare, and so banks needed to lend the coins to each other to manage their cash-flows.
In terms of policy proposals, MMT should specify the replacement reaction function with the same unanimity as the ditching of FedFunds.
If there isn’t agreement on the replacement, then its muddying the waters to say that you want to ditch FF as a stabilization tool. People will interpret that as not using interest rates as a stabilization tool.
And it seems to me that MMT inhabits this contradictory space — that there will be *some* sort of bank-specific stabilization policy aimed at increasing the marginal costs of banks during booms, but you are not calling this policy an interest rate policy, even though it is an interest rate policy. At the same time you are claiming that interest rate management doesn’t work. And moreover, you are making the leap from interest rate management not working as a stabilization tool to assuming you can permanently set rates to zero.
I think you should exit this rhetorical space. Yes, there are many problems with adjusting interest rates, but even ignoring the interest-elasticity of savings demands, you need to adjust rates to mitigate cyclical distortions in firm borrowing costs in addition to using fiscal policy to minimize cyclical distortions to income. One does not replace the other. And you cannot permanently set rates to zero. That would correspond to huge transfers to borrowers. It is a tax on consumption and a subsidy to investment that results in falling real yields — a less productive capital stock as even the least productive investments get funded. Many countries have tried this approach and it always ends badly.
In terms of market discipline of banks not “working” because credit markets are pro-cyclical, that is a bit like arguing that the labor market does not work because employment is pro-cyclical.
April 9th, 2011 at 6:34 pm PDT
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“but you are not calling this policy an interest rate policy, even though it is an interest rate policy”
I agree with you to some degree there, but I may be the only one. Even if you use “credit controls,” you are affecting interest rates by necessity. The only point I would make is that most MMT’ers see st interest rate manipulation as de-stabilizing, and that’s why they don’t like it. One can agree/disagree, but there it is.
April 9th, 2011 at 6:44 pm PDT
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mdm writes
“Start with a basic ISLM+PhillipsCurve model”
The model doesn’t balance in the first place. Commercial bank held savings are a leakage.
“Post Keynesian tradition argues that central banks cannot control monetary aggregates without causing severe instability in the payments system”
The money supply can never be managed by any attempt to control the cost of credit. Keynes’s liquidity preference curve & his demand for money are both false doctrines.
Art writes
If you only consider the money stock your right. But no money figure is adequate as a guide post for monetary policy. The equation of exchange MV=PT is a truism & the relationship between money flows & nominal gDp performs equally as well (it’s unpublished).
April 9th, 2011 at 7:27 pm PDT
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Sure, I sympathize with interest rates management being de-stabilizing.
But how do you get from that to a permanent rate of zero? Why not a permanent rate of 4%?
The point being, if every project that has a positive return is funded, then you are going to fund a lot of low-productivity investments. You don’t need to be a big believer in marginal productivity theory to see that the capital stock will get bloated and productivity will decline.
The fact that we require a positive return for making use of scarce resources is not a bad thing.
April 9th, 2011 at 8:23 pm PDT
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Ah! Agreement that challenges the conventional MMT wisdom. This is progress. And refreshing…
April 9th, 2011 at 11:31 pm PDT
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“Agreement that challenges the conventional MMT wisdom.”
Professional MMTers seem to be in agreement over the economics, and the macro understanding that MMT provides encompasses various policy options. The professional MMT’ers are not in complete agreement on policy recommendations. That should be obvious to those following the MMT blogs.
April 9th, 2011 at 11:53 pm PDT
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There is an important parallel between credit and labor markets.
Both require a rethinking of how reserves are distributed, whether loaned or spent.
The last 40 years or so has seen an erosion in the power of labor which MMT addresses.
Over the same time frame there has been an erosion in the credit markets as the size of large banks has increased at the expense of small banks. Regulation, driven by the idea of public purpose, has failed to address the concentration of power occuring in the credit market.
MMT supports the ELR to provide a floor to labor income to address inequities in how reserves are spent.
MMT lacks an equivalent program in the credit market to address inequities in how reserves are lent.
Both solutions should be citizen based.
April 10th, 2011 at 12:13 am PDT
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“if every project that has a positive return is funded”
doesn’t follow at all
every project requires a risk premium in the interest rate – doesn’t matter if the risk free rate is 0 or 100 per cent
April 10th, 2011 at 3:29 am PDT
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and with a 0 risk free rate, tax risk under MMT would act like interest rate risk now, and would increase risk premiums (credit spreads and required ROE)
April 10th, 2011 at 3:34 am PDT
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Anon,
Are you joking?
April 10th, 2011 at 3:59 am PDT
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..Which is to say, you are either saying something extremely redundant and pointless or extremely funny, and I’m too drunk at the moment to tell which.
April 10th, 2011 at 4:01 am PDT
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What anon said makes sense to me, RSJ. To keep AD stable, you either need to vary interest rates, or vary tax rates. Either one will introduce some risk.
There’s an old story, possibly apocryphal, about Russian engineers trying to decide how thick to make some electricity transmission wires. The thicker the wires, the less the resistance, and the lower the loss of power. So they were comparing a one-time current cost of thicker wires with a flow of benefits from less power loss into the indefinite future. They wired Moscow “what interest rate do we use in this cost-benefit calculation?”. The answer came back “Comrades; interest is a bourgeois concept. Use 0%”. So the engineers built the wires infinitely thick.
April 10th, 2011 at 5:29 am PDT
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right – taxation IS monetary policy under the (specific) 0 rate proposal of MMT
April 10th, 2011 at 5:41 am PDT
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i.e. higher taxes correspond to tightening, which will squeeze margins just like higher rates do now
April 10th, 2011 at 5:43 am PDT
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that’s a funny story, Nick.
I’m talking about investment, and not AD, though. Interest is not taxed (for the firm), so if the money rate is less than that capital return, more investment will occur. Never mind inflation, let’s assume the savings demand curve is interest inelastic. Nevertheless, MPK will tend to zero as more investment occurs, as the money rate will drag down the natural rate. Has nothing to do with taxes. A case in point would be China at present.
April 10th, 2011 at 5:50 am PDT
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RSJ: (Wow! You are either up very early or very late!)
Set aside anon’s point about risk.
We are talking about very much the same thing (in my apocryphal story and your concerns about MPK=0).
Assume savings is perfectly interest-inelastic. Ignore expected inflation. Ignore open economy stuff. Ignore my monetarism and pretend I’m a standard Keynesian. (All for simplicity). As r goes to 0%, all sorts of investment projects, including those that have MPK approaching 0, will become profitable. So desired I will approach infinity (just like in my story). AD=C+I+G. If desired I approaches infinity, AD will approach infinity. But the standard definition of the “natural rate of interest” is that r* such that AD(r*)= “full employment” output. So if the central bank sets r less than r*, AD will exceed full employment.
April 10th, 2011 at 6:07 am PDT
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“if the money rate is less than that capital return, more investment will occur”
you really must be hammered
you actually think that’s how investment/finance decisions are made?
do you believe the money multiplier as well?
ever hear of the cost of equity capital?
April 10th, 2011 at 6:19 am PDT
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OK, you only get i going to infinity if there are no marginal adjustment costs. In particular, if capital goods prices are not increasing.
But the point is to make them increase, so I will remain finite and capital goods will become expensive. Whatever the supply elasticity demand is of capital goods, it will determine I.
I will be big, but so what. Assuming savings are interest inelastic, you just get a savings glut. Lots and lots of savings.
A big boost to GDP, but no consumer price inflation to speak of, so that taxes will not be raised. It will be asset price inflation.
At least, that’s how I think of China. Except there, the savings are conveniently captured by state owned enterprises so that they do not hit the household sector to begin with.
The point is, MPK starts to drop (but of course never reaches zero), and the economy is now dynamically inefficient. It would be better to have less investment and more consumption, as the growth rate of GDP is in excess of the return on capital, as the return on capital has been pushed downward and the growth rate of GDP has been increased.
April 10th, 2011 at 6:26 am PDT
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anon: I’m 100% sober (I promise). And I basically agree with RSJ here. Remember, as r approaches 0%, the P/E ratio on stocks approaches infinity (abstracting from risk on those earnings). Because people must be indifferent between holding stocks and bonds. You can’t hold the cost of equity finance exogenous with respect to the rate of interest. In equilibrium, abstracting from risk and liquidity, E/P on stocks equals r.
April 10th, 2011 at 6:28 am PDT
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And Nick I should add that your definition of the natural rate is not Wicksell’s old-school definition, which is what I am going by, but you get the point. I actually don’t like your — “the modern” — definition, because there are a lot of leaps between capital arbitrage and full employment. But that’s another debate :)
April 10th, 2011 at 6:30 am PDT
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“In equilibrium, abstracting from risk and liquidity, E/P on stocks equals r.”
OK, I would say, in disequilibrium (during the boom), E/P + expected capital gain = r.
expected capital gain ~ price inflation of capital goods.
April 10th, 2011 at 6:33 am PDT
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RSJ 153: “I will be big, but so what. Assuming savings are interest inelastic, you just get a savings glut. Lots and lots of savings.”
Nope. If C is a positive function of Y (or, at least, C is not a decreasing function of Y), AD=C+I+G=Y will approach infinity too, as I approaches infinity. So AD will exceed full employment if I is too big.
April 10th, 2011 at 6:33 am PDT
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Nick, that’s wrong
The cost of equity capital is NOT the risk free rate, yet you and RSJ are talking like it is
And interest rates on risky assets (i.e. ALL assets except for the risk free asset) are NOT zero just because the risk free rate is zero
April 10th, 2011 at 6:33 am PDT
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interest rates and equity rates of return will become equal to a pure risk premium – expressed either as an interest rate or a rate of return – when the risk free rate is zero
setting the risk free rate to zero resets the entire interest rate and equity return level, other things equal
but other things won’t be equal because MMT will use taxation and fiscal more generally to manage aggregate demand – that will increase risk premia due to that factor alone
April 10th, 2011 at 6:36 am PDT
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RSJ 156: agreed.
April 10th, 2011 at 6:44 am PDT
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anon: yes, we are abstracting from risk. Assume AD(r, risk). We need to adjust either r or risk so that AD(r, risk)= full employment Y. In theory, the government could adjust risk to ensure that we stay at full employment. “Hmmm, AD is getting a bit too big. Let’s promise to do some more random things to scare investment”. But it doesn’t sound like a good way to stabilise the economy. (Maybe that was your point earlier? But I get a bit lost when people name themselves “anon” ;-) )
April 10th, 2011 at 6:53 am PDT
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my point was regarding how the private sector views risk and compensation for risk
interest rates generally and required equity rates of return don’t become zero just because the risk free rate becomes zero
so its very dangerous to talk about “the interest rate” in that sense; you can’t just starting plugging zero rates in everywhere and having things go to infinity
you CAN’T abstract from risk in this sense – risk is the whole game; the risk free rate is just a linear add on to required rates of return
in addition to how the private sector views risk, you have to look at how the government views risk – specifically inflation risk
and here the zero rate proposal is clear that fiscal policy, including taxes, takes over from the current role of monetary policy – e.g. you tighten policy with higher taxes – this is an entirely separate issue from what I was referring to, with its own problems and challenges as you point out
April 10th, 2011 at 7:05 am PDT
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Warren,
“WM: point? you’re free to say you don’t think we should make a fiscal adjustment now because you think inflation as you measure it might go up. but not because we could be the next Greece.”
Say the govt sells so many bonds the market values them as junk because the implied tax rates are so high, then the govt sells the bonds to the central bank, which prints money so that it can buy more. This will be very inflationary. Further, it clearly should be very inflationary, conditional on the assumption that people are not fools.
You think that the fact that the debt is fixed in nominal terms allows the government a lot of latitude. So the govt can change the real terms of this debt by changing the relative price of the currency, which implies that agents should expect inflation given some level of govt debt.
April 10th, 2011 at 7:38 am PDT
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“Nope. If C is a positive function of Y (or, at least, C is not a decreasing function of Y), AD=C+I+G=Y will approach infinity too, as I approaches infinity. So AD will exceed full employment if I is too big.”
The consumption share of GDP in China has been dropping like a rock.
C can be a positive function of Y, even if C(Y)/Y is a decreasing function. For example c = sqrt(Y).
And to re-iterate, I will not go to infinity.
First the rates wont actually be zero. They will be bounded from below.
But more importantly, rising adjustment costs will prevent dK/dt from being infinite.
(*) dK/dt = dK/dp*dP/dt
So as long as the price elasticity of supply of capital goods is finite, and dP/dt is finite, then dK/dt will also be finite.
But dP/dt will be finite because the price of capital goods, in percentage terms, will not increase faster than the money rate is decreasing, due to the bound in #156.
Ok, obviously capital goods prices can do anything, right, but there is no reason to believe that I will be infinite.
I’m still sticking with the possibility of my savings glut/inefficient outcome, although it might not be the most likely outcome.
April 10th, 2011 at 7:55 am PDT
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Seems to me that the prime rate much more related to investment than the risk-free rate. If the overnight rate were set at zero, what would happen to the prime rate? As anon asserts, it certainly would not fall to zero, too.
The prime rate would be set by creditors in terms of perceived risk, as it is now. Would the prime rate generally be lower than otherwise with a risk-free rate of zero, cet. par. Of course, setting rates is how the cb moves rates through the economy through spreads.
Setting the risk-free rate to zero would lower the prime rate, encouraging productive investment with taxation designed to discourage rent-seeking. With a strong safety net, household would not need to save as much for medical emergencies and retirement, since these would be covered. The “euthanasia of the rentier” would be underway.
But this is much wider than rates per se. Setting the risk-free rate to zero is to open up other avenues of approach. As anon points out, the MMT approach is get the cb out of the interest rate setting business and use fiscal policy instead, which can be more tightly targeted than rates, and more fairly targeted, too. Using interest rates as a tool favors particular interests that are rate sensitive and act first. Moreover, NAIRU uses unemployment as a tool instead of a target, in violation of the Fed’s mandate to “maximize unemployment” as well control inflation. This is a chief objection of MMT to present monetary policy, since MMT aims at full employment defined as a job offer for anyone willing and able to work, along with price stability and would replace NAIRU with NAIBER (Non-Accelerating-Inflation-Buffer Employment Ratio). See Mitchell and Muysken, Full Employment Abandoned, (Elgar, 2008).
In addition to interest rates and taxes, there are also other tools available. There’s capitalization rate and margin requirements, for example. The cb can also set lending conditions that limit leverage. One of the things that led to the crisis was relaxing existing leverage requirements when they should have at least been enforced as they stood, or even tightened down.
Then, there are accounting standards. The powers-that-be control those, too, and relaxed them when it appeared that the banks would be insolvent under existing mark-to-market rules.
The cb also has quasi-fiscal tools. It can adjust fees on interbank transactions, for example, and it doesn’t need congressional approval to do so. A number of other tools, already legal in the US, have been discussed on the MMT blogs, especially by beowulf, who is not here in this discussion. Lerner/Colander’s MAP (market anti-inflation plan) and the work of Bill Vickrey (auctions) are also relevant.
There are a lot of factors other than interest rates, and cet. par. is inapplicable other than in simplistic models because other things are never equal. Arguing from simple models to policy conclusions is simplistic. Simple models may be useful as rules of thumb, but engineers don’t use rule of thumb to build bridges. Economists should not use them to propose policy either.
The point of MMT is that interest rate setting is a blunt tool that history shows is incapable of achieving full employment and price stability, and involves a whole range of problems. MMT proposes other options. These kinds of issues have been discussed in some detail on MMT blogs. The point is that there are other ways of proceeding to the desired goal without the cb adjusting interest rates to get there.
April 10th, 2011 at 12:12 pm PDT
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Tom: the Fed’s mandate to “maximize unemployment”? :-)
April 10th, 2011 at 1:31 pm PDT
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Thanks for the heads up, Oliver I seem to have slipped and confused what they are doing with what their mandate is. :)
April 10th, 2011 at 1:49 pm PDT
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SRW, I’m not sure where Nick falls on this issue, and I apologize if it has already been addressed in the comments (which I have only skimmed), but I think your update still misses part of the neoclassical view of deficits. If I’m not mistaken, if we expect the growth rate and the interest rate to be constant in perpetuity and the former exceeds the latter, then the only condition necessary for the government budget constraint to be satisfied is that, at some point in time (possibly in the distant future) all primary deficits stop. After that time, the debt-to-GDP ratio will begin to fall, and at the limit as time goes to infinity, it will be zero. (Of course, technically, I’m assuming an eventual primary surplus to pay off the outstanding debt, but as time goes to infinity, the size of the necessary primary surplus, relative to GDP, goes to zero, so it represents only a vanishingly small increase in the tax rate if it is pushed sufficiently far into the future.) Since we can also push as far as we want into the future the point where the primary deficits must end, this means that there are plausible conditions under which there is effectively no government budget constraint. Or, interpreted in more practical, “real world” terms, it means that the government budget constraint is so squishy that it may not be worth talking about. And yet this comes straight out of the conventional mode of analysis.
April 10th, 2011 at 5:35 pm PDT
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Andy, that would be a possible scenario were the US to become a net exporter, and net exports offset leakage to saving and also made space for fiscal surpluses. But the US cannot be Norway due to the USD being the global reserve currency. For the US to become a net exporter in the future, wouldn’t the Triffin dilemma require a global reserve currency other than the dollar?
According to the sectoral balance approach, the other way for the US to accomodate fiscal surpluses is through private domestic sector dissaving, which is unsustainable over time since the private domestic sector is revenue constrained, being a currency user instead of issuer.
April 10th, 2011 at 7:35 pm PDT
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Back to the GBC, think of an (infinitely lived) firm. The capital structure will be some combination of debt/equity.
Now assume that the government is the firm, but its asset is the power to tax. This asset increases in value each period for free, without any need for investment on the part of government. There is also no depreciation.
What is the value of the taxing asset? How much money would you need to spend (by purchasing capital) in order to obtain a consol whose payouts grew with GDP each period?
For the U.S., capital income is 25% of GDP and gross investment is 15% of GDP, so the net is 10% of GDP. Purchasing the private sector capital stock today will give you an income stream equal to 10% of GDP. Taxes will give you an income stream of about 20% of GDP, so ballpark, the current tax asset (keeping rates fixed) is valued at twice the value of the entire private sector capital stock.
The BEA says that current-cost private fixed assets are about 34 Trillion, so the tax asset should be conservatively valued at around 68 Trillion dollars. But if we go by market value, Flow of Funds says that household net worth (excluding claims on government) is about 53 trillion, which would set the value the taxing asset at 106 Trillion. Let’s split this down the middle and say that the private sector capital stock is worth 3.1 GDP, and the taxing asset is worth 6.2 GDP.
In that case, as we know the cashflows (10% of GDP) and the price of the asset (3.1GDP), we can estimate the total cost of capital of the private sector capital stock at 3.2% + g, which is inline with other valuation results.
But that rate includes a premium for risk. If the firm sells a combination of bonds and equity, then equity holders get a higher (absolute) return in exchange for bearing volatility of payments. Bond holders pay a premium for guaranteed returns. Historical NYSE equity premiums over long term bonds range from 2.7% – 3.8%, so bondholders receive g + 3.2% – risk premium, which is again in-line with estimates of long term bond rates at about the growth rate of the economy.
If we say that bondholders receive a return of exactly g, then the government never needs to run any primary surpluses in order to keep the debt level constant, and it can increase the debt level every period (run primary deficits) if it keeps its capital structure constant — say 40% debt and 60% equity.
It then becomes a question of what the optimal debt level would be.
It would be non-zero, because going back to our model, the equity holders are everyone that receives government (primary) spending. Just as with an ordinary firm, equity holders can increase their dividends (in absolute terms) by having the firm sell debt that pays out a lower rate. Effectively the debt holders pay the equity holders the risk premium.
If a firm is less productive, so that it would not be able to meet its cost of equity, but has a more stable income, then it can exchange the excess income stability for higher dividends by selling debt, allowing it to meet the (general) cost of equity even though it’s overall weighted average cost of capital is less than the cost of equity. So for every firm, given a certain level and volatility of income, there is an optimal debt to equity ratio in these terms, and this ratio increases with the idiosyncratic income stability of the firm.
But the government, as it taxes a share of national income, has the law of large numbers working for it, allowing it, in theory, to maintain a debt level much higher than that of the private sector. And if the government is a currency issuer, then it is immune to liquidity crises. It has the power to smooth primary spending, and even increase primary spending by modulating its debt level. This allows equity holders (those receiving primary spending), on the one hand to avoid risk while at the same time receiving as transfers the entire risk-premium on those who purchase government debt. There is a huge advantage to selling debt.
So it’s strange when people worry about a government with a taxing asset worth 6xGDP carrying .5GDP of public debt, when firms routinely carry 40% of their asset values as debts held by households, and private sector firms have higher funding costs than the government.
Moreover, it’s idiotic — sorry no better word — to speak of the government as “paying off” its debt, when firms never pay off debts, they maintain a certain debt level. Debt is just a type of claim on the firm. To reduce it would require that equity holders buy out the bond holders, even though the bond holders are willing to pay a premium (to equity holders) in order to get the claim. It is like asking a widget seller to buy back widgets from the public, because some misguided economist decided that the total number of widgets needs to go to zero, as he didn’t know how to a solve a time series if it didn’t.
April 10th, 2011 at 10:54 pm PDT
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If you’re going to capitalize future taxes as an asset, you have to capitalize future expenditures as a liability. Game over.
April 11th, 2011 at 2:45 am PDT
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Anon,
“If you’re going to capitalize future taxes as an asset, you have to capitalize future expenditures as a liability. ”
LOL, Captain Obvious strikes again!
Of course assets = liabilities, but the return to equity holders — recipients of primary spending — is greater than to bondholders, as the latter group effectively pays the former group the amount of the risk premium each period.
But unlike a firm, in which equity holders need to face pro-cyclical volatility in exchange for the higher returns, so that returns are not higher on a risk-adjusted basis, recipients of government spending do not need to bear this volatility, so they get a higher return than bondholders.
Therefore it benefits them to sell bonds.
April 11th, 2011 at 3:18 am PDT
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That’s a steaming hunk of verbiage, but the numbers don’t add up.
I’d like to see you redo the numbers with capitalized expenditures included, perhaps with the objective of clear explanation rather than bombast – could help your cred here as well as be interesting.
thx
April 11th, 2011 at 5:48 am PDT
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Let me do it for you then.
“So it’s strange when people worry about a government with a taxing asset worth 6xGDP carrying .5GDP of public debt, when firms routinely carry 40% of their asset values as debts held by households, and private sector firms have higher funding costs than the government.”
Not so strange, because its wrong. You didn’t include the capitalized value of future government expenditures as a liability, along with the current debt, and which when included destroys the comparison and the analysis.
April 11th, 2011 at 7:19 am PDT
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RSJ,
Just as with an ordinary firm, equity holders can increase their dividends (in absolute terms) by having the firm sell debt that pays out a lower rate. Effectively the debt holders pay the equity holders the risk premium.
Not quite following here. What do you mean when you say that equity holders (receivers of primary spending, as you define them) receive a premium over bondholders? In what sense?
April 11th, 2011 at 7:43 am PDT
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Anon:
Can you explain how you get the taxing power of six times GDP?
Don Levit
April 11th, 2011 at 9:05 am PDT
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Tom Hickey wrote:
The other way for the U.S. to accomodate fiscal surpluses is through private sector dissaving.
When you say private sector dissaving, I assume you mean the private sector spending more than it is saving.
Isn’t another way to produce a surplus is when tax revenues exceed expenses?
Why can’t people save when that happens?
I have a feeling this has happened before, so there should be a precedent.
Don Levit
April 11th, 2011 at 9:14 am PDT
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Don, by “dissaving” I meant spending more than income. which means going into debt, drawing down savings, or selling assets.
According to the sectoral balance approach that MMT uses, the fiscal balance, the private domestic balance, and the external balance sum to zero. This is not theory. It is a national accounting identity.
This means that the only way that the government and the private domestic sector can be in surplus simultaneously is if net exports offset. If the private domestic sector tries to save overall when the government’s fiscal balance is in surplus and the external balance does not offset, then there will be demand leakage, the economy will contract and unemployment rise, and there will be a reset at a lower level with the economy underperforming. This is also true if the fiscal deficit is not large enough to offset the private domestic desire to save coupled with an external deficit, like now.
Here is the way Bill MItchell puts it:
From the sources perspective we write:
GDP = C + I + G + (X – M)
which says that total national income (GDP) is the sum of total final consumption spending (C), total private investment (I), total government spending (G) and net exports (X – M).
From the uses perspective, national income (GDP) can be used for:
GDP = C + S + T
which says that GDP (income) ultimately comes back to households who consume (C), save (S) or pay taxes (T) with it once all the distributions are made.
Equating these two perspectives we get:
C + S + T = GDP = C + I + G + (X – M)
So after simplification (but obeying the equation) we get the sectoral balances view of the national accounts.
(I – S) + (G – T) + (X – M) = 0
That is the three balances have to sum to zero. The sectoral balances derived are:
The private domestic balance (I – S) – positive if in deficit, negative if in surplus.
The Budget Deficit (G – T) – negative if in surplus, positive if in deficit.
The Current Account balance (X – M) – positive if in surplus, negative if in deficit.
These balances are usually expressed as a per cent of GDP but that doesn’t alter the accounting rules that they sum to zero, it just means the balance to GDP ratios sum to zero.
http://bilbo.economicoutlook.net/blog/?p=14106
April 11th, 2011 at 1:07 pm PDT
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Anon,
You are so lost. But feel free to think whatever you want. Perhaps others will be willing to engage you.
April 11th, 2011 at 7:40 pm PDT
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“You are so lost”
LOL back at you. This is a blog where you’re supposed to stand in reason on what you publish/comment. You wrote what you did, in grand style. I made a few comments on substance, and you offer nada. That’s inevitable, given the problem I see with it. So fine. Leave it there. I’m certainly not looking for engagement from others on what you wrote.
Don L., that’s not my calculation.
April 11th, 2011 at 11:19 pm PDT
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Oliver,
“Not quite following here. What do you mean when you say that equity holders (receivers of primary spending, as you define them) receive a premium over bondholders? In what sense?”
The tax asset, when discounted by the cost of capital is valued at, say, 6GDP. But the same asset when discounted by the risk-free rate has infinite present value. The government is able to borrow and spend during busts, and pay interest during booms, delivering a smoother and greater income to recipients of public spending.
But I think the interest rates and GDP growth rate is a bit of a distraction here, as the government is not able to deliver more real income, but it is able to close the Lucas wedge. This is the real sense in which deficit spending helps the private sector.
And for that, you don’t need the risk free rate to be greater than the growth rate of GDP. Suppose that household (nominal) income grows as
log h(t) = 3 + x(t) + gt
where x(t) is a white noise term.
Even at high interest rates, government can tax and spend so that log household disposable income + transfers is equal to:
3 + .5x(t)+ gt
Reducing the noise term but at no cost to households, even with positive interest rates in excess of the GDP growth rate. x(t) will spend as much time above the axis as below it, and even though x(t) is unbounded, it grows with sqrt(t), whereas income is growing with g*t. So the government can ignore the debt and stabilize household income to trend at no cost to households in terms of increased future tax rates, even if risk-free rates are in excess of the growth rate of the economy.
Without this policy, households would not have access to any risk-free liabilities other than deposits. With the policy, bondholders can purchase government bonds, obtaining a risk-free asset that can cushion their capital income and at the same time, recipients of primary deficit spending obtain an income stream that is negatively correlated with capital income. But any asset that is negatively correlated to capital income (as well as overall household income) is valuable, both in terms of utility and in terms of cash-flows. It will allow you to consume more and to purchase more capital.
April 11th, 2011 at 11:54 pm PDT
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Flow5
“Keynes’s liquidity preference curve & his demand for money are both false doctrines.”
When I see anybody writing such things, I think it is a waste of time to discuss anything with them. Flow5 – maybe you need to think about your language.
April 12th, 2011 at 8:11 am PDT
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Tom Hickey
“Andy, that would be a possible scenario were the US to become a net exporter, and net exports offset leakage to saving and also made space for fiscal surpluses. But the US cannot be Norway due to the USD being the global reserve currency. For the US to become a net exporter in the future, wouldn’t the Triffin dilemma require a global reserve currency other than the dollar?
According to the sectoral balance approach, the other way for the US to accomodate fiscal surpluses is through private domestic sector dissaving, which is unsustainable over time since the private domestic sector is revenue constrained, being a currency user instead of issuer.”
Yep – so why doesn’t the world look for a new global reserve currency?
April 12th, 2011 at 8:14 am PDT
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P.S. In case flow5 is confused – the term “false doctrines” belongs to religious factionalism, and has no place here.
April 12th, 2011 at 8:19 am PDT
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I find Tom Hickey’s very interesting here. But one thing just occured to me – if the overnight goes to 0, then might it not be that compared to the status quo, following MMT policy prescriptions we might end up with TIGHTER fiscal policy than we have now, since money policy would be effectively very loose. Everybody seems to think they are arguing for looser fiscal policy. It may not necessarily be the case.
April 12th, 2011 at 8:29 am PDT
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oops – ” I find Tom Hickey’s POSTS very …”
Particularly where he is arguing that MMT policy might boost real private investment.
April 12th, 2011 at 8:30 am PDT
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Tom:
Assuming this equation is accurate, how were Americans able to save 8-10% of their income in the 1950s through the 1970s, when the deficits were either a moot point, or insignificant?
Is it due to being a net exporter?
Does anyone have figures to back this up?
Don Levit
April 12th, 2011 at 9:34 am PDT
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Don,
Because “nominal net savings” are not the same as savings.
April 12th, 2011 at 11:16 am PDT
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@ don levitt
http://www.moslereconomics.com/wp-content/powerpoints/SFB%202010Q3.xlsx
April 12th, 2011 at 11:55 am PDT
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Don, here is a chart of US sectoral balances going back to ’61, showing how they move in relation to each other.
http://pragcap.com/wp-content/uploads/2011/04/sb1.gif
April 12th, 2011 at 3:39 pm PDT
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Tom:
That last chart showed the government sector pretty close to the private sector, mirror images of each other, in 2009.
What comprises the private sector for 2009?
Vimothy:
Can you define nominal net savings versus savings?
Don Levit
April 12th, 2011 at 5:09 pm PDT
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Don, the fiscal deficit is the sum of the private surplus (saving) and the external deficit (CAD). This is reflected in the chart as the fiscal deficit offsetting the sum of the private domestic sector surplus (saving) and the external deficit (CAD). The private domestic saving is almost the mirror image (inverse) of the fiscal deficit because deleveraging was so large.
What is happening is that the private domestic sector is deleveraging (saving) to repair balance sheets broken by the financial crisis. At the same time the US is running an external deficit due to a desire for cheap imports. These are both demand leakages.
Comparing this with unemployment, the fiscal deficit is not large enough to accomodate the desire to save (delever) and consume net imports. This means that nominal aggregate demand is insufficient to purchase the output which the economy is capable of producing. This shortfall results in an output gap and unemployment.
April 12th, 2011 at 9:25 pm PDT
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Don, this chart makes it more clear by using the capital account instead of the current account. The capital account is the inverse of the current account, i.e., a current account deficit is offset by an equal capital account surplus as an accounting identity (accounting always nets to zero).
http://pragcap.com/wp-content/uploads/2011/04/sb1.png
April 12th, 2011 at 11:44 pm PDT
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Don: because they invested their savings in the US.
April 13th, 2011 at 6:32 am PDT
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“Much of what is great about MMT is that it persuasively challenges a lot of ordinary and conventional views. But people who cling to those views, even famous economists who perhaps “ought to” know better, are mostly smart people who simply have not yet been persuaded. Neither ridicule nor patronizing lectures are likely to help.”
Some people made this point over at Bill Mitchell’s site the other day. I’m not sure that I agree. Of course, there are people who are open to argument — but there are far more that are not. I think Krugman is a good case-in-point. Over at Mitchell’s blog I pointed out that Krugman attacks MMT not because he finds it irrational — we know this because he doesn’t bother reading up on it — but instead because it furthers his own influence.
It does so in two ways:
(1) It ‘proves’ to more mainstream economists that while ‘ol Krugman may be a bit left-wing, he sure isn’t as ‘crazay’ as those wacky MMTers. This is a classic political tactic by a beleaguered minority that has managed to gain traction within the establishment (you even see Obama engaged in this in the US at the moment).
(2) If Krugman accepted MMT then a lot of what Krugman said in the past would have been wrong. A lot of that stuff he said about Japan, for example, wouldn’t only have proved to be empirically but also theoretically false. Now, an economist can survive being proved empirically wrong — in fact, they seem able to withstand this better than any other profession — but a public economist admitting theoretical weakness would be the equivalent to a bishop doubting God at the pulpit. His credibility would instantly evaporate.
So, all in all I wouldn’t worry about the prickliness of MMTers. What they need to focus on is trying to gain institutional power — both academic and governmental. This is how new theories REALLY spread. You’d be naive if you thought that new theories spread by rational argument.
The Philosopher of Science Paul Feyerabend wrote in ‘Against Method’ — a book everyone concerned with this should read — “It is very difficult, and perhaps even impossible, to combat the effects of brainwashing by argument”. Amen.
April 14th, 2011 at 9:35 am PDT
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[…] Modern Monetary Theory – “MMT offers the most promising toolkit for crafting a desperately needed replacement of status quo central banking.” […]
April 14th, 2011 at 11:51 am PDT
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Sorry for the late hit. Finally got around to reading through all the comments. I see the stalwart Tom Hickey mentioned the prime rate and the Fed’s existing power to, in effect, levy taxes.
Steve pointed out several years ago “The average spread between the Federal Funds Rate and the Prime Rate from August 1955 through August 1989 was 1.33%. From 1991 onward, that spread has been nearly constant at 3%.”
http://www.interfluidity.com/posts/1160447599.shtml
Even though we’ve been at zero bound for a couple of years, the prime rate markup is still 3%. The most basic credit control the Fed could impose on member banks is to increase or reduce this markup. At the same time, the Fed could bar them from using LIBOR rates to set loans or from undercutting the prime rate markup rate it sets.
Second, as we all know, the Fed rebates its net earnings to Tsy (annually, but I suppose they could do it as often as daily). What’s more, as Tom mentioned, Congress has been given the Fed authority to set and adjust user fees for “services which the Federal Reserve System offers, including but not limited to payment services to effectuate the electronic transfer of funds”.
http://www.law.cornell.edu/uscode/uscode12/usc_sec_12_00000248—a000-.html
What praytell could they do with this authority? Not long before Steve made is observation about the prime rate, UW-Madison Economics Professor Edgar Feige presented his APT bank transaction tax proposal to the Bush tax reform panel.
http://www.scribd.com/doc/25299549/Feige-APT-Presentation-to-Tax-Reform-Panel-2005
Interesting read, especially since the Fed already has authority to impose the transaction fees Feige proposes. I’ll go further and suggest that RSJ’s (#110) “asset tax on all non-central bank liabilities” could be levied by the Fed governors as a user fee (and then rebated to Tsy) as an alternative to paying interest on net reserves (or T-bond sales) to anchor the Fed Fund rate. Lets say the Fed imposed Feige’s APT “user fee” at the same time Congress abolished the FICA payroll tax (but continued paying out SS and Medicare checks). The Fed would have a $900 billion a year fiscal tool. increasing transaction fee, net drain and decreasing fee, a net add. The fiscal impact of RSJ’s asset tax would be even more dramatic, since it would convert interest maintenance operations from a net debit to Tsy to a net credit. If the Fed continued to adjust Fed Fund rate, the CBO’s $5 trillion in projected net interest outlays this decade would turn into $5 trillion in Fed earnings (rebated, of course, to Tsy General Fund).
April 16th, 2011 at 4:20 am PDT
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Again, as usual, among the best economic thinking currently happening. Worth the two hours devoted to reading and re-reading post and comments. Also great to see you’re getting cred out there, at least among the “new” economists.
Somewhat random responses:
I don’t think they’re necessarily “scare” quotes. It’s more like saying “so-called.”
The whole issue of “institutional changes that could be plausibly implemented in time to matter and that could ensure support of the value of government claims”:
I’m back again to banging my spoon on the highchair about the EITC. Ramp it up significantly and — this perhaps an answer to your concern — somehow index it to some measure of unemployment. Automatic stabilizers/countercyclicals, clumsily algorithmic as they may be, seem to be about the only solution to the political challenges of implementing functional finance. Yes: “transfers as an instrument.” The EITC is our largest, most effective, and most efficient (functionally and economically) cash transfer program. Grow it enough and a lot of specifically targeted transfers become unnecessary. “Let the market decide.” “Wisdom of the crowds.” Such like that.
As an aside, I’m devastated to note that the “Advanced EITC” — which allowed people to receive it on their weekly paychecks, thereby greatly increasing its salience hence incentive effects — was eradicated in recent bouts of austerity legislation. Only about 1% of recipients used it (or even knew about it, for all I know), but its removal is a step backwards. And its removal was nothing more than a fiscal-year revenue shift. Useless.
“quality-of-expenditure concerns”
Just to note that — assuming for the moment that government investments are of superior quality than government consumption — the quality of government expenditure fell off a cliff from the 50s/60s to the 70s/80s, and has been in a much lower-quality zone ever since:
http://www.asymptosis.com/government-investment-and-the-post-70s-prosperity-gap.html
“MMT-ers rhetorically attach the positive normative valence associated with “saving” to deficit spending by government.”
This identical to those who use the Savings = Investment identity to argue that we need more savings, aka financial assets.
“Household savings is mostly a proxy for real investment”
Is that really true? Aren’t personal savings and undistributed business profits simply additions to the pool of financial assets? Money comes out of that pool to fund real investment (and consumption, and loan payoffs, and tax-paying), but the balloon that is “financial assets” is extremely elastic. cf my reply to DLR below re semantics, the failure to distinguish between real assets and financial assets, and between real investment and financial “investment” (actually: saving) drives much confusion in this world. I think it’s a big conceptual mistake to equate savings with investment, as if intermediation were complete, instant, and perfect, or even close.
This post makes me realize that my current favorite proposal — a tax on financial assets — is in addition to myriad other benefits (especially encouraging real investment instead of savings/financial “investment”), an excellent automatic implementation of functional finance: the tax burden rises in boom times, and drops in times of “low animal spirits. ”
http://www.asymptosis.com/want-a-flat-tax-i-got-a-flat-tax-for-you.html
I’d much appreciate hearing your thoughts on this approach.
DLR: “The Private Sector’s net Government Obligations position is reciprocal to Public Sector’s net Government Obligations position. Calling these respective positions in Government Obligations “net private sector saving” or just “net saving” is perfectly accurate given the language used in sectoral accounting… and perfectly unhelpful. It is unhelpful because “saving” is used in other contexts to mean something much broader, i.e. “income not consumed.” This semantic confusion isn’t, I don’t think, merely benign.”
I could not agree more. Obligations are stocks (balance sheet). Savings are flows (income statement). Confusing the two (as you do to some extent in the first part of this paragraph, perpetuating the semantic confusion) results in much muddled economic discourse.
Okay I’ve run out of time only a third of the way through the comments. Thanks again for a great post.
April 16th, 2011 at 9:26 am PDT
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Oh but I did mean to ask: should we be demanding a significantly higher inflation rate from the fed? It is, among other things, a functional near-equivalent to a financial assets tax, (again among other things) transferring value from financial assets to real assets.
And of course it would drive spending — both investment and consumption.
April 16th, 2011 at 9:32 am PDT
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“Government obligations, like all financial assets, are disproportionately held by the wealthy. . . . In practice, a large stock of government claims serves as the lifeboat through which prior wealth inequality carries itself into the future. Absent an accommodative stock of government obligations, recessions would be crucibles that separate the deserving from the undeserving rich, and would thin the ranks of the rich generally. Recessions should be periods that decrease inequality, but the availability of default-risk free claims whose purchasing power is politically protected inverts the dynamic.”
As a non-economist, it seems wacko to me that a nation should not have a reasonably large buffer of money that is not interest-bearing debt. One objection to that is that “monetizing the debt” is inflationary. It also seems to me that too large a buffer might reduce the flexibility of the gov’t/central bank. Back in the old days of the Gold Standard, we had such a buffer, and as far as I know, that fact did not bother economists.
From what you say here, perhaps one value of a buffer would be to reduce the stock of gov’t obligations that serve as the lifeboat for inequality. And if recessions should be periods that reduce inequality, would it make sense that those might be times to increase the size of the buffer by gov’t spending without issuing interest-bearing debt?
I would appreciate your comments. :) Thanks.
April 16th, 2011 at 9:40 am PDT
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Vimothy: “It makes sense that in the limit govt debt goes to zero.”
It doesn’t make sense in the short run. (See the depression of 1837 – 1843.) Why should it make sense in the limit?
April 16th, 2011 at 10:49 am PDT
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RSJ: “In terms of market discipline of banks not “working” because credit markets are pro-cyclical, that is a bit like arguing that the labor market does not work because employment is pro-cyclical.”
Hmmm. Isn’t that the MMT line? That the labor market does not work. Hence, the Job Guarantee.
Besides, it certainly does not look like the labor market is working right now, eh?
April 16th, 2011 at 3:17 pm PDT
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“As a non-economist, it seems wacko to me that a nation should not have a reasonably large buffer of money that is not interest-bearing debt. One objection to that is that “monetizing the debt” is inflationary.”
Not possible. The supply of paper money is not under government control. You can always change it for interest earning debt/money.
April 16th, 2011 at 3:29 pm PDT
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Max: “The supply of paper money is not under government control. You can always change it for interest earning debt/money.”
So you are saying that, suppose this year the Congress did not raise the debt limit, but authorized the Treasury to spend without issuing T-bills or bonds, then it is possible that the money supply would not increase, if people bought enough bonds?
April 16th, 2011 at 4:49 pm PDT
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“So you are saying that, suppose this year the Congress did not raise the debt limit, but authorized the Treasury to spend without issuing T-bills or bonds, then it is possible that the money supply would not increase, if people bought enough bonds?”
I’m saying if the government tried to print money, people would just deposit the money in banks. Bank reserves would increase, but not the supply of non-interest bearing (paper) money. Of course, it’s possible for the Fed to set its interest rate target at 0%. In that case bank reserves would not earn interest for as long as the Fed maintained a 0% target.
April 16th, 2011 at 6:12 pm PDT
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Last I heard, Swedish bank reserves had a negative interest rate. How is that working out?
April 16th, 2011 at 8:26 pm PDT
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MIn, the JG does not replace the market allocation of employment, rather it absorbs the quantity of unemployed. But removing all market discipline from bank lending is replacing the market allocation of all bank liabilities. The equivalent of a JG for bank borrowing would be for the government to be a lender of last resort similar to a JG being an employer of last resort. But just as with a JG, you would not set the wage to be above the market wage as you are not trying to replace private sector employment with JG employment. Similarly you would only lend to the banks at a penalty rate, to discourage them from obtaining funding from the lender of last resort as opposed to the market.
April 16th, 2011 at 9:49 pm PDT
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The above should read “removing market discipline from bank borrowing”, obviously, and not lending.
April 16th, 2011 at 9:50 pm PDT
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[…] and Japan are pretty prominent. But before we get the inevitable counterblast from aficionados of Modern Monetary Theory — Rabobank’s analyst, Shahin Kamalodin, acknowledges that the index excludes important […]
April 21st, 2011 at 5:31 am PDT
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