Rebalancing the Global Recovery

Chairman Ben S. Bernanke

November 19, 2010

The global economy is now well into its second year of recovery from the deep recession triggered by the most devastating financial crisis since the Great Depression. In the most intense phase of the crisis, as a financial conflagration threatened to engulf the global economy, policymakers in both advanced and emerging market economies found themselves confronting common challenges. Amid this shared sense of urgency, national policy responses were forceful, timely, and mutually reinforcing. This policy collaboration was essential in averting a much deeper global economic contraction and providing a foundation for renewed stability and growth.

The main policy response as the automatic fiscal stabilizers that, fortunately were in place to cut govt revenues and increase transfer payments, automatically raising the federal deficit to levels where it added sufficient income and savings of financial assets to support aggregate demand at current levels. And while the contents selected weren’t my first choice, the fiscal stimulus package added some support as well.

In recent months, however, that sense of common purpose has waned. Tensions among nations over economic policies have emerged and intensified, potentially threatening our ability to find global solutions to global problems. One source of these tensions has been the bifurcated nature of the global economic recovery: Some economies have fully recouped their losses

Those who have sustained adequate domestic aggregate demand through appropriate fiscal policy.

while others have lagged behind.

Those who have not had adequate fiscal responses.

But at a deeper level, the tensions arise from the lack of an agreed-upon framework to ensure that national policies take appropriate account of interdependencies across countries and the interests of the international system as a whole. Accordingly, the essential challenge for policymakers around the world is to work together to achieve a mutually beneficial outcome–namely, a robust global economic expansion that is balanced, sustainable, and less prone to crises.

Unfortunately, that would require an understanding of monetary operations and that a currency is a (simple) public monopoly. And with that comes the understanding that the us, for example, is far better off going it alone.

The Two-Speed Global Recovery
International policy cooperation is especially difficult now because of the two-speed nature of the global recovery. Specifically, as shown in figure 1, since the recovery began, economic growth in the emerging market economies (the dashed blue line) has far outstripped growth in the advanced economies (the solid red line). These differences are partially attributable to longer-term differences in growth potential between the two groups of countries, but to a significant extent they also reflect the relatively weak pace of recovery thus far in the advanced economies. This point is illustrated by figure 2, which shows the levels, as opposed to the growth rates, of real gross domestic product (GDP) for the two groups of countries. As you can see, generally speaking, output in the advanced economies has not returned to the levels prevailing before the crisis, and real GDP in these economies remains far below the levels implied by pre-crisis trends. In contrast, economic activity in the emerging market economies has not only fully made up the losses induced by the global recession, but is also rapidly approaching its pre-crisis trend. To cite some illustrative numbers, if we were to extend forward from the end of 2007 the 10-year trends in output for the two groups of countries, we would find that the level of output in the advanced economies is currently about 8 percent below its longer-term trend, whereas economic activity in the emerging markets is only about 1-1/2 percent below the corresponding (but much steeper) trend line for that group of countries. Indeed, for some emerging market economies, the crisis appears to have left little lasting imprint on growth. Notably, since the beginning of 2005, real output has risen more than 70 percent in China and about 55 percent in India.

No mention of the size of the budget deficits in those nations, not forgetting to include lending by state owned institutions that is, functionally, deficit spending.

In the United States, the recession officially ended in mid-2009, and–as shown in figure 3–real GDP growth was reasonably strong in the fourth quarter of 2009 and the first quarter of this year.

Mainly a bounce from an oversold inventory position due to the prior fear mongering and real risks of systemic failure.

However, much of that growth appears to have stemmed from transitory factors, including inventory adjustments and fiscal stimulus. Since the second quarter of this year, GDP growth has moderated to around 2 percent at an annual rate, less than the Federal Reserve’s estimates of U.S. potential growth and insufficient to meaningfully reduce unemployment. And indeed, as figure 4 shows, the U.S. unemployment rate (the solid black line) has stagnated for about eighteen months near 10 percent of the labor force, up from about 5 percent before the crisis; the increase of 5 percentage points in the U.S. unemployment rate is roughly double that seen in the euro area, the United Kingdom, Japan, or Canada. Of some 8.4 million U.S. jobs lost between the peak of the expansion and the end of 2009, only about 900,000 have been restored thus far. Of course, the jobs gap is presumably even larger if one takes into account the natural increase in the size of the working age population over the past three years.

Of particular concern is the substantial increase in the share of unemployed workers who have been without work for six months or more (the dashed red line in figure 4). Long-term unemployment not only imposes extreme hardship on jobless people and their families, but, by eroding these workers’ skills and weakening their attachment to the labor force, it may also convert what might otherwise be temporary cyclical unemployment into much more intractable long-term structural unemployment. In addition, persistently high unemployment, through its adverse effects on household income and confidence, could threaten the strength and sustainability of the recovery.

Low rates of resource utilization in the United States are creating disinflationary pressures. As shown in figure 5, various measures of underlying inflation have been trending downward and are currently around 1 percent, which is below the rate of 2 percent or a bit less that most Federal Open Market Committee (FOMC) participants judge as being most consistent with the Federal Reserve’s policy objectives in the long run.1 With inflation expectations stable, and with levels of resource slack expected to remain high, inflation trends are expected to be quite subdued for some time.

Yes, the FOMC continues to fear deflation.

Monetary Policy in the United States
Because the genesis of the financial crisis was in the United States and other advanced economies, the much weaker recovery in those economies compared with that in the emerging markets may not be entirely unexpected (although, given their traditional vulnerability to crises, the resilience of the emerging market economies over the past few years is both notable and encouraging). What is clear is that the different cyclical positions of the advanced and emerging market economies call for different policy settings. Although the details of the outlook vary among jurisdictions, most advanced economies still need accommodative policies to continue to lay the groundwork for a strong, durable recovery. Insufficiently supportive policies in the advanced economies could undermine the recovery not only in those economies, but for the world as a whole. In contrast, emerging market economies increasingly face the challenge of maintaining robust growth while avoiding overheating, which may in some cases involve the measured withdrawal of policy stimulus.

Let me address the case of the United States specifically. As I described, the U.S. unemployment rate is high and, given the slow pace of economic growth, likely to remain so for some time. Indeed, although I expect that growth will pick up and unemployment will decline somewhat next year, we cannot rule out the possibility that unemployment might rise further in the near term, creating added risks for the recovery. Inflation has declined noticeably since the business cycle peak, and further disinflation could hinder the recovery. In particular, with shorter-term nominal interest rates close to zero, declines in actual and expected inflation imply both higher realized and expected real interest rates, creating further drags on growth.2 In light of the significant risks to the economic recovery, to the health of the labor market, and to price stability, the FOMC decided that additional policy support was warranted.

Again, fear of deflation, especially via expectations theory.

The Federal Reserve’s policy target for the federal funds rate has been near zero since December 2008,

And not done the trick. And no mention that the interest income channels might be the culprits.

so another means of providing monetary accommodation has been necessary since that time. Accordingly, the FOMC purchased Treasury and agency-backed securities on a large scale from December 2008 through March 2010,

Further reducing interest income earned by the private sector.

a policy that appears to have been quite successful in helping to stabilize the economy and support the recovery during that period.

I attribute the stabilization to the automatic fiscal stabilizers increasing federal deficit spending, adding that much income and savings to the economy.

Following up on this earlier success, the Committee announced this month that it would purchase additional Treasury securities. In taking that action, the Committee seeks to support the economic recovery, promote a faster pace of job creation, and reduce the risk of a further decline in inflation that would prove damaging to the recovery.

Although securities purchases are a different tool for conducting monetary policy than the more familiar approach of managing the overnight interest rate, the goals and transmission mechanisms are very similar. In particular, securities purchases by the central bank affect the economy primarily by lowering interest rates on securities of longer maturities,

Very good! Looks like the officials in monetary operations have finally gotten the point across. It’s been no small effort.

just as conventional monetary policy, by affecting the expected path of short-term rates, also influences longer-term rates. Lower longer-term rates in turn lead to more accommodative financial conditions, which support household and business spending. As I noted, the evidence suggests that asset purchases can be an effective tool; indeed, financial conditions eased notably in anticipation of the Federal Reserve’s policy announcement.

Incidentally, in my view, the use of the term “quantitative easing” to refer to the Federal Reserve’s policies is inappropriate. Quantitative easing typically refers to policies that seek to have effects by changing the quantity of bank reserves, a channel which seems relatively weak, at least in the U.S. context.

While the channel is more than weak- it doesn’t even exist- even here his story has improved.

In contrast, securities purchases work by affecting the yields on the acquired securities and, via substitution effects in investors’ portfolios, on a wider range of assets.

Leaving out that they remove interest income from the private sector.

This policy tool will be used in a manner that is measured and responsive to economic conditions. In particular, the Committee stated that it would review its asset-purchase program regularly in light of incoming information and would adjust the program as needed to meet its objectives. Importantly, the Committee remains unwaveringly committed to price stability and does not seek inflation above the level of 2 percent or a bit less that most FOMC participants see as consistent with the Federal Reserve’s mandate. In that regard, it bears emphasizing that the Federal Reserve has worked hard to ensure that it will not have any problems exiting from this program at the appropriate time. The Fed’s power to pay interest on banks’ reserves held at the Federal Reserve will allow it to manage short-term interest rates effectively and thus to tighten policy when needed, even if bank reserves remain high. Moreover, the Fed has invested considerable effort in developing tools that will allow it to drain or immobilize bank reserves as needed to facilitate the smooth withdrawal of policy accommodation when conditions warrant. If necessary, the Committee could also tighten policy by redeeming or selling securities.

Not bad!

The foreign exchange value of the dollar has fluctuated considerably during the course of the crisis, driven by a range of factors. A significant portion of these fluctuations has reflected changes in investor risk aversion, with the dollar tending to appreciate when risk aversion is high. In particular, much of the decline over the summer in the foreign exchange value of the dollar reflected an unwinding of the increase in the dollar’s value in the spring associated with the European sovereign debt crisis.


The dollar’s role as a safe haven during periods of market stress stems in no small part from the underlying strength and stability that the U.S. economy has exhibited over the years.

Further supported by the desire of foreign govts to support exports to the US, but that is a different matter.

Fully aware of the important role that the dollar plays in the international monetary and financial system, the Committee believes that the best way to continue to deliver the strong economic fundamentals that underpin the value of the dollar, as well as to support the global recovery, is through policies that lead to a resumption of robust growth in a context of price stability in the United States.

This is a bit defensive, as it implies he does believe QE itself weakens the dollar in the near term. If he knew that wasn’t the case he would have stated it all differently.

In sum, on its current economic trajectory the United States runs the risk of seeing millions of workers unemployed or underemployed for many years. As a society, we should find that outcome unacceptable. Monetary policy is working in support of both economic recovery and price stability, but there are limits to what can be achieved by the central bank alone. The Federal Reserve is nonpartisan and does not make recommendations regarding specific tax and spending programs. However, in general terms, a fiscal program that combines near-term measures to enhance growth with strong, confidence-inducing steps to reduce longer-term structural deficits would be an important complement to the policies of the Federal Reserve.

Ok, it’s something.

But how about repeating that operationally, govt spending is not constrained by revenues, and therefore there is no solvency problem? That’s not politics, just monetary operations.

He could also explain how tsy secs are functionally nothing more than time deposits at the Fed, while reserves are overnight deposits, and funding the deficit and paying it down are nothing more than shifting dollar balances from reserve accounts to securities accounts, and from securities accounts to reserve accounts.

And he could spell out the accounting identity that govt deficits add exactly that much to net financial assets of the non govt sectors.

In other words, he could easily dispel the deficit myths that are preventing the policy he is recommending.

So why not???

Global Policy Challenges and Tensions
The two-speed nature of the global recovery implies that different policy stances are appropriate for different groups of countries. As I have noted, advanced economies generally need accommodative policies to sustain economic growth. In the emerging market economies, by contrast, strong growth and incipient concerns about inflation have led to somewhat tighter policies.

Unfortunately, the differences in the cyclical positions and policy stances of the advanced and emerging market economies have intensified the challenges for policymakers around the globe. Notably, in recent months, some officials in emerging market economies and elsewhere have argued that accommodative monetary policies in the advanced economies, especially the United States, have been producing negative spillover effects on their economies. In particular, they are concerned that advanced economy policies are inducing excessive capital inflows to the emerging market economies, inflows that in turn put unwelcome upward pressure on emerging market currencies and threaten to create asset price bubbles. As is evident in figure 6, net private capital flows to a selection of emerging market economies (based on national balance of payments data) have rebounded from the large outflows experienced during the worst of the crisis. Overall, by this broad measure, such inflows through the second quarter of this year were not any larger than in the year before the crisis, but they were nonetheless substantial. A narrower but timelier measure of demand for emerging market assets–net inflows to equity and bond funds investing in emerging markets, shown in figure 7–suggests that inflows of capital to emerging market economies have indeed picked up in recent months.

To a large degree, these capital flows have been driven by perceived return differentials that favor emerging markets, resulting from factors such as stronger expected growth–both in the short term and in the longer run–and higher interest rates, which reflect differences in policy settings as well as other forces. As figures 6 and 7 show, even before the crisis, fast-growing emerging market economies were attractive destinations for cross-border investment. However, beyond these fundamental factors, an important driver of the rapid capital inflows to some emerging markets is incomplete adjustment of exchange rates in those economies, which leads investors to anticipate additional returns arising from expected exchange rate appreciation.

The exchange rate adjustment is incomplete, in part, because the authorities in some emerging market economies have intervened in foreign exchange markets to prevent or slow the appreciation of their currencies. The degree of intervention is illustrated for selected emerging market economies in figure 8. The vertical axis of this graph shows the percent change in the real effective exchange rate in the 12 months through September. The horizontal axis shows the accumulation of foreign exchange reserves as a share of GDP over the same period. The relationship evident in the graph suggests that the economies that have most heavily intervened in foreign exchange markets have succeeded in limiting the appreciation of their currencies. The graph also illustrates that some emerging market economies have intervened at very high levels and others relatively little. Judging from the changes in the real effective exchange rate, the emerging market economies that have largely let market forces determine their exchange rates have seen their competitiveness reduced relative to those emerging market economies that have intervened more aggressively.

It is striking that, amid all the concerns about renewed private capital inflows to the emerging market economies, total capital, on net, is still flowing from relatively labor-abundant emerging market economies to capital-abundant advanced economies. In particular, the current account deficit of the United States implies that it experienced net capital inflows exceeding 3 percent of GDP in the first half of this year. A key driver of this “uphill” flow of capital is official reserve accumulation in the emerging market economies that exceeds private capital inflows to these economies. The total holdings of foreign exchange reserves by selected major emerging market economies, shown in figure 9, have risen sharply since the crisis and now surpass $5 trillion–about six times their level a decade ago. China holds about half of the total reserves of these selected economies, slightly more than $2.6 trillion.

It is instructive to contrast this situation with what would happen in an international system in which exchange rates were allowed to fully reflect market fundamentals. In the current context, advanced economies would pursue accommodative monetary policies as needed to foster recovery and to guard against unwanted disinflation. At the same time, emerging market economies would tighten their own monetary policies to the degree needed to prevent overheating and inflation. The resulting increase in emerging market interest rates relative to those in the advanced economies would naturally lead to increased capital flows from advanced to emerging economies and, consequently, to currency appreciation in emerging market economies. This currency appreciation would in turn tend to reduce net exports and current account surpluses in the emerging markets, thus helping cool these rapidly growing economies while adding to demand in the advanced economies. Moreover, currency appreciation would help shift a greater proportion of domestic output toward satisfying domestic needs in emerging markets. The net result would be more balanced and sustainable global economic growth.

Given these advantages of a system of market-determined exchange rates, why have officials in many emerging markets leaned against appreciation of their currencies toward levels more consistent with market fundamentals? The principal answer is that currency undervaluation on the part of some countries has been part of a long-term export-led strategy for growth and development. This strategy, which allows a country’s producers to operate at a greater scale and to produce a more diverse set of products than domestic demand alone might sustain, has been viewed as promoting economic growth and, more broadly, as making an important contribution to the development of a number of countries. However, increasingly over time, the strategy of currency undervaluation has demonstrated important drawbacks, both for the world system and for the countries using that strategy.

First, as I have described, currency undervaluation inhibits necessary macroeconomic adjustments and creates challenges for policymakers in both advanced and emerging market economies. Globally, both growth and trade are unbalanced, as reflected in the two-speed recovery and in persistent current account surpluses and deficits. Neither situation is sustainable. Because a strong expansion in the emerging market economies will ultimately depend on a recovery in the more advanced economies, this pattern of two-speed growth might very well be resolved in favor of slow growth for everyone if the recovery in the advanced economies falls short. Likewise, large and persistent imbalances in current accounts represent a growing financial and economic risk.

Second, the current system leads to uneven burdens of adjustment among countries, with those countries that allow substantial flexibility in their exchange rates bearing the greatest burden (for example, in having to make potentially large and rapid adjustments in the scale of export-oriented industries) and those that resist appreciation bearing the least.

Third, countries that maintain undervalued currencies may themselves face important costs at the national level, including a reduced ability to use independent monetary policies to stabilize their economies and the risks associated with excessive or volatile capital inflows. The latter can be managed to some extent with a variety of tools, including various forms of capital controls, but such approaches can be difficult to implement or lead to microeconomic distortions. The high levels of reserves associated with currency undervaluation may also imply significant fiscal costs if the liabilities issued to sterilize reserves bear interest rates that exceed those on the reserve assets themselves. Perhaps most important, the ultimate purpose of economic growth is to deliver higher living standards at home; thus, eventually, the benefits of shifting productive resources to satisfying domestic needs must outweigh the development benefits of continued reliance on export-led growth.

Improving the International System
The current international monetary system is not working as well as it should. Currency undervaluation by surplus countries is inhibiting needed international adjustment and creating spillover effects that would not exist if exchange rates better reflected market fundamentals. In addition, differences in the degree of currency flexibility impose unequal burdens of adjustment, penalizing countries with relatively flexible exchange rates. What should be done?

The answers differ depending on whether one is talking about the long term or the short term. In the longer term, significantly greater flexibility in exchange rates to reflect market forces would be desirable and achievable. That flexibility would help facilitate global rebalancing and reduce the problems of policy spillovers that emerging market economies are confronting today. The further liberalization of exchange rate and capital account regimes would be most effective if it were accompanied by complementary financial and structural policies to help achieve better global balance in trade and capital flows. For example, surplus countries could speed adjustment with policies that boost domestic spending, such as strengthening the social safety net, improving retail credit markets to encourage domestic consumption, or other structural reforms. For their part, deficit countries need to do more over time to narrow the gap between investment and national saving. In the United States, putting fiscal policy on a sustainable path is a critical step toward increasing national saving in the longer term. Higher private saving would also help. And resources will need to shift into the production of export- and import-competing goods. Some of these shifts in spending and production are already occurring; for example, China is taking steps to boost domestic demand and the U.S. personal saving rate has risen sharply since 2007.

In the near term, a shift of the international regime toward one in which exchange rates respond flexibly to market forces is, unfortunately, probably not practical for all economies. Some emerging market economies do not have the infrastructure to support a fully convertible, internationally traded currency and to allow unrestricted capital flows. Moreover, the internal rebalancing associated with exchange rate appreciation–that is, the shifting of resources and productive capacity from production for external markets to production for the domestic market–takes time.

That said, in the short term, rebalancing economic growth between the advanced and emerging market economies should remain a common objective, as a two-speed global recovery may not be sustainable. Appropriately accommodative policies in the advanced economies help rather hinder this process. But the rebalancing of growth would also be facilitated if fast-growing countries, especially those with large current account surpluses, would take action to reduce their surpluses, while slow-growing countries, especially those with large current account deficits, take parallel actions to reduce those deficits. Some shift of demand from surplus to deficit countries, which could be compensated for if necessary by actions to strengthen domestic demand in the surplus countries, would accomplish two objectives. First, it would be a down payment toward global rebalancing of trade and current accounts, an essential outcome for long-run economic and financial stability. Second, improving the trade balances of slow-growing countries would help them grow more quickly, perhaps reducing the need for accommodative policies in those countries while enhancing the sustainability of the global recovery. Unfortunately, so long as exchange rate adjustment is incomplete and global growth prospects are markedly uneven, the problem of excessively strong capital inflows to emerging markets may persist.

As currently constituted, the international monetary system has a structural flaw: It lacks a mechanism, market based or otherwise, to induce needed adjustments by surplus countries, which can result in persistent imbalances. This problem is not new. For example, in the somewhat different context of the gold standard in the period prior to the Great Depression, the United States and France ran large current account surpluses, accompanied by large inflows of gold. However, in defiance of the so-called rules of the game of the international gold standard, neither country allowed the higher gold reserves to feed through to their domestic money supplies and price levels, with the result that the real exchange rate in each country remained persistently undervalued. These policies created deflationary pressures in deficit countries that were losing gold, which helped bring on the Great Depression.3 The gold standard was meant to ensure economic and financial stability, but failures of international coordination undermined these very goals. Although the parallels are certainly far from perfect, and I am certainly not predicting a new Depression, some of the lessons from that grim period are applicable today.4 In particular, for large, systemically important countries with persistent current account surpluses, the pursuit of export-led growth cannot ultimately succeed if the implications of that strategy for global growth and stability are not taken into account.

Thus, it would be desirable for the global community, over time, to devise an international monetary system that more consistently aligns the interests of individual countries with the interests of the global economy as a whole. In particular, such a system would provide more effective checks on the tendency for countries to run large and persistent external imbalances, whether surpluses or deficits. Changes to accomplish these goals will take considerable time, effort, and coordination to implement. In the meantime, without such a system in place, the countries of the world must recognize their collective responsibility for bringing about the rebalancing required to preserve global economic stability and prosperity. I hope that policymakers in all countries can work together cooperatively to achieve a stronger, more sustainable, and more balanced global economy.

55 Responses

  1. Mr. Mosler,

    MMT Newbie Question?

    “But how about repeating that operationally, govt spending is not constrained by revenues, and therefore there is no solvency problem? That’s not politics, just monetary operations.”-Mosler

    I can understand there is no solvency problem, but could you help me comprehend why growing defecits at an exponential rate greater than tax revenues won’t eventually lead to a worthless currency?

    Thank you in advance,


    1. excess spending will drive up prices, particularly when excess capacity is used up.

      that’s why we are currently where we are- taxes are too high for the size govt we have,
      so the private sector doesn’t have sufficient spending power (given its savings desires and credit conditions) to keep itself fully employed.

      10 years ago we had low inflation and 3.7% unemployment, so we pretty much know we can get down to that level of unemployment without ‘overspending’

      And to get out of a hole, first you have to stop digging. Right now the output gap is still probably growing. It can’t shrink and get too small until it stops growing

    2. “I can understand there is no solvency problem, but could you help me comprehend why growing defecits at an exponential rate greater than tax revenues won’t eventually lead to a worthless currency?”

      The most important thing to understand about MMT is this: All currencies are worthless first, and then given value by taxation. So it is not that the currency will become worthless, it already is worthless. You cannot eat or build things out of money (maybe a paper airplane or some origami)

      Then to directly address your question, the answer is: if the desire for savings also grows an an exponential rate equal to or greater than the growth in deficits, then the currency will not be debased.

      There are at least 2 ways the desire for savings can increase exponentially. Exponential population growth will drive an exponential desire for savings. Exponential GDP growth will also drive exponential savings growth.

      For example, the average deficit for the last 15 years has been about 2%. Of course, this is exponential growth. Still the other factors I listed have also grown exponentially during that time. The population growth for the U.S has been about 1%, and for the world about 1.2%. World GDP growth has been about 3%.

      So, for savings to remain a constant percentage of total dollars, the desired level of savings would have to grow at roughly 2%. However, the economy has grown faster, so there is more wealth in the world. If USD savings is a constant percentage of total economic activity, then the base money needs to grow faster. How much? With the population growth- these “new” people are also going to want savings – the desired level of savings is probably growing around (1.03*1.012)-1 = 4.2% per year.

      You can see that the U.S. dollar is very far from a hyper-inflationary spiral with numbers like these.

      Of course, there are many other factors in this, but just back-of-the-enveloping these numbers gets you here.

  2. The government’s credit card is special. It has the best cashback deal ever. Not only does it get ‘cashback’ (tax) when it spends money on its credit card, but when the recipient of that money spends it that transaction gets taxed as well, and the next, and the next until the money disappears.

    So as a simple matter of mathematics if the government spends $100 it will always get $100 back in taxation for any positive tax rate. So as long as everybody immediately spends everything they earn there can never be a deficit.

    So what causes the deficit?

    The only possible reason for a deficit is that people aren’t spending everything they earn. In other words, in aggregate, they are saving.

    So what you call a deficit the rest of the economy calls ‘money in the bank’.

    And if its left in the bank then its not being spent, and if its not being spent then how can it be inflationary?

    And if it’s not inflationary why would the currency rates change?

    1. good way to put it, except it can be inflationary.

      award everyone a $1 Trillion each to spend and leave taxes where they are, and watch prices go through the roof, Zimbabwe style!

      1. I didn’t say anything about the initial spending. I was talking about the deficit.

        I said “if they’re saving, they’re not spending, and if they’re not spending it can’t be inflationary”.

        In other words the deficit isn’t inflationary, which is born out by the figures.

        Are you suggesting that there are circumstances when the deficit (ie private net-saving) is inflationary? What are those circumstances?

    2. Mr. Neil Wilson,

      I have a question to your reply if you don’t mind:

      You said: “So as a simple matter of mathematics if the government spends $100 it will always get $100 back in taxation for any positive tax rate. So as long as everybody immediately spends everything they earn there can never be a deficit.”

      My question:

      When US citizens purchase goods from Asia, the USD leaves the economy and is now not being taxed away. But, the original U.S. debt still exists. Isn’t there eventually a point where servicing the original U.S. debt is not possible?

      Another question I am having is if another country keeps accumulating USD, then it is they that can purchase a growing percentage of our assets (i.e. land, companies, natural resources). Isn’t this a concern?

      Thank you again in advance.


      1. There is no US debt as you understand it. Warren’s book explains that. The US dollar credit card has no limit and no repayment terms.

        If you purchase goods from Asia, and they don’t immediately purchase something with those USD, then all they are doing is saving.

        It’s exactly the same as a US citizen saving.

        Trade isn’t about pieces of paper. It’s about real things.

        If US citizens want real LCD TVs from Asia they have to expect to provide something real in return. That it is done through the medium of the US dollar is beside the point.

        But ultimately any US assets are subject to US tax codes. Taxation policy and capital controls can be put in place if need be.

        I doubt that would ever be needed. The US is a big economy and can create real assets and stuff to purchase to satisfy the demand.

  3. This is just anecdotal, so FWIW: my business is starting to see a bit of an uptick in sales – which is a little odd since we usually don’t sell this time of year, but our clients (other firms) seem to be moving forward on projects that have been delayed for a while.

    But who knows, could just be the equivalent of a inventory depletion in the capital goods market.

    At any rate, I was thinking that in the possible event of a some kind of economic uptick in early 2011, wouldn’t it be ironic if the Fed would receive some credit and they point to QE2 as a successful policy?

    1. About par for the course. They took credit for ending inflation when it was the oil glut that did it, they’ve taken credit for virtually every recovery in the last 40 years, when the automatic stabilizers did it (just like they will have if we start seeing real recovery any time soon). They are like the Wizard of Oz (not surprising, since that story is a monetary fable anyway…)

  4. Mr Mosler – I am just an average working joe. I have read your book (7 Deadly…) and understood 90%. It seems to me the fundamental starting point is that the federal govt can create new money at will – everything seems to follow from that.

    How can it be that our top economic people in govt don’t get it? This is more than a rhetorical question – I am serious. It makes me wonder if I am missing something. For example Mr Bernanke clearly understands the creation of new money – he is doing it right now.

    Sample dialog: Me: Mr Bernanke do you understand that the govt can create new money as needed?

    Mr Bernanke: yes.

    Me: Is there anything in Mr Mosler’s book you don’t understand?

    Mr Bernanke: No.

    Me: then why do you say things like: April 27, at the National Commission on Fiscal Responsibility and Reform: “Thus, the reality is that the Congress, the Administration, and the American people will have to choose among making modifications to entitlement programs such as Medicare and Social Security, restraining federal spending on everything else, accepting higher taxes, or some combination thereof. ”

    —End of dialog.

    It is really important for me to understand why a smart guy like Mr Bernanke who understands that we operate using fiat money etc thinks the budget deficit is important and taxes are needed to pay for things.

    What is really going on here?

    1. I think a lot of people have a question like James does. It doesn’t seem to be a rocket science on basic level.
      I guess It’s really difficult for academic people to admit that their career has been a lie. It’s gonna make them look stupid.
      What kind of an expert or scientist you are if you are wrong on something so simple like this? Money is difficult to grasp I guess ’cause your senses tell you another story.

    2. Pretty sad for sure. The Chairman is smart enough to get it right. But unfortunately he seems to have his head full of what’s called the ‘New Keynesian’ school of economics, which is a mainstream theory that’s steeped in expectations theory, particularly inflation expectations as the cause of inflation.

      This comes from the failure to recognize that the currency is a simple public monopoly, which makes the govt. ‘price setter.’

      Instead, their economic models are all relative value models, that generally don’t even have ‘money’ in them, and in which the nominal price level can be anything.

      (Take the same model, and switch yen for dollars, for example, and prices are 83x higher.)

      So they have no theory as to why any price level is where it is-why yen prices are 83x higher than dollar prices for the same thing.

      Or why the entire price level shifts up and down.

      It used to be money supply, the output gap, and inflation expectations.

      Money supply was dropped in the 80’s, and the output gap fell by the wayside as ‘the’ cause in the late 90’s
      when unemployment fell below 4%, growth was robust, and core inflation was low and falling.

      So that left inflation expectations, and that’s their story and they’re sticking to it.

    1. the dollar is a monopoly and the US govt is the dollar monopolist.

      having a monopoly doesn’t mean everyone is forced to use it.
      it just means they can’t get it anywhere else

      1. Imagine dollars start dropping in value on a regular basis and the rest of the world no longer wants to hold dollars. How does the US pay for oil? They do not export enough to pay for all the stuff they are used to importing. It seems like a big problem.

  5. Vincente, it will be a problem when it becomes a problem. Right now. no problem. The US, with the largest economy by far, continues to be the world’s market. Net exporters like China are faced with saving dollars or cutting back on exports to the US. They have greatly expanded productive capacity and without the US are faced with a substantial output gap and rising unemployment. Unless China finds other markets, it is stuck in dollar hegemony, i.e., having to fund US CAD with saving in dollars. Similarly, the Saudis take dollars for oil and either save in dollars or purchase weapons from the US.

    But Michael Hudson sees resistance to dollar hegemony developing.

    Dollar War in Detail

  6. Isn’t Hudson’s view of Q2 contrary to that of MMT? Also see Ellen Brown

    It is remarkable how there can be such incredibly divergent views on this subject–even from those who supposedly are of the same school of thought. No wonder there is such a chaos of opinion.

    1. Henry/Tom, This from the Hudson article:

      “Hudson (H): Yes, the currency crisis is caused by what’s called Quantitative Easing (QE) – flooding the economy with credit, and specifically Ben Bernanke’s and Tim Geithner’s threat to create another $1 trillion worth of new Federal Reserve credit over the next twelve months. The Financial Times reports that all of the last $2 trillion the Fed created has gone to the BRIC countries (Brazil, Russia, India and China) and to Third World raw materials exporters. Since the start of 2009 this speculative dollar outflow has pushed up the Brazilian real by 30 percent, from 2.50 to 1.75 per dollar.

      This has created a bonanza for speculators in the carry trade. Arbitrageurs can borrow from U.S. banks at 1% interest (and banks don’t have to pay anything on their own gambles), buy a Brazilian bond and get almost 12%, and pocket the difference.”

      How can this have been a bonanza? Isnt the 11% spread they got not blown away by the 30% exchange rate loss they take via the figures he has just provided to us in the previous paragraph? Am I looking at this correctly? Do I have the currency conversion backwards or something? Resp,

      1. Matt, isn’t Hudson is saying that they borrow dollars which they sell to buy other currencies, which makes them stronger against the dollar, making the borrowed dollars less expensive to repay on cash out. So when the other currencies are sold to repay the dollar loan, the difference is additional profit on the deal over the higher interest earned in the meanwhile in the other countries’ bonds. However, if the dollar would go against the other currencies being used in the deals, then there would be a squeeze and the carry trade would unwind quickly. That’s the risk.

      2. Tom,
        Thanks. Here it seems if you would have borrowed in the US and converted to Real, then when you came back, you would have gotten more USD than you originally put in. So you would probably made more just in the forex change than in the ‘carry trade’. So for a ‘carry trade’ to really work, the currency you borrow in seems like it has to depreciate vs the currency you ‘invest’ in, in many ways to me it seems like a glorified forex speculation as you point out, if the exchange rate goes against you, it seems like you would quickly have to get out of it. Iceland a few years ago had high interest rates but that exchange rate it seems went the other way (Kroner became weak after their crisis) so you probably would have gotten taken out…seems like it keeps coming back to the forex issue on these ‘carry trades’.

      3. Matt, what makes a carry trade work is low probability that it will reverse. The yen stayed relatively stable for a long time, so that carry trade worked pretty well. But the dollar is lot more volatile in this kind of environment because it is still the safe haven. Any shock or even big stress in the global economy and everyone runs home.

        This is really disruptive to emerging economies, with a lot of capital flowing in quickly and then rushing out quicker. That is why they are objecting to QE2 increasing dollar liquidity.

        When increased liquidity is neither needed nor wanted, it flows into longer duration assets paying a higher yield. So folks are taking their leveraged gains in tsy’s and looking for more in foreign bonds, or at least that is the thinking on this.

      4. all it means is that the currency with the higher interest rate will be cheaper in the forward markets than it is in the spot markets (and vice versa)

        so if you buy the currency forward at a cheaper price than the spot price, you’re betting accordingly

    2. Henry, the exporting country “finances” the trade deficit of the importing country by saving in the importer’s currency in the sense that the current (trade) account and the capital account have to balance. There is no question here of financing the budgetary deficit.

    1. Ramanan,

      Yes I saw that thank you, ….and I am still trying to digest it! I think it contains all of the critical accounting info on any type of international transaction. But I will have to read it 100 times before it starts to sink in with me…

      As far as the external sector, it looks to me that you are looking for a “theory” that works in every case, and you seem to think that the external sector can truly become a problem for many countries other than perhaps the US (or similar) that currently enjoys an external sector that is more than willing to accept USD in exchange for real products.

      I would think maybe Armenia (landlocked/no nat resources/no transportation, etc) would be good to look at in this regard. In other words, can Armenia expect fiscal policy alone to be a solution for the acquisition of critical external goods/services? It would seem that they would have the types of problems with access to foreign goods that you are cautioning against if they just spent their own fiat currency, they might find it hard to just pay in their own currency. It has not escaped me that you are currently outside of “The West”, and this perhaps gives you a different vantage point. Resp,

      1. Yes I tried to make it formal and hence complicated.

        If A is the importer country and B is the exporter, importer’s bank account in A gets debited and bank in A has its account debited in the account kept at bank B. Bank A has to to fund the account.

        Even Australians receive more import invoices in USD than AUD.

        I tried to write about this because free trade and ideas such as that have been promoted (and enforced by law) by the IMF and institutions such as that. Nations which are struggling go into a worse off position.

        Neoliberals hold all kinds of opinion and one of them is that imports are bad – but thats a fraction, the other half says imports are good and that free markets will take care.

      2. Ramanan,
        Do you think it would help (i mean i think it would help ME) if I tried to do a multi-step, T-account diagram like Prof Kelton did over at UMKC blog in that case to desribe the process of Treasury issuance?

        If so what involved entities should be across the top row of this international transaction diagram: importer, importer’s bank x , exporter, exporter’s bank y ? or would it be useful to show other entities also being involved? (CBs?, etc)

      3. Will try – but it is so complicated – that’s why the IMF has a Balance of Payments Manual. Both v5 and v6 are good. It also has a Balance of Payments compilation guide and a Balance of Payments textbook. There are zillions of things happening and it takes time to understand the associated causalities. The IMF may be quite right with its accounting and in those manuals doesn’t go into implications, thankfully. On the other hand, in other writings, it really messes things up.

    2. Ramanan, Warren,

      W’s reply “exactly” (November 21st, 2010 at 8:13 pm) to my 8:04 is in contradiction to R’s “super-incorrect” (November 22nd, 2010 at 2:02 pm).

      What’s up with that?

      1. The importing countries liabilities do not necessarily increase in its own currency.

        Ok “super-incorrect” was getting carried away.

        But, there is a risk of generalizing the case of the US to all nations and it is too dangerous.

      2. From your comment at Bill Mitchell’s:

        So its incorrect to say that foreigners are not financing the current account deficit.

        This is identical to what Tom Hickes said above @ 8:04:

        Henry, the exporting country “finances” the trade deficit of the importing country by saving in the importer’s currency in the sense that the current (trade) account and the capital account have to balance. There is no question here of financing the budgetary deficit.

        The only point you make in your comment that seems at slightly at odds with what I’ve read from MMTers on the subject is:

        Also currency markets’ movement are far from smooth. A massive devaluation is bound to increase the oil price because of the exchange rate pass-through effect.

        Maybe Scott Fullwiler is the right person to ask about the dynamics of unwinding CA deficits. I know you’ve had long discussions with him :-).

        But just for my own understanding, and pardon me if this is trivial (or heaven forbid, nonsense) to any of you, it seems important to me that one paints scenarios that are realistic for a specific country and then compares the pros and cons of alternative policy reactions. I have a feeling you’re mixing the two and thus arriving at a hypothetical meltdown, that, while not impossible, seems unlikely to me.

        To make my point: let me divide the world into 2 sets of countries. 1: those with highly coveted reserve currencies (mostly larger, wealthy, developed countries with diversified economies) 2: those that haven’t managed to convince the world that it makes sense to hold their currency (including emerging, 3rd world and small economies).

        For set 1, a current account deficit will appear and grow quite atmatically. The question is, what effect will deficit spending at full employment (let’s not question that assertion for the moment) have? I would envision 3 possible scenarios: a) domestic output will grow faster than leakages, reinforcing the currency and its reserve status. b) the CA deficit grows faster than the domestic economy, thus slowly and smoothly eroding the exchange rate, which should lead back to scenario a at some point. c) same as b but the process is abrupt when all foreign holders suddenly rid themselves of their reserve savings, taking large losses into account. This seems counter to the holders’ own interests and thus highly unlikely. Is this what you’re afraid will happen? And, more importantly, how would austerity improve things?

        For set 2, scenarios a-c will never take place, because there is no desire to hold their currencies in the first place. Deficit spending will lead to linear currency depreciation long before any (large) CA deficits accumulate, no?

        regards. Oliver

        P.S. I’m not quite sure how invoices and nostro/vostro banking come into play. I’ll have to join Matt and go over your post a couple more times :-).

      3. Oliver, didn’t get a chance to reply.

        “This is identical to what Tom Hickes said above @ 8:04:”

        Not really. A nation may be financing it in another currency, not necessarily due to its choice.

        More importantly, there are zillions on the direction of causality that is to be taken care of when one starts talking about this.

        Plus, there are many things one can think of if one is thinking of “unwinding of current account deficits”. Suffice to say here that the assumption of exchange rate doing the job for you is equivalent to advocating laissez-faire ideas.

        How does austerity “help” ? Austerity is a immoral strategy to reduce imports because imports are demand-dependent. Austerity reduces demand and income and hence imports because people will purchase less.

        If one starts with a story where all your imports are automatically in your own currency, one can reach different conclusions.

      4. Thanks, Ramanan – I’m still digesting, as usual.

        I can see that most countries need foreign currency ($) to buy necessary commodities and inputs, which they can attain either through CA surpluses (lesser evil) or by taking up credit (greater evil). 3rd world countries are, per definition probably, in the latter position and struggle to join the ranks of the emerging nations. I guess, standard industrialization and growth strategies often involve a leap to higher dependency on oil and other foreign inputs, so it’s a difficult position to get out of initially. In that sense I would agree with you that the US is in a very privileged situation which should reflect in the way it is treated within academic discourse.

        I also take your point that the currency markets are not benign.

        What I can’t see is to why any of this must have an impact on such a country’s ability to run at full domestic employment or why it would be in the interest of the currency markets to pressure them to do otherwise. Education, building knowhow and a sensible use of domestic resources should be able to help in most cases. And the fact that it doesn’t often has reasons that lie beyond the scope of any economist to remedy, I would say. But then maybe that’s not what you were trying to say.


      5. Oliver,

        Great you appreciate my points, at least some of them. My stand is that external debt is as much debt like any other – doesn’t matter what currency etc is – too much.

        For a closed economy, the government debt is a mirror of the private sector wealth. And the debts cancel out to zero. For an open economy, there is leakage and a nation as a whole may be indebted to the rest of the world mainly due to trade imbalances, though other items in the balance of payments and international investment position contribute to it as well.

        Nations’ fortunes have been decided on how well they have been doing in their external sector. There is hardly an example of cases where growth has not been determined/limited by the external sector. The US is an exception and I will come to that. Of course one can grow domestically as well and governments around the world – partly due to poor lack of understanding of macroeconomics and partly intentionally – suppress domestic demand.

        On top of that the IMF and other international organizations have imposed “free trade” – trying to fit human behavior to their theories instead of the other way round.

        Analyzing the case of full employment is a bit difficult because one is always far from it. So the question then is how to reach the state. Its fully possible but there are some issues to take care of simultaneously.

        The issue is that the free market ideology imposed on nations has led to situations where governments have not been able to relax fiscal policy sufficient to reach full employment. Now, whatever rhetoric is carried out by the Finance Ministers, financial analysts and the media – such as government defaulting etc, the problem is that the external sector does not allow the path to full employment to be smooth. Current accounts deficits increase – for nations on fixed exchange rates, the markets start worrying about the ability of the central bank to defend the hard peg and for floating exchanges, there is a price inflation bias created due to devaluation and governments have to take some non-popular steps.

        Some nations have become slaves of the currency markets and have made complicated arrangements such as crawling pegs, managed floats etc. Its not out of choice! International transactions arise from the correspondent banking channels through nostro/vostro accounts and Govt/CBs have to attract foreigners to hold IOUs for their currencies and create credibility by having situations where currency is not to volatile – else their banks face funding pressures in foreign markets.

        Fiscal expansion under “free trade” is difficult because citizens will import more stuff due to higher income. Exports, on the other hand depend on demand in the external world and the competitiveness of the nation compared to other nations.

        Hence you see so much talk of protectionism!

        The neoliberals however have a point – restricting imports may featherbed domestic producers 🙂 – though it may not happen for developed nations.

        Continuous trade deficits just lead to a rising public debt and external debt and something has to be done to cut it off – usually happens due to fiscal austerity. Luckier ones have made a strategy and have exported crazy to the rest of the world to reduce indebtedness and in fact become creditors of the rest of the world.

      6. “Fiscal expansion under “free trade” is difficult because citizens will import more stuff due to higher income.
        Continuous trade deficits just lead to a rising public debt and external debt and something has to be done to cut it off”

        Why should the US govt care if the $ in savings accounts at the fed (tsy secs outstanding) are held by non residents?
        Why does something ‘have to be done to cut it off’?

        Why kill the goose laying the golden eggs?

      7. Agreed! And for the individual, the quickest if not always easiest way to balance the current account is to export oneself :-).

        greetings from my exile in Switzerland, Oliver

      8. “Why should the US govt care if the $ in savings accounts at the fed (tsy secs outstanding) are held by non residents?
        Why does something ‘have to be done to cut it off’?”

        Talking the general case here – not specific to the US.

        Poor African nations don’t have foreigners automatically purchasing government debt when they import, instead their banks’ indebtedness in foreign currency (typically USDs) increase.

        At any rate, if the US is doing a free lunch as per your story, why does the US pay interest to foreigners ? Foreigners also purchase private sector securities. Imports don’t do anything except leading to negative income streams till perpetuity.

      9. “and the first step is to realize a trade deficit is a benefit”

        And the zeroth step is to realize that a trade deficit is financed by borrowing from foreigners or selling foreign assets.

        The phrase “we do not borrow”, in particular the word “borrow” – rather the “inapplicability” seems to have driven the MMTers to conclude that “trade deficits are not a problem”

      10. Ramanan has staged a coup! Wherever Ramanan has his command post, THAT is now The Center of the Universe. :o)

  7. Good article from Chris Cook:

    Taxpayers’ Money – Myth and Reality

    Money for Nothing
    Quite a few economists – and almost the entire population – are under the mistaken impression that bank deposits precede credit creation, and that banks ‘lend out’ the deposits they receive, leaving a fraction in reserve. In fact, such ‘fractional reserve banking’ has long ceased to exist.


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