Where am I wrong, if at all?
I agree with the political analysis.
I know Bruce Bartlett and he’ll be the first to tell you he does NOT understand monetary operations. Even simple statements like ‘China keeps its dollars in its reserve account at the Fed’ seem to cause him to glass over. He can only repeat headline rhetoric and has no interest in drilling down through it.
Krugman’s column a week ago, however, may have been a major breakthrough. He conceded the issue of long term deficits was inflation and not solvency. And while his maths and graphs disqualified him from participating in the inflation debate, it so far seems to have shifted the deficit dove position to much firmer ground.
A Congressman might vote to cut Social Security due to fear of Federal insolvency, with all ‘noted’ economists arguing only how far down the road it may be, along with dependence on foreign creditors.
However, I doubt most Congressman would vote to cut Social Security based on some economists predicting possible inflation in 20 years.
So even though Krugman’s reasoning was simply ‘they can always print the money’ followed by highly suspect graphs and statements about how someday that could cause hyper inflation, hopefully it did shift the discussion from solvency to inflation, where it belongs.
So now the hawk/dove question is, as it should be, whether long term deficits imply long term run away inflation. And while the correct answer is: depends on the offsetting demand leakages/unspent income like pension contributions and other nominal savings desires. Just the fact that the debate shifts away from solvency should be enough for a change of global political attitude.
And, if so, this opens the door to a new era of prosperity as yet unimagined.
The political genius of supply-side economicsBy Martin Wolf
July 25 (FT) – The future of fiscal policy was intensely debated in the FT last week. In this Exchange, I want to examine what is going on in the US and, in particular, what is going on inside the Republican party. This matters for the US and, because the US remains the world’s most important economy, it also matters greatly for the world.
My reading of contemporary Republican thinking is that there is no chance of any attempt to arrest adverse long-term fiscal trends should they return to power. Moreover, since the Republicans have no interest in doing anything sensible, the Democrats will gain nothing from trying to do much either. That is the lesson Democrats have to draw from the Clinton era’s successful frugality, which merely gave George W. Bush the opportunity to make massive (irresponsible and unsustainable) tax cuts. In practice, then, nothing will be done.
Indeed, nothing may be done even if a genuine fiscal crisis were to emerge. According to my friend, Bruce Bartlett, a highly informed, if jaundiced, observer, some “conservatives” (in truth, extreme radicals) think a federal default would be an effective way to bring public spending they detest under control. It should be noted, in passing, that a federal default would surely create the biggest financial crisis in world economic history.
To understand modern Republican thinking on fiscal policy, we need to go back to perhaps the most politically brilliant (albeit economically unconvincing) idea in the history of fiscal policy: “supply-side economics”. Supply-side economics liberated conservatives from any need to insist on fiscal rectitude and balanced budgets. Supply-side economics said that one could cut taxes and balance budgets, because incentive effects would generate new activity and so higher revenue.
The political genius of this idea is evident. Supply-side economics transformed Republicans from a minority party into a majority party. It allowed them to promise lower taxes, lower deficits and, in effect, unchanged spending. Why should people not like this combination? Who does not like a free lunch?
How did supply-side economics bring these benefits? First, it allowed conservatives to ignore deficits. They could argue that, whatever the impact of the tax cuts in the short run, they would bring the budget back into balance, in the longer run. Second, the theory gave an economic justification – the argument from incentives – for lowering taxes on politically important supporters. Finally, if deficits did not, in fact, disappear, conservatives could fall back on the “starve the beast” theory: deficits would create a fiscal crisis that would force the government to cut spending and even destroy the hated welfare state.
In this way, the Republicans were transformed from a balanced-budget party to a tax-cutting party. This innovative stance proved highly politically effective, consistently putting the Democrats at a political disadvantage. It also made the Republicans de facto Keynesians in a de facto Keynesian nation. Whatever the rhetoric, I have long considered the US the advanced world’s most Keynesian nation – the one in which government (including the Federal Reserve) is most expected to generate healthy demand at all times, largely because jobs are, in the US, the only safety net for those of working age.
True, the theory that cuts would pay for themselves has proved altogether wrong. That this might well be the case was evident: cutting tax rates from, say, 30 per cent to zero would unambiguously reduce revenue to zero. This is not to argue there were no incentive effects. But they were not large enough to offset the fiscal impact of the cuts (see, on this, Wikipedia and a nice chart from Paul Krugman).
Indeed, Greg Mankiw, no less, chairman of the Council of Economic Advisers under George W. Bush, has responded to the view that broad-based tax cuts would pay for themselves, as follows: “I did not find such a claim credible, based on the available evidence. I never have, and I still don’t.” Indeed, he has referred to those who believe this as “charlatans and cranks”. Those are his words, not mine, though I agree. They apply, in force, to contemporary Republicans, alas,
Since the fiscal theory of supply-side economics did not work, the tax-cutting eras of Ronald Reagan and George H. Bush and again of George W. Bush saw very substantial rises in ratios of federal debt to gross domestic product. Under Reagan and the first Bush, the ratio of public debt to GDP went from 33 per cent to 64 per cent. It fell to 57 per cent under Bill Clinton. It then rose to 69 per cent under the second George Bush. Equally, tax cuts in the era of George W. Bush, wars and the economic crisis account for almost all the dire fiscal outlook for the next ten years (see the Center on Budget and Policy Priorities).
Today’s extremely high deficits are also an inheritance from Bush-era tax-and-spending policies and the financial crisis, also, of course, inherited by the present administration. Thus, according to the International Monetary Fund, the impact of discretionary stimulus on the US fiscal deficit amounts to a cumulative total of 4.7 per cent of GDP in 2009 and 2010, while the cumulative deficit over these years is forecast at 23.5 per cent of GDP. In any case, the stimulus was certainly too small, not too large.
The evidence shows, then, that contemporary conservatives (unlike those of old) simply do not think deficits matter, as former vice-president Richard Cheney isreported to have told former treasury secretary Paul O’Neill. But this is not because the supply-side theory of self-financing tax cuts, on which Reagan era tax cuts were justified, has worked, but despite the fact it has not. The faith has outlived its economic (though not its political) rationale.
So, when Republicans assail the deficits under President Obama, are they to be taken seriously? Yes and no. Yes, they are politically interested in blaming Mr Obama for deficits, since all is viewed fair in love and partisan politics. And yes, they are, indeed, rhetorically opposed to deficits created by extra spending (although that did not prevent them from enacting the unfunded prescription drug benefit, under President Bush). But no, it is not deficits themselves that worry Republicans, but rather how they are caused: deficits caused by tax cuts are fine; but spending increases brought in by Democrats are diabolical, unless on the military.
Indeed, this is precisely what John Kyl (Arizona), a senior Republican senator,has just said:
“[Y]ou should never raise taxes in order to cut taxes. Surely Congress has the authority, and it would be right to — if we decide we want to cut taxes to spur the economy, not to have to raise taxes in order to offset those costs. You do need to offset the cost of increased spending, and that’s what Republicans object to. But you should never have to offset the cost of a deliberate decision to reduce tax rates on Americans”
What conclusions should outsiders draw about the likely future of US fiscal policy?
First, if Republicans win the mid-terms in November, as seems likely, they are surely going to come up with huge tax cut proposals (probably well beyond extending the already unaffordable Bush-era tax cuts).
Second, the White House will probably veto these cuts, making itself even more politically unpopular.
Third, some additional fiscal stimulus is, in fact, what the US needs, in the short term, even though across-the-board tax cuts are an extremely inefficient way of providing it.
Fourth, the Republican proposals would not, alas, be short term, but dangerously long term, in their impact.
Finally, with one party indifferent to deficits, provided they are brought about by tax cuts, and the other party relatively fiscally responsible (well, everything is relative, after all), but opposed to spending cuts on core programmes, US fiscal policy is paralysed. I may think the policies of the UK government dangerously austere, but at least it can act.
This is extraordinarily dangerous. The danger does not arise from the fiscal deficits of today, but the attitudes to fiscal policy, over the long run, of one of the two main parties. Those radical conservatives (a small minority, I hope) who want to destroy the credit of the US federal government may succeed. If so, that would be the end of the US era of global dominance. The destruction of fiscal credibility could be the outcome of the policies of the party that considers itself the most patriotic.
In sum, a great deal of trouble lies ahead, for the US and the world.
Where am I wrong, if at all?
I am sorry to tell you… but we are back to square one (or zero?) with Krugman. Please read this post:
http://krugman.blogs.nytimes.com/2010/07/25/martin-wolf-is-shrill/
Right. Krugman specifically repudiates the claim that he conceded on insolvency, holding that this is possible for the US.
He apparently did not read this comment on Wolf’s article in FT
Well, a default happens when the debtor does not pay interest and principal on schedule, subject to any grace period there may be. As far as I know, there is no grace period for Treasury bonds and bills, so a default could certainly happen. It might not last longer than a few days or weeks, but there could be considerable damage done to the financial system in the interim.
Default in the conventional sense does not happen with a floating rate fiat currency like the USD, GBP or JPY. Instead, the convenient way to default becomes by way of inflation over time, which is why nominal interest rates on US Treasury debt embodies an inflation premium over and above the perceived real interest rate.
Default remains an operational option or choice with a fiat currency.
It is not an option with a fixed rate currency – in the sense that an event of default, when it happens, is forced by a currency shortage.
The other operational option for a fiat currency in similar circumstances is no default with hyperinflation.
This stuff is well explained in Scott’s paper.
From my reading, Krugman’s “insolvency” comes about because of a choice to default rather than inflate. That’s the standard neoclassical view of fiscal sustainability, by the way, so it’s nothing new. I haven’t seen him suggest the state can’t make its payments. Indeed, his model–poor as it is–suggests otherwise (and again is completely consistent with the neoclassical view).
Neoclassicals, then, or at least their theories (which many if not most of them conveniently ignore in times like these), already recognize solvency is not an issue in the sense that the govt can always make its payments. The problem is, they believe in a monetarist transmission mechanism (a la Krugman’s model) if the govt “prints money” and in the loanable funds market to set interest rates on the national debt. Thus, as the debt grows and markets worry about default, they raise rates and debt service grows exponentially. The state then has the choice to meet its payments by printing money (hyperinflationary via assumption of qty theory of money) or default.
I explained this neoclassical view in detail and critiqued it all from the MMT perspective in “interest rates and fiscal sustainability” at cfeps.org back in 2006.
Are you saying that it makes no sense for MMTers to be quarreling insolvency vs. voluntary default with neoclassicists because there is no meaningful disagreement on the issue? And that they should concentrate on attacking the presumed links between deficits / debt levels and hyperinflation instead (which is how I understand your paper which after quickly flying over it)? Hmm, but it was Krugman who brought up the hair splitting in the first place. So it was a trap!
Well, there is a point in the sense that most of the public and policymakers don’t understand, and a good many economists conveniently “forget” that part of their own theories. But, if we’re just going with the theory here, then they already (should) know that solvency isn’t an issue for the currency issuer. Also, I think Krugman was genuinely clueless about MMT, since he described us as a bunch of people who think deficits are never a problem, so then he went back to the actual theory to go at inflation.
And yes, your interpretation of my paper is correct. The link is the key part, as they have all the parts of the link wrong.
And read this: Uncle Same has worse woes than Greece.
It is totally naive to say that the Dove vs. Hawk debate is now about inflation, not solvency. Total Pollyannaism.
My point from above at 12.03pm is much the same. The neoclassical argument was ALWAYS about inflation, since default for them is always to stave off inflation in the case of a currency issuer. Their theories already say that the govt can meet its payments–ever heard of seigniorage?–it’s just that many of them have been conveniently ignoring that.
Also, not to sound like a broken record, but my paper “interest rates and fiscal sustainability” at cfeps.org directly addressed the framework Kotlikoff is using in that article.
Mike ask him why is the political/economic debate always about solvency and never about inflation?
Will be on “Cavuto” tonight on Fox Business at 6pm EDT. Discussing “need” to cut SS to reduce the deficit. Catchy MMT soundbites welcomed.
Mike, the chief objection that I can see them making is “unfunded obligations.” If Cavuto brings up “unfunded,” ask him how in the world the US can have “unfunded” obligations when under the present monetary system, the US funds itself directly through currency issuance, rather than by taxing or borrowing since it is not financially constrained. If he comes back with political restraints, show that they are not financially necessary, but merely voluntary and can be altered at will. If he brings up inflation, ask him why is concerned with inflation when the world is facing deflation and depression if governments do not address demand shortfall due to deleveraging resulting from the GFC.
Let him go where he wants to go when he interrupts and hammer him on what he claims, i.e., turn the tables and you become the interlocutor. He will make a fool of himself and soon realize it — unless he really is a fool.:)
Good opportunity to remind him that the fundamental error in thinking arises from the false government-finance-is-the-same-as-household-and-firm-finance analogy, which overlooks the fact that government as currency issuer is not financially constrained (although there are political restraints that can easily be modified) while households and firms are currency users, hence are revenue constrained.
The only question is whether the real resources will be available in the future when retirees demand them. That is an entirely separate question.
Go, MIke. We’ve got your back.
BTW, I got to have some fun with him one time. He called a friend of mine and I happened to pick up the phone. He announced himself as Neil Cavuto and asked to speak to my friend. I asked who was calling and he answered, “Neil Cavuto.” I came back with, “Who?,” like I didn’t recognize the name, He answered again, “Neil Cavuto.” I said, nonchalantly, “Oh, OK, I’ll see if he is in.”
Hahaha!
“A country does not go bankrupt.”
— Walter Wriston, Chairman of Citi Group, 1982, right after Mexico massively defaulted
“Nor should the argument seem strange that taxation may be so high as to defeat its object, and that, given sufficient time to gather the fruits, a reduction of taxation will run a better chance than an increase of balancing the budget.”
— John Maynard Keynes, per Bartlett
“the theory of aggregated production, which is the point of [‘The General Theory of Employment Interest and Money’], nevertheless can be much easier adapted to the conditions of a totalitarian state than the theory of production and distribution of a given production put forth under conditions of free competition and a large degree of laissez-faire.”
— John Maynard Keynes, in forward of the German edition of “The General Theory of Employment Interest and Money”
“We can guarantee cash benefits as far out and at whatever size you like, but we cannot guarantee their purchasing power.”
— Alan Greenspan (Chairman of the Federal Reserve US Central Bank), appearing before the Senate Banking Committee on February 15, 2005, in response to Democratic Senator Jack Reed of Rhode Island on the topic of funding Social Security.
“Is there any reason why the American people should be taxed to guarantee the debts of banks, any more than they should be taxed to guarantee the debts of other institutions, including the merchants, the industries, and the mills of the country?”
— Senator Carter Glass during Senate debate on the Banking Act of 1933 (Glass-Steagall Act) [source: Rixey Smith and Norman Beasley, Carter Glass: A Biography (1939)]
The illiterates of the 21st century will not be those who cannot read and write, but those who cannot learn, unlearn, and relearn.”
— Alvin Toffler
Thanks! I like the Greenspan one!!
These 2 quotes have to be taken together Mike:
“We have seen security prices soar out of sight of earnings, brokers’ loans swell till they absorb a third of the banking resources of the country, and the blind pools of ancient days return and multiply by endless crossing and pyramiding as the investment trusts of today. Banks merge and emerge in chains, trailing trusts and holding companies, while industrial corporations pay dividends not by producing goods but by buying each others’ stocks and by borrowing and lending everybody’s money in the market. But of all these things can anyone say with surety what they signify, whether they are safe and sound, or what they are leading to? We do not even know, or cannot agree, whether inflation exists, what it means, or how it shall be measured.”
— Business Week – September 7, 1929
Mr. Greenspan: “Let me suggest to you that the monetary aggregates as we measure them are getting increasingly complex and difficult to integrate into a set of forecasts. The problem that we have is not that money is unimportant, but how we define it. By definition, all prices are indeed the “ratio of an exchange of a good for money.” And what we seek is what that is. Our problem is we used M-1 at one point as the proxy of money, and it turned out to be a very difficult indicator of any financial state. We then went to M-2 and had the similar problem. We have never done M-3 per se because it largely reflects the extent of expansion of the banking industry. And when in effect banks expand, in and of itself, it doesn’t tell you terribly much about what the real money is. So our problem is not that we do not believe in sound money. We do. We very much believe that, if you have a debased currency, that you will have a debased economy. The difficulty is in defining what part of our liquidity structure is truly money. We have had trouble ferreting out proxies for that for a number of years. And the standard we employed is whether it gives us a good forward indicator of the direction of finance and the economy.
Regrettably, none of those which (?) have been able to develop, including MZM – has not done that. That does not mean that we think that money is irrelevant. It means that we think our measures of money have been inadequate. And, as a consequence of that, we, as I have mentioned previously, have downgraded the use of the monetary aggregates for monetary policy purposes, until we are able to find a more stable proxy for what we believe is the underlying money in the economy.”
Representative Ron Paul: “So it’s hard to manage something you can’t define?”
Mr. Greenspan: “It is not possible to manage something you can’t define.”
— Alan Greenspan, Humphrey-Hawkins testimony, February 17,2000
Mike,
He is assigning the same legal authorities to the US Treasury as a 19th Century Housefrau putting money into and out of a cigar box.
Go get ’em!
I know Warren used to have a quote up here by Greenspan saying the government can meet any future obligations, but the question was what purchasing power would those SS payments have. A little tongue in cheek to bring a smile on this boring monday – and since we are talking about the reagans and supply side and voodoo economic stuff – Nancy Reagan Kissing Mr. T’s gold chains (rolls eyes)- I guess what tom hickey says about gold chains signifying wealth is not confined to India – I thought it was a joke, but it is real, amazing this woman was our first lady.
http://static.neatorama.com/images/2009-01/mr-T-nancy-reagan.jpg
Supply side economics is more tax cuts for the rich than anything else. What does this mean for the economy. Well lets see what has happened.
It means higher corporate profits. Lower interest rates. Asset speculation. Higher percentage of financial sector part of the economy. Higher CEO pay. Higher private debt.
Because as Bruce Bartlett pointed out. Working people did pay higher taxes during Reagan’s time, see social security tax increases.
So supply side economics does equal more capital. There is plenty of capital and productivity in our economy. The problem as you all know it is jobs/wages aka demand.
Adam, the more things change, the more they stay the same, it has been the same story for centuries now!
The paper system being founded on public confidence and having of itself no intrinsic value, it is liable to great and sudden fluctuations, thereby rendering property insecure and the wages of labor unsteady and uncertain. The corporations which create the paper money can not be relied upon to keep the circulating medium uniform in amount. In times of prosperity, when confidence is high, they are tempted by the prospect of gain or by the influence of those who hope to profit by it to extend their issues of paper beyond the bounds of discretion and the reasonable demands of business; and when these issues have been pushed on from day to day, until public confidence is at length shaken, then a reaction takes place, and they immediately withdraw the credits they have given, suddenly curtail their issues, and produce an unexpected and ruinous contraction of the circulating medium, which is felt by the whole community. The banks by this means save themselves, and the mischievous consequences of their imprudence or cupidity are visited upon the public. Nor does the evil stop here. These ebbs and flows in the currency and these indiscreet extensions of credit naturally engender a spirit of speculation injurious to the habits and character of the people. We have already seen its effects in the wild spirit of speculation in the public lands and various kinds of stock which within the last year or two seized upon such a multitude of our citizens and threatened to pervade all classes of society and to withdraw their attention from the sober pursuits of honest industry. It is not by encouraging this spirit that we shall best preserve public virtue and promote the true interests of our country; but if your currency continues as exclusively paper as it now is, it will foster this eager desire to amass wealth without labor; it will multiply the number of dependents on bank accommodations and bank favors; the temptation to obtain money at any sacrifice will become stronger and stronger, and inevitably lead to corruption, which will find its way into your public councils and destroy at no distant day the purity of your Government.”
— President Andrew Jackson, in his farewell address of March 4, 1837
Wealth without Labor? Huh? Imports are a benefit, exports are a cost, Jackson you want me to work! I like Mosler much Better!! Warren for President!
“It is corrupting the public morals. It is converting the business of the country into gambling and seriously diminishing the labour of the country. . . . Men are apparently getting rich while morality languishes . . . . Upon the demoralizing influence of an inconvertible government currency it is not necessary to enlarge. . . . It is not to be expected that a people will be more honest than the government under which they live, and while the government of the United States refuses to pay its notes according to their tenor . . . it practically teaches the people the doctrine of repudiation.”
— Henry McCulloch, U.S. Treasury Secretary 1865-1869
“If some lose their whole fortunes, they will drag many more down with them . . . believe me that the whole system of credit and finance which is carried on here at Rome in the Forum, is inextricably bound up with the revenues of the Asiatic province. If Those revenues are destroyed, our whole system of credit will come down with a crash.”
— Cicero, 66 B.C. (Translation by W.W. Fowler, 1909)
“The national budget must be balanced. The public debt must be reduced; the arrogance of the authorities must be moderated and controlled. Payments to foreign governments must be reduced, if the nation doesn’t want to go bankrupt. People must again learn to work, instead of living on public assistance.”
— Cicero, 55 BC
“Until 1922 and the very brink of collapse, Germans and especially foreign investors were absorbing marks in huge quantities. Only the international reputation of the Reichsmark, the faith that an economic giant like Germany could not fail, made this possible. The storage factor caused by the investors willingness to save marks kept the marks from being dumped immediately into the markets, and thereby for a long while held prices in check. The precise moment when the inflation turned sharply upward, toward its vertical climb, was undoubtedly timed by no event, but by the dawning psychological awareness of the German and foreign investor that Germany was not going to back its money. With that, the rush to get out of the mark was on. Like a damn bursting, the seas of marks flooded into the markets and drove prices beyond all bounds. The German government strove mightily to outflood the sea. The sea of marks which had been stored up by Germans and especially by trusting foreigners flooded forth and fought to buy into other investments, foreign currencies, tangible goods, almost anything but marks.”
— Jens O. Parssons, “Dying of Money: Lessons of the Great German & American Inflations”
WOW the audacity!
http://www.huffingtonpost.com/2010/07/26/neel-kashkari-tarp-guru-s_n_659423.html
“ECCLES: We created it.
PATMAN: Out of what?
ECCLES: Out of the right to issue credit money.
PATMAN: And there is nothing behind it, is there, except our government’s credit?
ECCLES: That is what our money system is.”
— Federal Reserve Board Governor Marriner Eccles in testimony before the House Committee on Banking and Currency in 1941, during questioning by Congressman Wright Patman about how the Fed got the money to purchase two billion dollars worth of government bonds in 1933.
I like where KashNKarri talks about self interest:
#
# “What is supposed to happen in a democracy is that each sovereign citizen will always vote in the public interest for the safety and welfare of all. But what does happen is that he votes his own self-interest as he sees it … which for the majority translates as ‘Bread and Circuses’,” said Jubal Harshaw in “Stranger in a Strange Land”
— Robert Heinlein
Wow, great paper Scott. You have a lot of moving parts there, and a whole bunch of things worth commenting on– This the gold medal part of the article is on p. 31-
An interest rate policy that is unsustainable could be defined as one in which rates on the national debt are held above the rate of nominal GDP growth. Now that is THAT is something to think about, instead of focusing deficits or the debt/GDP ratio. Focus on national debt interest rate and nominal growth, interesting stuff. I’d point out that the CBO is projecting $5 trillion in federal debt service over the decade. By use of the pre-1951 Accord tap system, net interest costs could be cut by dramatically.
I also liked your discussion of the IOR. So are the “billions if not trillions” in excessive balances simply deficit spending that went to bank reserves instead of time deposits?
Finally, since monetization is just dismissed as the “inflation tax” by critics, if you discss Functional Finance, as you did a couple of times in this paper, perhaps it’d be worthwhile to bring up (if only to dismiss) Abba Lerner’s work on anti-inflation policies. Towards the end of his life he added a fourth rule to Functional Finance (‘The government must establish policies which stabilize the price level and coordinate both the money supply rule and the aggregate total spending rule with this stable price level at the unemployment level it prefers.’). (p.12).
http://community.middlebury.edu/~colander/articles/Functional%20Finance,%20New%20Classical%20Economics%20and%20Great%20Great%20Grandsons.pdf
Gotta run now, but will be on later this evening. Thanks again for mentioning (and writing) this article.
Beowulf,
If this is the first time you’ve seen this paper, you haven’t lived. My favourite, über-macro quote:
“Any transaction in a capitalist economy results in changes in the agents’ financial statements; if the hypothesized supply and demand relations are not consistent with the actual changes occurring within the financial statements of the relevant agents, then the hypothesized supply and demand model is irrelevant.”
Timeless – it begs for a tattoo gun for that to be stenciled into the foreheads of a few hundred thousand of Scott’s peers. Then we might get somewhere.
I really like quote as well. I think it captures exactly what is wrong with economics and where economics should develop.
I’m convinced – by the various mmt (particularly Scott’s)and several post keynesian papers that I have read – that studying and understanding account is one of the most, if not the most important concept to understand for anyone interested in economics. It’s meant that I’ve had to rearrange my bachelor, so that I can pick up some accounting units.
Beowulf . . .thanks a bunch! Completely agree with you on all points. The Lerner point is spot on, too. That’s the intent of the job guarantee, of course, is to make full employment with price stability “automatic,” but there’s any number of things that could be done that could complement.
JKH …thanks, as well, naturally. It’s become a bit of a badge of honor for anyone to receive such commendation from you online (not that Beowulf is any slouch, of course). It never ceases to amaze me how hard of a sell basic accounting is to economists, both how it works and why it’s important.
“it begs for a tattoo gun for that to be stenciled into the foreheads of a few hundred thousand of Scott’s peers”. Ha ha, now that’s an exogenous shock! :o)
I’m in the law racket, so I’m always “accounting” for what statutory box something belongs to what statutory box you could back into to get the desired result. For example, Congress didn’t understand they were creating automatic stabilizers when they set up “mandatory spending” programs like unemployment insurance, food stamps and student loans. Most govt spending, Congress may authorize a program for 5 years or more at a time, but Congress still has to appropriate the money every year. On the other hand, mandatory spending is automatic. I believe the magic words are something like, “Notwithstanding any other provision of law, the Secretary of the Treasury shall transfer from the general fund of the Treasury (from funds not otherwise appropriated)”… I think a JG would best fit in as an add-on to unemployment insurance. Any state government who wants offer a Job Guarantee to unemployed citizens not eligible for unemployment insurance (I think that lasts 6 months unless Congress extends it). Tsy would send the money to fund participating state programs, and all the states would participate, its free money to help the unemployed.
A congressman or senator has a chance to offer it as floor amendment, whenever vote to extend unemployment benefits comes up, then the argument is instead of continuing to pay people to sit at home after their state benefits are expired, why not give a job to earn that govt check instead of just giving them a check. I still think a Lerner/Vickrey market anti-inflation plan (ditto the Buffet import certificates) would be a good idea), if only to to give the Fed something to occupy themselves with instead of raising interest rates. 🙂
The CBO projects $5 trillion over the next decade in debt service (I think the avg rate was 5%). Drop long bonds and cap short-term bonds or IOR at .0.25%,– You now have a rather large pile of money that’s already been factored into 10 year budget projection that could be reallocated to new spending or tax cuts without increasing the deficit.
Here is a criticism:
Such discussions raise nice questions.
Why does the public debt need to be “sustainable”. For a closed economy it is plausible that the public debt keeps rising at some rate but interest payments also increase. A more careful analysis would involve taking ratios because in absolute terms the public debt is generally increasing.
Since increase in public debt would push national income upward, it creates higher tax payments to the government as well. So its not compulsory to have the debt stabilized at some level such as 60%. If one relaxes the fiscal policy, the debt/gdp ratio increases initially but likely automatically/endogenously stabilize at some higher level.
However, the inclusion of the foreign sector can change the game. For low trade deficits, it is possible for the public debt to be sustainable if growth is fast enough. Growth puts a downward pressure on the public debt/gdp ratio and interest rates put an upward pressure. Deficits put an upward pressure and it’s a game of these numbers. The deficits should atleast be equal to the trade deficit if the private sector’s net saving is to remain positive – unless one takes a chance of an unsustainable path of growth led by private debt (by gdp) increasing in one direction.
For an open economy it is possible that the public debt keeps increasing without limit. The exchange rate does not move smoothly as many/most Post Keynesians have emphasized. When a crisis is triggered, the balance of payments problems worsen because of quantity adjustment takes time and price adjustment is much faster leading to further currency falls creating increased nervousness.
For countries which issue reserve currencies, the crisis points can be delayed. For currencies which are not so fortunate (which is most countries), the situation is complex.
Why did I say all this ? The MMT hypothesis that countries can run trade deficits forever is an implausibility.
Ramanan, I sympathise with your point but I don’t think it’s necessarily at odds with MMT. Or at least I think there are ways to argue along MMT lines without having to make such an absolute statement for all eternity. Especially with policy and debates with other schools of thought in mind, I’d say it’s probably more important to keep track of priorities and inherent dependencies than to always be in agreement about the ultimate implications in the philosophical long run. This is also important because, left standing alone, most absolute statements that aren’t tautologies / identities are implausible anyway. Generic political statement: my proposal guarantees eternal prosperity for all! Generic answer: sure…
A related problem is that of misrepresentations of MMT, e.g. by Mr. Krugman and others. False simplifications like ‘deficits never matter’ (a bastardisation of ‘in defence of deficits’ I guess), can be countered with sensible statements like ‘there is a case to be made for continuously running deficits’ that can then be qualified with something like ‘the economically significant measure is the effect they have on aggregate demand but there are always issues of distribution and subsequent instability that must be dealt with by politics’. Or ‘aspiring to fix the deficit or debt at some arbitrary level without regards to whose savings or incomes are affected in the process can have the opposite of the intended effect, even at full employment’. Or ‘I’m open to talk about attaining more balance in world trade and whether that would reduce debt or the deficit and at what cost (real and monetary), but if demand suffers in the process it will be counterproductive’. Or ‘hyper-inflation and voluntary default are theoretical possibilities but since our central bank controls interest rates on the national debt it has the power to keep it from spiralling out of control under all but the most implausible circumstances’. etc.
So although the longer the qualification the less sexy the statement, I do think nuances help keep priorities in place while leaving room for fine tuning among pro- and/or opponents and for the inevitable philosophical uncertainties that arise. I think MMT needs a set of general statements whereby anybody who disagrees with them is forced to argue the issues. Not that you’re not doing that but others certainly aren’t.
Oliver,
My objections are not like school A arguing with school B and I am very friendly with the MMTers – in case you get some other impression due to my recent “hostile” nature.
So while this blog is a good place to debate with each other, why not make the most of it and be persistent with a point I have to make ?
Sorry, I had no doubts about your affiliations and you don’t seem hostile at all. I think I conflated various points that have been discussed over the past few days and thereby missed the core of your concern. A lost post… I shall straighten up and fly right.
Well, I agree with Ramanan in that what he is arguing IS at odds with MMT.
As far as the actual argument, I can’t quite parse it. I found this paragraph particularly confusing:
“For an open economy it is possible that the public debt keeps increasing without limit. The exchange rate does not move smoothly as many/most Post Keynesians have emphasized. When a crisis is triggered, the balance of payments problems worsen because of quantity adjustment takes time and price adjustment is much faster leading to further currency falls creating increased nervousness.”
the govt. can run a budget deficit equal to non govt savings desires forever without ‘inflationary’ consequences from the demand side.
the nation can run a trade deficit equal to foreign savings desires without that situation altering the level of the currency.
these statements are tautologies
Precisely my point. The statement for the external sector is not a tautology.
Even neoclassicals know the identity
G – T + X – M = S – I
attempting to run a trade deficit larger than the foreign savings desires is a force that drives down the value of your currency.
am i missing something?
If it were that simple I would have had no issues or minor issues. The foreign sector has no “saving desire”. Banks do not have a lending desire function. It is demand led. Similarly the foreign sector can be thought of as quantity takers. The imports of a nation depends on its competitiveness and the volitional decisions taken by its citizens. The exports of this nation depends on the demand in the foreign nation. The exchange rate doesn’t adjust automatically to clear these markets.
Consider a closed economy. S = I. Interest rates do not adjust to bring this equality. Just like saving is the accounting record of investment (your words), the trade deficit is the accounting record of so many volitional decisions.
Even if one plainly states that exchange rates adjust automatically, then one can accept that there is no problem. However, they do not. And when they do, it causes a lot of problems. Moreover, policy makers do not want to go there and factor this in.
If the foreign sector has no desire to net save your financial assets and make it a point not to there won’t be any trade deficit.
that benefit comes from what i call foreign savings desires- willingness to net hold your financial assets.
If they sell things to you, get paid in your currency, and don’t want to hold your currency, their choices are to buy something from you, in which case there is no trade deficit, or sell the currency to each other (presumably at lower prices) until they either decide to hold it, in which case there is a trade deficit, or buy something from you in which case there isn’t.
so either they net save your financial assets or take action to see that they don’t. If they do- trade deficit. if they don’t- balanced trade
Ramanan,
The mathematics of current account deficit sustainability should work in analogous fashion to those for the budget deficit, as per Scott’s paper – hinging on a sustainable relationship between the growth rate and the interest rate. A current account deficit is a capital account surplus, which is saving. A capital account surplus represents the foreign demand for net financial assets, similar to a private sector net financial surplus. The exchange rate should work to calibrate net financial asset demand from foreigners so that it remains consistent with the bounds of mathematical sustainability. Infinite duration current account deficits are possible, provided the mathematics of growth and interest continues to work, and provided the demand for net financial assets persists, and is consistent with those mathematical bounds.
in other words, a nation like China, if they wish, can simply sell us their stuff forever, get paid in dollars, and simply accumulate that many dollar financial assets forever.
that’s fully sustainable until/unless they change their mind and decide to do something else.
Does the relative size of their position have any affect on the potential run of affairs if they at some point no longer ‘wish’?
This is not an argument that I follow closely, but from what I can pick up, a primary objection is that in increasing budget deficits, national debt, and CAD become politically unsustainable before they become economically unsustainable. This is what “vigilantism” is about. The system is supposedly protected by “growing concern” and “deteriorating confidence.” As Krugman points out, this is often based on superstition rather than fact, but it is a powerful force politically, even though it is bad economics.
As I have been emphasizing, MMT has to be economically sound, but it has to present itself strategically in a hostile political and professional environment, in which the mindset and universe of discourse is unfavorable to it. That means not only persenting a new paradigm but attacking the old paradigm successfully. What I am seeing is a lot of hyperventilation over “inevitable” hyperinflation, on one hand, and currency crisis, on the other, if we stay on the present “profligate” course. MMT has to undermine that view, while presenting a viable alternative.
As you say, it’s a tautology at the basic operational level.
If I’m Chinese, and export a TV for dollars, that transaction increases my NFA at the instant of dollar payment. If I didn’t want that dollar NFA at that point, I wouldn’t transact. And so on for subsequent iterations and aggregations.
Every current account transaction is a transaction in NFA on at least one side. The sum of it all equals the aggregate NFA desire.
The economic tautology is the accounting tautology.
Its more the behavioral dynamics.
Lets say JPM has the license to do business in country X and the US and the country X are the only two ones. The two countries trade openly and are dependent on each other.
If the US exports $100 worth of a DVD player to X, JPM credits the exporters bank account and debits the importer in X at the ongoing exchange rate. US of A has not net saved in the currency X. Probably you can say that JPM’s reduction is a saving in some sense in X’s currency but it doesn’t do anything with it. It continues its loan making in both countries.
Why is this problematic ? Because it reduces employment in X if done at a large scale such as a few percentages of X’s GDP.
Now it can be argued that the government X can relax its fiscal policy. It increases the imports of X. Its puts the country X’s public debt in an unsustainable path. Now, one can say that the public debt is just a number so what is the meaning of sustainability etc. The point is that the currency. changes are not so smooth. As the public debt increases in X and is heading to this so called unsustainable path, the currency falls can be rapid leading to imported inflation and all kinds of issues. The government has to tighten its fiscal policy for example leading to more umemployment.
in your example if the dvd is paid for in fx, those net financial assets held in that fx are ‘saved’/accumulated by the exporter.
so our exports to that country are matched by holdings of their local currency outside that country.
if the dvd is paid for in dollars, that nation has reduced its dollar net financial assets.
domestic employment in the US would be higher, but real terms of trade and domestic consumption worse than if we had consumed the dvd we produced.
and work is a real cost, not a benefit. the benefit is the subsequent consumption
“US of A has not net saved in the currency X”
The USA has net saved in the currency the exporter was credited with.
JPM is not a factor in the net saving event (apart from its spreads, fees, etc.).
Currency markets can be volatile, but so can government bond markets.
Yes. The current account deficit is equal to the decrease in liabilities of JPM in the currency X.
The currency markets can be volatile but unlike the government bond markets, out of control of the government. They will not allow any endemic trade disbalances, however. They have mood swings, its ironical but very punishy about trade balances.
The export-import didn’t involve any saving desire in currency X in some sense (of citizens of the US) and it depended to the competitiveness of producers in country X versus the USA. And hence indirectly the propensity to import and the total import depends on the income in X multiplied by this propensity.
True, but there are political reasons preventing that from happening. What I am saying is that it is insufficient to lay out the case economically. You also have to figure out a political strategy for getting by the existing barriers. I would put 7 Deadly Innocent Frauds in that category, for instance.
The trade imbalance/job loss thing is turning into a big deal. We need to meet it not only economically but also politically. Just saying “floating rates” is not going to cut it.
Ramanan,
I can’t see in your US and X example that you have recognized Warren and JKH’s point–somewhere, there was a fx transaction OR the transaction was in $ and country X saw its $ reserves reduced.
Its a simple transaction.
JPM increases the US exporter’s deposits in $$$s and reduces the country X citizen’s deposits in the local currency. Its like me purchasing a book from amazon.com using my Citibank debit card. Just assume amazon.com banks with Citibank.
There’s still a fx transaction in there, if only via fees, etc.
Regardless, as JKH said, the domestic private sector has seen its NFA increased, as there is additional income to the seller in the US without anyone else in the US spending. And vice versa in X.
The fx transaction is automatic. Its simple I do not see any issues with this.
Imagine you buying a book from amazon.co.uk using your Citibank debit card. Citibank debits your account and credits amazon.co.uk’s account. Thats it. No other transaction.
OK, fine, for the sake of argument at least.
My broader point, which I incorrectly tied to the fx transaction, was the NFA that I mentioned (and JKH did, too.)
Let’s take your scenario where the currency markets repudiate country X’s currency because it has been running trade deficits (again, for the sake of argument). Now, for country X, the DVD player is more expensive, and at the margin the desired qty’s to import are then lower (ceteris paribus). That’s an improvement in X’s trade balance. Maybe nobody in the US buys anything more of X’s stuff (for the sake of argument). How is the ability of X’s govt impaired if it wants to sustain full employment?
Haven’t double checked this, but the banking system accounting would work something like the following:
JPM US and JPM X each have their own regional balance sheets, within a consolidated global JPM entity.
The US exporter is paid in dollars.
JPM US credits the exporter’s account with dollars.
JPM US in turn is looking for payment from the importer’s bank, which happens to be JPM X.
So JPM US records a dollar asset “due from” JPM X.
JPM X at the same time debits the importer’s account in FX terms.
JPM X records a dollar liability “due to” JPM US.
Thus, JPM X’s previous FX liability to the importer has now been replaced by a dollar liability to JPM US.
Other things equal, JPM X now has a foreign exchange mismatch, where it is long FX (from an assumed previously matched FX position) and short US dollars.
Combing JPM US and JPM X, the consolidated JPM position is also long FX and short dollars.
Turning to the financial statements of the exporter:
The exporter receives dollar revenue from foreign sources in exchange for the DVDs. That revenue, AT THE MARGIN (i.e. subsequent to accounting for the costs of goods sold on the income statement), represents an inflow of net income. Furthermore, this income contributes to a marginal current account surplus in the same amount. Accordingly, AT THE MARGIN, it reflects income, saving, and net equity. The net equity is reflected immediately on the exporter’s books as a long dollar bank account position with JPM US, and AT THE MARGIN an increase in the exporter’s equity account. The exporter has saved in the form of net financial assets, at the margin. On consolidated USA books, this represents new dollar NFA, notwithstanding that on consolidated JPM books, there is a foreign exchange exposure that may eventually affect JPM’s net income globally and therefore the current account as well. The current account surplus is primarily due to the exporter’s activity. As I said before, JPM is just the balance sheet intermediary, without direct current account effect for the most part (e.g. the marginal CA income effect of the FX mismatch ex post would be an exception).
P.S.
In the above example, everything has to be looked at “at the margin”, because macro current account consolidation implies micro telescoping back through all costs of goods sold inputs in order to consolidate their respective contributions to current account surplus, income, saving, and net equity effects in total. It’s somewhat awkward to fit that into a single example, and somewhat difficult to describe in aggregate.
Exactly. As I said, sorry for tying the NFA change incorrectly to the FX transaction.
Thats okay if you break the balance sheet.
JPM – as a consolidated entity doesn’t have to do anything in the FX markets. It itself is a player.
Its dollar liabilities have increased but doesn’t need to cover it or borrow from the Fed.
JKH,
I agree that it has to be looked at the margin. I have used a very special example. However, just to illustrate the breakdown at the sectoral level.
MMT just says foreign saving desire to save the currency etc. In the example, I wanted to illustrate that my arguments against it and the usage of the word “saving” and how its not so simple a concept. The exporter does not intend to save in currency X.
JPM has reduced its liabilities in X and did it a bit passively.
It also illustrates that if X increases its demand through fiscal action, exports of the US will increase – without me having to assume anything about the “saving desire” of the US.
I agree that international settlements are not so straightforward. However, just throwing in some behavioral stuff.
Warren, this may be true theoretically, but in practice it works out that China is using what Pettis calls “financial repression” to pull off depriving its workers of the fruits of their labor, since the majority of profit goes to special interests with state connections. While it works for a while, it looks to be politically unsustainable for China, and it cannot “go on forever” without a backlash, even in a controlled state. Similarly, in the US with high unemployment intractable, there is a backlash brewing against the “job drain” that Perot graphically called “the giant sucking sound.”
Yes Tom,
Ramanan sez: ” The deficits should at least be equal to the trade deficit if the private sector’s net saving is to remain positive ”
—this is the key thing Im taking out of Ramanan’s interest here. Our US policymakers dont have a clue here, how not maintaining a deficit here that well execeeds the current account will degrade employment in the US. Or even look deeply at the external sectors effect on US employment situation.
And imo you cant just look at the nominal current account. If the external sector lowers their prices in an increasingly desperate grab for USD NFA via their exports to the US, this can almost hide the effect on US employment if all you look at is the $ CAD. Yesterday FEDEX came out with a good quarterly #s and positive outlook, this should not be surprising as units shipped/tonnage is probably going up, while perhaps import unit prices are being reduced, FEDEX will do well in that environment, domestic manufacturers not. US employment is based on quantity of orders, if the external sector reduces prices and increases units shipped, you could theoretically have an unchanged CAD and more US workers could be displaced & thrown out of their jobs. I think this is whats happening now as US employment in certain sectors is being stealthily eroded via this channel. resp,
yes, it may be politically unsustainable for China, but for us all we have to do is recognize we can keep taxes low enough for any size govt such that we can buy all can produce domestically at full employment plus whatever anyone else wants to sell us.
‘Ramanan sez: ” The deficits should at least be equal to the trade deficit if the private sector’s net saving is to remain positive ”’
Well, if that’s the point, then there’s nothing inconsistent with that and what MMT’ers have been saying all along. I’m still trying to figure out what the point really is, myself.
the fact that MMTers views are completely different from the other Post Keynesians.
Yes, they’ve made us quite aware of that through the years.
JKH,
The mathematics unfortunately doesn’t work out in the case of an open economy. The dynamics of public debt is such that for a growing economy, there is no problem whatsoever. Of course, scott has correctly shown that the neoclassical analysis is all wrong.
Even with high interest rates, the public debt is sustainable and converges to some value in the long run. This is because interest payments – atleast on government debt is not a “burden”. So the condition that growth has to be high is not needed at all. Of course in the long run, we are in the short run as Abba Lerner put it, but it shows that one doesn’t have to be fearful.
In the open economy case however, it doesn’t exactly work out that way. Foreign interest payments is a burden. A permenant current account deficit keeps increasing that burden and is unsustainable in some sense.
Current accounts are doubly problematic – they reduce employment and there is a cost in servicing foreign debt. Of course, I know all the arguments coming my way – what is the meaning of being indebted in one’s own currency etc.
The loss of employment due to the deficit and the burden of servicing foreign debt can be handled by relaxing fiscal policy. That puts the government debt in an unsustainable path if it is endemic. However, one can again argue – whats wrong with the public debt growing faster than income. I hope you appreciate my coming out with points which can be used to counter my arguments.
My point is that in this game, the currency markets finally win. It is this dynamic that I am trying to come out with if you check some of my recent comments in other posts.
If a country runs a current account deficit, someone has to pickup its IOUs as a matter of accounting. There is another way out – loss of foreign reserves. Investors invested in other currencies do so for various reasons. China buys US Treasuries for being seen as powerful and to be able to do international trade successfully. For other countries, foreigners buy IOUs to make a killing. Their “saving” in the currency is a dynamic behaviour. Here today, gone tomorrow.
Countries price this in already and one simply cannot ask them to expand domestically because of problems which may possibly happen with their currencies. The balance of payments sheet is a really important statistic. In fact, according to some the most important factor for growth.
I am also aware of arguments such as if Chinese sell their holdings it may be useful for the US of A since it devalues the dollar and good chance that it improves the trade balance. However, the dynamic I have in my head is the later the fall, the harder it will be. The case for the US is the most difficult to argue out, and hence I am building it up for other currencies.
“In the open economy case however, it doesn’t exactly work out that way. Foreign interest payments is a burden. A permenant current account deficit keeps increasing that burden and is unsustainable in some sense.”
Three things.
First, foreign interest payments for the govt are not a burden for it, as it can always meet its payments, AND it’s level of debt service is a policy variable. Foreign interest payments for the domestic private sector are definitely a burden for it just as debt service within the domestic private sector can bring financial instability and crisis (and just did). No MMT’er would ever deny this; quite the contrary.
Second, you may not be completely considering Warren’s point about tautology and the implications for MMT. Due to capacity constraints, we recognize that govt’s can’t or at least shouldn’t run deficits of any size, so the fact that govt’s can always service debts and that level of debt service is at least potentially a policy variable DOES NOT imply that deficits are never a problem. By the same token, Warren’s tautology is not arguing that current accounts of any size are never a problem. As he has said many, many times, the supply of fx is driven by NFA qty, and the demand side is foreign saving desires of NFA. If foreign net saving falls, it is precisely at that moment that the qty of NFA must fall or domestic private desired NFA saving must rise (reducing domestic demand overall including desired imports) to avoid a strong correction in the exchange rate.
Third, as in point one above, debt service burdens of the domestic private sector, INCLUDING (perhaps, including in particular where exchange rate fluctuations can affect debt and debt service) those incurred from abroad are quite key to understanding financial fragility and instability in the Minskyan sense. See Jan Kregel’s paper from the late 1990s on Asia titled “‘It’ Did Happen Again,” for instance.
All of these points are quite consistent with MMT. There is no contradiction.
Am I missing something? Apologies if so.
I should add, though, to my second point above, that many wouldn’t consider a strong downward correction to the exchange rate to be a problem in some instances. Witness the US’s continuous complaining about other countries manipulating exchange rates–some in the US would like a significant downward correction in the $ to enhance employment in export industries (which is the flip side of a decreased foreign demand to hold $), and from the sector balances, we know that if this did occur to sustain the same level of AD you would need either a smaller govt deficit or increased domestic private saving desires.
Scott @1:08
I believe that this was the US strategy under Bush, Bush, when the US was talking a strong dollar and letting it slid. I also think that the Obama administration has adopted it as the best solution to intractable unemployment in a divisive political environment where the necessary stimulus to increase NAD is impossible to appropriate. Again, political.
“it is precisely at that moment that the qty of NFA must fall”
Which means that taxes must increase — the pesky political thing again. In the present environment any US administration that gets itself into the position of having to raise taxes is in trouble. Alternatively, the cb can jack up interest rates, increasing the cost of credit and reducing demand for it. That’s not popular either.
Politically, you want a policy that maintains full employment and price stability. Trade does affect that. Trade policy that works toward trade balance is politically shrewd. A constant trade surplus might seem more desirable, but it adversely affects workers who are laboring for foreign markets instead of enjoying the fruit of their labor, in aggregate. A trade deficit exports jobs and requires constant stimulus to correct, which involves problems of cronyism, malinvestment, and so forth, maybe even military adventurism.
The US is in a happy position with foreign central banks not minding the low interest rates. Not true for other countries because these countries have to attract foreigners and pay them a high interest rate.
It is a burden because an expansionary fiscal policy to make citizens of the country share a greater proportion of the national income than foreigners will lead to worsening of the current account deficits leading to a fall in currency, perhaps a rapid fall. In such cases, the government is forced to go into a contractionary mode even if it is not revenue constrained.
I understand that “imports are benefits” may be used as an argument to counter this but when my points are to argue against it, it can’t be used 🙂
I understand your points and I understand that you have never meant that “deficits are never a problem” or that “size is never a problem” – unlike what most people incorrectly assume when they criticize MMT. I understand that it can have implications for price levels and I understand the details on the casualities which lead to price rises, for example.
It is the basic assumption about the underlying fx mechanism and the “net saving desire of the foreign sector” is what my underlying debate is all about – which you can see in some of my comments. The foreign sector saving is just the accounting record of the trade deficit. It says a lot about the competitiveness of a country versus the rest. The exchange rate markets do not adjust to bring the quantities “saving desire” and the trade deficit in an equilibrium.
These dynamical things are the ones I am talking of.
The proposition of the public debt increasing without limits because of the leakage in the current account is an implausibility and if you happen to read Wynne Godley and Gennaro Zezza’s work, you can see them saying the same things.
It is not stressed too much in MMT blogs that it is a consensus amongst Post Keynesians that endemic trade deficits are bad and currency fluctuations do not bring them to balance. More than anyone else, Wynne Godley has written a lot about the public debt moving into unsustainable levels because of trade deficits. A more technical way of saying this is that “the New Cambridge approach holds in the long run”.
Not that one has to believe in whatever they say. I am merely trying to put forward a narrative of the dynamics associated with the external sector. Trying to convince that fiscal policy has limits. I am not arguing for reduction of deficits in ANY sense if someone gets the impression. I am merely arguing that continuous trade deficits are not sustainable and trying to convince the MMTers about it. Not only that but the fact that currency issues or the possibility of that has led to a shortage of aggregate demand because governments do not wish to do it.
Ramanan . . .the fiscal policy paper by Lavoie/Godley at Levy showed that permanent currency account deficits didn’t matter. I disagree with the Levy stuff you are citing on US current account deficits–they’ve been saying for 15 years that the US couldn’t keep it up. Also, if you want to convince MMT’ers that continuous trade deficits are not sustainable, you will have to make a different case. We’ve heard that one for many years from many angles and aren’t convinced.
“The foreign sector saving is just the accounting record of the trade deficit. It says a lot about the competitiveness of a country versus the rest.”
In goods and services that are tradable internationally. But it also says a lot about desired saving. If Germany were to desire less foreign saving, they would have a smaller trade surplus even if they maintained the same “competitiveness.”
“The exchange rate markets do not adjust to bring the quantities “saving desire” and the trade deficit in an equilibrium.”
And what on earth is an equilibrium, anyway? Regardless, though, if the rest of the world desires to net-save less in $ (that means, for whatever reason, they want to hold fewer $; perhaps they worry about the future value of the $, or perhaps they move to more consumer-driven growth), ceteris paribus, do you dispute that the exchange rate will fall? Do you dispute that the trade balance would improve for the US? Please explain your rationale if you do in either case. That would help.
For instance, examples like Japan in the 1980s don’t make the point you are trying to make. Japan allowed its currency to appreciate vs. the $, but they still kept their saving desires in $–they just lowered yen equivalent prices to try and maintain competitiveness.
Ramanan . . .the fiscal policy paper by Lavoie/Godley at Levy showed that permanent currency account deficits didn’t matter.
Nope they didn’t say that !
Amazing as they are they only found a situation or some special situations where it was sustainable.
“it cannot be assumed that a debtor country requires a trade surplus if interest payments on debt are not to explode.”
I am not talking of an equilibrium either.
Yes, you need not be convinced of the Levy authors – that is fair. However, the point is that they have in mind a detailed dynamical mechanism. In fact they have been arguing for a devaluation.
That brings me to the brilliant question – if the exchange rates fall, whats the worry ? How can one be worried about an exchange rate in the future and want an exchange rate fall now. Aren’t these two contradictory. The point is that they are not contradictory. The fall now is good and a fall later can be very dangerous.
The other point is about the increase in exports if the exchange rates fall. Unfortunately its not so obvious. In Post Keynesian stock flow models, the processes are demand led but there are supply side constraints. How competitive one country’s products and producers is a supply side issue. At any rate its highly possible that the exchange rate moves can increase exports by some amount.
The point is that if you think that exchange rates move by some market factors and there is some automatic adjustment, then the viewpoint is difficult to argue with.
“The exchange rate markets do not adjust to bring the quantities “saving desire” and the trade deficit in an equilibrium.”
I think that this statement is the nub of the problem I am having with Ramanan’s argument. I think he is really saying that the fx rate does not adjust to match foreign net savings desire with domestic net import demand. I believe that for a floating rate fx regime, where the government is not manipulating the fx rate, the negation of what Ramanan claims is a tautology.
“Nope they didn’t say that !”
You’re wrong. I just looked at their paper again, and pages 24-25 say it exactly as an MMT’er would.
“Well one can keep arguing about the definitions of sustainability.”
No you can’t. In ECONOMICS, there is one definition in the academic literature, and that definition is the non-exponential rise in debt service.
Aside from that, what you’re saying is you believe that markets just will decide at some point they don’t like the $ or the currency of whomever is running the continuous trade deficit. This is obviously more significant than when neoclassicals say that bond mkts would reject US debt, because MMT’ers are talking about flexible fx, so there is absolutely the possibility of the currency falling, even a lot. To that possibility, we say “maybe,” but even then, the currency issuer can still create full employment, as it can still service its debt and it can still cut taxes or raise spending to fill the gap (whether by discretion or automatic stabilizers).
No they do not say that. Please not the choices of parameters for imports or exports. They have just created a situation in which it is sustainable. Please see the choices of parameters.
Again page 26 says “second, that it cannot be assumed that a debtor
country requires a trade surplus if interest payments on debt are not to explode.” It doesn’t mean that all trade deficits are sustainable
Yes I am pretty much saying that the currency markets will decide to ruin a nation. If you think otherwise not sure why.
It is NOT analogous to the bond market situation because the central bank and the Treasury can set the yield curve if the wish.
One can reply to me saying that my views on the currency markets are as if anything can happen etc and that is not a good argument etc. Not really – it is really important. You cannot expect a country’s debt/gdp ratio increasing forever and expect the currency markets to like you. The State is bigger than the bond market but is not bigger than the currency markets.
Thats brings me to a very important dynamic. If the currency markets fall in a more volatile manner, the balance of payments worsens! This is because the price adjustment is fast but the quantity adjustment is not. Many PKEists have emphasized this. As the balance of payments worsens, it leads to further problems and the only solution is to tighten fiscal policy – and that too in difficult times.
“It doesn’t mean that all trade deficits are sustainable”
OK, back to square one. WHEN DID WE SAY THAT ALL TRADE DEFICITS ARE SUSTAINABLE?
Also, I was agreeing with you that the bond mkt and currency mkt situations were not analogous. Please re-read.
Also, EVERY economist recognizes that the price adjustment is faster than the qty adjustment. It’s standard in neoclassical literature, too. But it doesn’t stop the currency issuer from providing for full employment.
Finally, you’ve misinterpreted them on p. 26. They are validating the MMT argument there, unless your point is the same and we’re talking past each other.
Not I haven’t misinterpreted them. I believe you have.
Lavoie/Godley write “second, that it cannot be assumed that a debtor country requires a trade surplus if interest payments on debt are not to explode.”
This means it is not necessarily the case that a permanent trade deficit is unsustainable. This is the MMT position.
Then you said, “It doesn’t mean that all trade deficits are sustainable.”
And hence my “back to square one” comment at 3:28pm. We never said all trade deficits are sustainable. We said that trade deficits consistent with the desire of the rest of the world to net save in the currency can be sustainable. Very big difference. If the US tried to double its current trade deficit, it would be problematic, because the rest of the world doesn’t want to net save $ to that degree at current exchange rates.
So you are accepting that MMT is overdoing this 🙂
“trade deficits consistent with the desire of the rest of the world to net save in the currency can be sustainable.”
You are changing our stand. Where did “consistent” come from? – MMT says trade deficits are caused by the foreign sector’s desire to accumulate financial assets.
On the other hand, your behavioral hypothesis are very different from G&L.
Further points.
If you look at the G&L paper, they have assumed that the trade deficit is fixed and in some sense exogenous etc. A more accurate way of saying this is that they have assumed an import/export ratio of 1.05. They of course realize the simplicity of this assumption and the fact that this is not the case always. They just wanted to create a situation where a few things are shown to be possible. They have different assumptions in other more complicated models. X depends on external world demand and imports depend on domestic demand and hence the ratio is not fixed.
The assumptions are crucial. In your paper for example, you have assumed the deficit to be fixed and hence you have a condition that r g is also sustainable for a closed economy. That is because they have endogenized the deficit.
The reason these things are crucial is because if domestic demand increases, imports also increase – widening the trade deficit. Hence policy makers do not wish to increase domestic demand – it’s an important factor in the budget decision. If the imports increase the financial balance of the rest of the world increases and in no way due to their own volition. They accommodate all purchase requests. The trade deficit cannot be said to be caused by the increase in the saving desire of the foreign sector.
Some words got missed out:
The assumptions are crucial. In your paper for example, you have assumed the deficit to be fixed and hence you have a condition that r g is also sustainable for a closed economy. That is because they have endogenized the deficit.
“MMT says trade deficits are caused by the foreign sector’s desire to accumulate financial assets.”
Ramanan,
MMT does not express a view on what “causes” a trade deficit. It merely expresses the view that whatever the net trade deficit is, the foreign sector is happy to accumulate domestic financial assets at that rate. And the domestic sector is happy to consume above its own prodution at that rate.
When 100 shares of IBM trade at a price of 128.50, is it the seller that wants to sell at 128.50, or is it the buyer who wants to buy at 128.50? I would say that it is both. At a price of 129, there are more aggressive sellers than buyers. At a price of 128, there are more aggressive buyers than sellers. At 128.50, there is balance at that point in time. It’s a two-way street.
That’s why what Scott said was obvious. If the US wanted to increase its imports by $500B per year, clearly the value of the US dollar would have to fall from where it is now until the ROW wanted to accumulate enough of our financial assets (a cheaper dollar would make the dollar more attractive) or enough of our goods and services (a cheaper dollar would make our exports more attractive too) to offset the extra $500B of imports.
1. In my paper, the point was to show that the crucial variable in the IGBC, the interest rate, was a policy variable. As you know from MMT, the state could put the interest on its own debt to 0.
2. You still haven’t explained why, given all the points you’ve made, the state somehow cannot sustain full employment as with a JG for instance, regardless of the trade deficit. How do the currency markets somehow keep the state from providing a JG or similar?
First some background before I move on to issues of full employment.
Marc Lavoie (my favourite and my book shelf is full of books with his articles) has this to say in his book “Introduction to Post Keynesian Economics”
It is true that a surplus in the capital account, arising from the
influx of foreign capital, can easily compensate for the negative
current account. But such a situation can only be a temporary one
for countries other than the USA, since its currency serves as an
international reserve asset. Indeed, countries cannot tolerate such
current account deficits for too long because of the interest and
dividends that must be paid on the accumulated external debt and
foreign investments. In the long run, therefore, the current account
must be balanced and imports must, at most, be equal to exports.
How is this consistent with the G&L JPKE article ? Thats because there are situations where it is possible but its difficult to fine tune an economy that way. A country has to be highly competitive to get to the sustainable situation with a small but continuous trade imbalance.
(Page 125)
The growth of a country is restricted by the balance of payments problems (also in page 125) and this is known as Thirlwall’s law.
Page 126:
The USA notwithstanding, this balance of payment constraint
carries important implications because it forces countries with high
growth rates to curtail domestic demand, just as recommended by
bureaucrats at the IMF and the World Bank. As a result, there is a
strong downward pressure on global aggregate demand.
The Thirwall law formulated in 1994 by Mccombie and Thirwall http://books.google.com/books?id=nxsP8ygXff4C&lpg=PP1&dq=mccombie%20thirlwall&pg=PP1#v=onepage&q&f=false was I guess framed earlier by Nicholas Kaldor as well and you can see its influences in Godley and Cripps’s work in 1983 where they construct stock-flow consistent models for the open economy as well.
The above book also talks of issues with currencies. It raises points why current accounts are problematic. The logic is not so difficult to understand – continuous current account deficits lead to currency falls. As the currecy falls, it worsens the balance of payments instead of improving it. It causes more problems with the currency and the government has to go into an austere mode exactly when the opposite is needed. The austerity “helps” because it reduces imports and there is a chance of improving the balance of payments.
Its an irony more than anything else. The reason Thirlwall’s law fits well with emperical data is because policy makers do not want to go “there” and increase demand and imports.
There are many causalities needed to be believed in agreeing with such arguments. However, trade deficits are not “caused” by the foreign sector desiring to hold your currency. Foreigners need to be paid high interest rates because there are actually only a few currencies that are easily acceptable and a country needs the foreigners for both providing them with foreign currency and because the domestic sector’s products do not sell well for the consumers to purchase them.
Now why it is still possible that governments can maintain high demand ? That is true because governments must take concerted action to uniformly maintain high demand. A single country cannot do so in isolation.
There are many behavioral things needed to understand the financing of the current account. The sectoral balances identity just tells you the foreign sector balance depending on the trade balance. It tells you nothing about causalities.
I’ve had discussions with both Marc and Tony a few years ago and I believe they resulted in complete agreement
We are well aware of all those literatures and disagree with it and have told them so. Like you, they are not convinced. Oh well. We’re all still friends and we can keep discussing.
Also, regarding Thirlwall, I remember reading all that stuff several years ago and was convinced that it was a fixed fx framework. I asked Randy what he thought, and he agreed.
Perhaps more time to engage on this later. Best!
Yes I know the views of both sides well now and I precisely am on the money on why is it so. Its the behavioural aspects which are important.
Convinced or not convinced is a different matter. Simply telling government policy makers that governments are not revenue constrained is not sufficient – far from it. There have been enough currency issues with countries for them to be more active with fiscal policy.
MMT just assumes currency will depreciate and its a one time price rise and not inflation.
OK, agree to disagree for the moment, and continue on in the future, hopefully.
One small correction regarding MMT–we don’t assume currency WILL depreciate. We acknowledge it MIGHT depreciate. It seems you (and most others, so you are in good company, for sure) are the one making the assumption about what currency markets WILL do. Randy put it best last week at ND2.0:
“We have always advocated floating exchange rates — in which exchange rates will, well, “float”. While we have rejected any simple relation between budget deficits and exchange rate depreciation, we have admitted that currency depreciation is a possible outcome of using government policy to stimulate the economy.”
Yes mine was a minor stress on the word “will” but you seem to have understood that and I guess just clarifying. Agree with Randy. Its the rejecting of the simple relation where the debate is about. You may argue it happens one way and I may (inspired by PKEists) give another description and the feedback effects.
“The mathematics of current account deficit sustainability should work in analogous fashion to those for the budget deficit, as per Scott’s paper – hinging on a sustainable relationship between the growth rate and the interest rate.”
Exactly. It’s the interest rate that’s the issue and that is unsustainable more than the govt debt, domestic private debt, and foreign debt. Witness Latin America in the early 1980s, and Asia in the late 1990s. What I would label unsustainable monetary policy was the real problem. This is not to say that actual deficit or debt levels themselves cannot be a problem, but the typical analysis of “unsustainability” usually is based on debt service and the assumption that the rate paid is greater than the nominal growth of income or GDP. So, in that sense (only!), it’s not current or projected US deficits that are “unsustainable” but instead the assumption that the Fed will raise interest rates–unsustainable monetary policy (as an aside, I’ve long believed that Taylor’s rule was unsustainable for the very reasons we are discussing here).
When you include the external sector in your analysis, continuous current account deficits do not lead to sustainable public debt.
Wrong. The definition of sustainable public debt is that debt service doesn’t rise exponentially as a % of GDP. Under flexible FX, the interest on the public debt is always at least potentially a policy variable, regardless who owns it.
On the other hand, domestic private sector debt to foreigners CAN BE unsustainable according to the definition. That is where the unsustainability of a current account deficit could come into play. But the link of the current account and unsustainability is not to the public sector if you have flexible fx.
Also, again, as Lavoie/Godley show in their fiscal policy paper, a functional finance fiscal policy is consistent with the intertemporal budget constraint even with high interest rates, so is not unsustainable. That goes for open or closed economies, as they showed (though they didn’t say this in the paper, that’s what they showed).
Well one can keep arguing about the definitions of sustainability. At any rate, you are assuming a lot about the acceptability of the currency. Here is what Wynne Godley wrote in his 1983 book with Francis Cripps. (The first book to introduce stock flow consistency and endogeous money together, their own baby)
As a long-term proposition the hypothesis of ever-increasing government deficit relative to income accompanied by continuous external deficits is implausible. A full steady state could be restored by a reduction in the fiscal policy or by a rise in trade performance ratio. These are two, related sets of pressures which might cause such adjustment to occur. One is the potential difficulty in financing the government budget when increases in government debt much directly or indirectly be taken up by foreigners. The other is the probability that continuous external deficits will make the national currency less and less acceptable in currency markets, provoking rapid falls in the exchange rate for the currency
One question you may have is “increase in difficulty” ? The reason is perhaps given by Moore in his book Shaking The Invisible Hand
“So long as countries trade with the rest of the world, they must avoid all expansionary domestic policy that threatens external imbalance. Countries that engage in international trade must attempt to maintain expected future conversion rates of their currency at their current values. If the exchange rate is expected to fall, CBs must pay a risk premium to attract funds to compensate foreign portfolio holders for expected capital losses. Since currencies represent a store of wealth in asset portfolios, countries are doubly concerned about the current size of their foreign exchange reserves and the future value of their exchange rate. When a country’s current foreign exchange outflows consistently exceed its foreign exchange receipts, it has limited choices. It must either pay out foreign currencies from its reserves, borrow foreign currencies to cover its negative balance, let the exchange rate depreciate, or devalue its currency.”
There are many things in the two comments you may criticise. However, its important to remember that one is not making the assumption of currency acceptability.
These reasons may not apply immediately to the US because the status it has. You cannot however bet on this status. At any rate, true for many nations.
“I hope you appreciate my coming out with points which can be used to counter my arguments.”
absolutely
can you define/clarify what you mean by “burden”?
It is difficult to really pin point.
A country can be a debtor nation (likely). If the country has a fixed exchange rate then its obvious – its the interest rate or the interest income foreigners make. Of course since the word “burden” is a bit loose, you can use it for either I guess.
For a floating exchange rate regime it is more tricky. However some amount is paid to foreigners. Its a burden because unlike the case of a closed economy, it “goes” to foreigners.
Even in a closed economy, the coupons paid is a part of someone’s income and in some sense it is not clear if it is a “burden”. However, high interest rates on debt – bank loans, corporate credit etc is bad for the economy and can be shown by considering the economy as a whole and its also a bit intuitive.
In national accounts, there are payments to foreigners and I guess you can call it a burden.
In the US, for example, the foreigner’s net assets position is around 40% of GDP.
If I am not wrong, interest payments to foreigners as a percentage of gdp is the closest proxy to the burden.
payment of your own fiat currency to a foreigner is not a real burden. the real burden is when he buys something and you have to export it to him
The real “burden” is not if the foreign entity buys your exports when reducing savings in your currency but when it buys your assets. Just imagine the political flak that would go up if China decided to covert its savings in dollars to US physical assets. Americans would see this as some sort of hostile take-over, even though it is just China selling us stuff and then buying our stuff with the proceeds in a financially equal exchange.
Remember what happened when the Japanese bought Rockefeller Center? Economically, no problem, maybe. but psychologically, it was a big blow in the eyes of many.
it might be a political problem but the real macro burden only increases if they somehow increase rents and usage fees we have to pay, and they use the funds to import from us.
they didn’t dig up R center and take it to Japan, or even raise the rents. not like the prior owner was giving the space away. it’s all subject to market forces, etc.
“they didn’t dig up R center and take it to Japan, or even raise the rents. not like the prior owner was giving the space away. it’s all subject to market forces, etc.”
Subject to market forces plus federal, state and local tax laws. I’d love see foreign-held dollars flow into real estate holdings. They can’t leave and they can’t vote so you’d see States start replacing income and sales taxes with Henry George-style land value taxation. The safest place foreigners can keep their money is in their Fed account, anything thats flows into a physical asset is just giving hostages to the tax man.
“absolutely”
One giveaway. I am not giving out any example of an actual event because to do so will require me to study the whole story and if I do not do so, I may be accused of quoting an example of a country with a fixed exchange rate or some kind of managed float which will destroy the credibility of my arguments.
It is the regime one is in – meaning why some country is behaving so etc which is what I may like to bring in at some point. Or, why countries wouldn’t freely float their currencies like the US does.
The advantage of addressing the trade deficit is political, its the most painless way to reduce a govt savings deficit (since its a tax paid out of the current account balance instead of private savings). If, as Dimitri Papadimitriou suggested, import certificates are auctioned off, thats $250 to $500 billion annually (depending on whether petroleum imports are included) in revenue that can recycled into private savings by cutting taxes by like amount.
http://www.levyinstitute.org/publications/?docid=1077
Do we need to reduce the trade deficit ? No. Do we need to reduce the budget deficit? No again, both are sustainable for as long and at high a level as the US wishes. However, we’re sailing into a strong political headwind with public pressure to reduce both deficits. The most economically efficient (or the least damaging, if you prefer) policy to reduce both the trade and budget deficits would be to auction off import certificates.
Its not simply political – thats the point I am making.
or have the fed buy stuff instead of the tsy as that doesn’t count as deficit spending and they just let it pile up as reserve balances so it doesn’t could as debt either.
there are all kinds of things one could do if they understood monetary operations, but if they understood monetary operations they wouldn’t think the deficits were a problem in the first place.
“there are all kinds of things one could do if they understood monetary operations, but if they understood monetary operations they wouldn’t think the deficits were a problem in the first place.”
Therein lies the political problem — convincing the country of this. There is a further political problem even when the country is convinced, in that fiscal policy becomes the chief tool and raising taxes is always fractious owing to competing interests. This is where automatic stabilizers come in, and the JG would be an automatic stabilizer on steroids.
I think you’d have to kick the money to states for their own JG program (think of it as a 100% reimbursement for state JG spending) since the Feds hasn’t had a public job employment program since the early 80’s. As a consequence, establishing a new federal require would meant the House and Senate spending months debating the issue, shrink into a 3 state pilot program and then require annual appropriations even for that. Automatic stabilizers like food stamps and unemployment insurance are “mandatory spending” items, basically there’s an automatic appropriation for whatever amount is required.
Congress should attach the JG funding to unemployment as an alternative to endless 6 month “extended benefits” extensions and leave it to the states to set up their own programs (unemployment benefits are actually administered by each State, the Feds just pony up the extended benefits funding).
http://workforcesecurity.doleta.gov/unemploy/uifactsheet.asp
Call it “Employment Assurance”
Until the Truman Administration, the Social Security Administration ran the unemployment insurance program (since it was just providing funding to states and not actually providing services). Anyway in the early 50’s, the Dept of Labor came in and poached unemployment. But in fact, unemployment compensation was listed as the second item on the original 1935 Social Security report. the first item was…
EMPLOYMENT ASSURANCE
Since most people must live by work, the first objective in a program of economic security must be maximum employment. As the major contribution of the Federal Government in providing a safeguard against unemployment we suggest employment assurance– the stimulation of private employment and the provision of public employment for those able-bodied workers whom industry cannot employ at a given time. Public-work programs are most necessary in periods of severe depression, but may be needed in normal times, as well, to help meet the problems of stranded communities and overmanned or declining industries. To avoid the evils of hastily planned emergency work, public employment should be planned in advance and coordinated with the construction and developmental policies of the Government and with the State and local public-works projects.
We regard work as preferable to other forms of relief where possible. While we favor unemployment compensation in cash, we believe that it should be provided for limited periods on a contractual basis and without governmental subsidies. Public funds should be devoted to providing work rather than to introduce a relief element into what should be strictly an insurance system.
UNEMPLOYMENT COMPENSATION
Unemployment compensation, as we conceive it, is a front line of defense, especially valuable for those who are ordinarily steadily employed, but very beneficial also in maintaining purchasing power. While it will not directly benefit those now unemployed until they are reabsorbed in industry, it should be instituted at the earliest possible date to increase the security of all who are employed.
We believe that the States should administer unemployment compensation, assisted and guided by the Federal Government…
http://workforcesecurity.doleta.gov/unemploy/uifactsheet.asp
What is different between mmt and pk?
As I undertand the distinction, MMT is a subset of PK. All MMT’ers are PK’ers, but not all PK’ers are MMT’ers. MMT draws on PK, but has its own unique features as a school of thought that set is apart.
OK, what is unique feature(s) of PK that set it apart from MMT?
PK’ers agree that Keynes took the correct approach in adopting effective demand as central. PK’ers agree in opposing both New Classicalism and New Keynesianism, which PK’ers see as a compromise with New Classicalism.
MMT emphasizes a number of things that aren’t universal among PK’ers, that is, one doesn’t have to subscribe to to be a PK’er e.g., Chartalism, Lerner’s functional finance, MInsky’s financial fragility hypothesis, Godley’s stock-flow consistent macro modeling. It’s uniqueness is its way of integrating these into a particular approach and method, the goal of which is full employment and price stability. The role of the JG as a wage-price anchor in achieving full employment and price stability also sets MMT apart.
My take, anyway.
and keynes was discussing it all in the context of the gold standard of the time.
most pk’s miss that distinction.
I believe Steve Keen is an example of a PK who is not MMT, mostly because he has not incorporated vertical money into his analysis.
yes, except ‘draws on’ is a bit too strong.
better: ‘has some common elements’
How did Laffer get Supply-Side economics so far off base?
It starts off glossing over the fundamental perspective that all governments using fiat currency are ISSUERS of the currency they use for denominating internal bookkeeping. From that point on, it’s clear that no issuer derives REVENUE in the form of it’s own bookkeeping currency. From that perspective, all aspects of Martin Wolf’s entire article are revealed as confused and off base.
Supply-Side economics, started off – via either innocent or intended fraud – as a half-truth used to mislead a populous, and has since predictably spiraled out of control – though not for most of the reasons the article dwells on.
Given the off-base approach to all aspects of this discussion, we’ll never be able to sleep peacefully as long as this many ill-informed people continue trying to trick populations into staying on the right course, by use of political mis-direction. That approach is unstable.
Watching politics in action is like watching a multi-dimensional Kabuki theatre in a house of mirrors! With this crowd, it’s a wonder that anything works at all.
Scott,
Here’s one of those things where you don’t know whether to laugh or cry or shoot yourself:
http://www.themoneyillusion.com/?p=6372
Made me think of your paper again.
Ouch. Thanks, I think 🙂
FYI,
Ben Friedman demonstrated years ago he didn’t understand CB operations, and he’s at it again. I critiqued his earlier stuff in “Setting Interest Rates in the Modern Money Era” in 2004 at cfeps.org.
Also, the fact that there is no link b/n the funds rate and changes in OMO has been around for some time (and not surprising to an MMT’er) and I critiqued this literature in principle 10 of “Modern Central Bank operations: The General Principles.” It’s somewhere online, but unfortunately the book I wrote it for a few years ago still hasn’t come out so it’s not published. Here’s the relevant passage, though:
A number of researchers have recently raised again the issue of how or if it is that the central bank’s interest rate target “matters” in terms of its effect on the determination of other interest rates. The issue was most widely discussed following Benjamin Friedman’s (1999) questioning of the central bank’s abilities to affect other market interest rates given the small size of its open market operations relative to dollar value of trades overall in these other markets. He concluded in a second paper that it was markets that “go along” with the central bank’s target given its “credible threat” to engage in larger operations, and that if the central bank’s “willingness” to engage in such operations were ever doubted “in time, the market would cease to do the central bank’s work for it,” leading to a “decoupling” of the market interest rates from the central bank’s target rate (Friedman 2000, 271). Thornton (2006, 24) agreed that “as long as market participants believe the Fed can control the federal funds rate through open market operations, such operations are unnecessary.”
Thornton’s empirical research (cited in Principle 7) finds no evidence of a statistically significant liquidity effect at the daily frequency associated with the Fed’s open market operations; however, this leads him, like Friedman, to argue that the Fed is not actually exhibiting exogenous control over short-term interest rates, but rather that target changes are endogenously made in response to changes in the “equilibrium” short-term market rate (Thornton 2006, 2007a, 2007b). In other words, he argues, as did Pollin, that there is a market “equilibrium” short-term interest rate set by money markets independent of the central bank’s target; again, like Friedman, to the conclusion that “it would take very large open market operations to defend a target rate that differed significantly from the equilibrium rate should market participants come to doubt the Fed’s ability to defend its rate objective” (Thornton 2006, 24).
Thornton’s analysis, however, does not demonstrate that the central bank would need large operations to set and sustain (or “defend,” as he puts it) its interest rate target. Thornton’s study deliberately abstracts from high payment flow days and the few days that there were significant “outlier” shocks to the Fed’s balance sheet that unexpectedly affected the aggregate quantity of reserve balances. Thus, what his analysis actually demonstrates is the already well-documented ability of banks to substitute balances across days within the maintenance period to meet reserve requirements; for this reason, his finding that shocks to the Fed’s balance sheet do not have a statistically significant correlation with daily movements in the federal funds rate is quite expected. Consider once again the case of Canada, with no reserve requirements: since there are zero reserve balances circulating overnight in Canada, there obviously would be no econometric evidence of a daily liquidity effect to uncover; though, just as self-evidently, the Bank of Canada does set and sustain its own target rate. From Principle 6, a central bank can set its own target rate as precisely as it desires; this is most easily done by narrowing the range between the rate paid on reserve balances and the penalty charged on borrowing from the central bank.
More importantly, Thornton, Friedman, and others making similar arguments neglect the fundamental fact that banks need reserve balances to settle payments each day and (where applicable) to meet reserve requirements; that is, there is no other financial asset that can substitute for central bank balances in these cases, and thus the central bank’s target rate influences other short-term rates, not vice versa. In other words, because banks need reserve balances, the central bank’s target rate “matters” and serves as an “anchor” in the determination of other short-term rates via arbitrage even as the central bank makes no attempt to directly affect these other rates (Fullwiler 2006, Rochon and Rossi 2007). For the U. S., this is confirmed empirically in numerous studies, most recently by Bartolini et al. (2005), Cyree et al. (2003), Demiralp et al. (2004), Griffiths and Winters (1997), and Lee (2003), all of which find evidence of day-of-maintenance period and high-payment-flow day effects in overnight Eurodollar and/or repurchase agreement markets that mimic well-documented and well-understood patterns of the federal funds rate. Research shows that arbitrage between these markets is very active to the point that differences in default risk, collateral, and availability of offshore facilities come into play.
In other words, he argues, as did Pollin, that there is a market “equilibrium” short-term interest rate set by money markets independent of the central bank’s target…
The lump of lendable funds fallacy :o)
Very interesting, Scott, thanks.
BTW, one reason I had to laugh at this was because of Friedman’s paper. I’ve never read it, but I had a blog debate a few years ago about this very issue, with somebody who lived and breathed Friedman’s paper like it was the interest rate bible. Central banks control short rates? Impossible!
The word “leverage” is used in a number of ways in finance and monetary economics, but it certainly applies in brutal fashion in the case of central banks and short term interest rates. I remember the Canadian rate hikes that paralleled Volcker in the early 80’s. That was a time when the CB could force short rates up by 1 per cent in a single day, just by draining a few million of excess reserves from the system (in Canada). And that small drain didn’t need to last long in order to have a sizeable effect on rates, following which it was quickly reversed. I think this may have been before the “announcement effect” mechanism, but I don’t recall exactly. In any event, the leverage was not only in the competition for “spot” reserves that were deliberately squeezed by the CB, but in the discipline and fear invoked as reserve managers approached the end of the reserve averaging period under those sorts of conditions. You’ve referenced that in your papers, of course. Banks and investment dealers used to await the weekly announcement of both the “spot” and “cumulative” system excess reserve position, whereupon they pounced on the market to trade their interpretation. The leverage on the money market by the CB withdrawing a relatively tiny amount of reserves was absolutely enormous.
Since then, we’ve lived through so much disinflation in the past couple of decades, that such tightening action seems like ancient history. And the some of the technical design of reserve systems has changed, and now we’ve had quantitative easing, etc. But the power of leverage over short term rates in particular remains with the CB, one way or another.
I particularly liked this part from your 2006 paper (which I think you reproduced in the other one you referenced):
“Because banks need reserve balances to settle large numbers of payments each day and to meet reserve requirements, the Fed’s target rate influences other short-term rates through arbitrage, not vice versa. In other words, because banks need reserve balances, the interbank rate targeted by the Fed “matters” in the determination of other short-term rates even though the Fed makes no attempt to directly affect these other rates”
You’ve got this stuff exactly right.
It’s appalling and surreal that so many and such a large majority in the economics profession are so wrong on these issues.
It continues to amaze me.
There is a distinct advantage to being a monopoly provider. 🙂
Especially a monopoly provider of an offer you can’t refuse. Banks have no choice but to balance their balance sheets. That’s what the reserve entry does at the end of the day.
(The CB as godfather)
“The CB as godfather”
ROFL
Does Canada have no reserve requirement or reserve requirement of zero (exactly)?
To be honest, I’m not sure of the right technical answer to that question (Scott probably knows), or whether it matters much. I believe there’s been a previous blog debate on it somewhere.
People tend to say colloquially there’s no reserve requirement. I tend to think the right way to look at it is as a zero requirement for reserves/settlement balances. Banks can be long or short net balances and the central bank can add or drain them. From an MMT perspective on interest rate control, it wouldn’t matter if the requirement were positive, zero, or negative. As long as there’s a defined target for balances at some level and as long as banks get paid on quantitatively eased excess system balances in some fashion, the system works in terms of interest rate control. Here’s an old paper from the Bank of Canada that would seem to support that interpretation, I think:
http://www.bankofcanada.ca/en/res/wp/1997/wp97-8.pdf
“It is not sufficient for the implementation of monetary policy that the central bank be able to control the supply of settlement balances. It is also necessary for the commercial banks to have a determinate demand for these balances on a daily basis; in other words, to have firm targets each day for the quantity of settlement balances that they desire to hold. Otherwise, if the demand curve shifts erratically, a given supply of balances will produce unpredictable effects on monetary conditions in the economy. In particular, the central bank would not then have an adequate degree of influence over short-term interest rates, which are essentially determined in the market for settlement balances. To ensure that there is a determinate demand for balances, a zero-reserves framework has to contain a set of rules and incentives that motivate the banking system to target zero settlement balances at the central bank.”
The other point is whether they’re referred to as reserves or settlement balances or both. Here’s the Bank of Canada annual report:
(ii) Quantitative easing – This involves buying financial assets (public sector and/or private sector debt) through the creation of excess settlement balances (i.e., central bank reserves). These purchases would push up the price of, and reduce the yield on, the purchased assets. The expansion of settlement balances would also encourage financial institutions to acquire assets or increase the supply of credit to households and businesses, which in turn would help to support aggregate demand.
http://www.bankofcanada.ca/en/annual/2009/annualreport2009.pdf
If Mark Carney refers to them as reserves, that’s good enough for me.
The Bank of Canada no longer uses “reserves” I think, just “settlement balances”.
This seems to be the latest http://www.bankofcanada.ca/en/lvts/lvts_primer_2010.pdf
The Bank of Canada auctions government balances (at the central bank) to the markets. The net amount of settlement balances is zero everyday (I think).
Thank you, Ramanan, but did you actually read what I excerpted from their latest annual report?
Yeah think so, but so used to it! (if you are talking of “…encourage…”)
I think that the move toward using “settlement balances” is salutary. “Reserves” is often associated with gold reserves, i.e., backing. The idea that the cb is increasing “reserves” through “printing” means to many people even today that their money’s backing a being watered down.
“Settlement balances” more correctly represents current operational reality and removes any ambiguity. I like it. Hope it catches on.
“through the creation of excess settlement balances (i.e., central bank reserves)”
jeez
Tom,
Agree.
The point was what the monetary authority actually refers to them as.
Very interesting. If you can get everyone to call them settlement balances, then I think that would be very positive in and of itself. That’s what they are, after all.
So I guess I’m just repeating exactly what Tom said. Sorry, didn’t see that at first.
Agree, Scott.
That would be a good thing to do when having a final bonfire for the multiplier theory.
JKH,
Damn didn’t catch that in the second time as well – got interested in their description of QE.
Even the Fed is Federal Reserve.
Ramanan, you might want to check out Rajiv Sethi’s post, Equilibrium Analysis, at Naked Capitalism. It is actually on disequilibrium as a natural state. FX certainly seems to fit here.
Henry C. K. Liu’s theory of dollar hegemony also speaks to how the US can maintain a capital surplus to counterbalance a continuous CAD. Other countries aren’t in the same position and have to compete, which means imposing domestic austerity that leads to demand deficiency. As each country seeks advantage in exporting, it leads to global overcapacity and Greenspan’s “global savings glut,” while domestic economies lag behind.
The US can essentially pick and choose what it would like to have for free, since it runs the global reserves currency that everyone else needs. So there is a constant desire to save in US$, and the US is the only one that can supply dollars. Moreover, the dollar being a fiat currency, the US can do so without financial constraint. Dependent countries live in fear that the US market will contract, on one hand, or that their currencies will come under pressure in the FX market, on the other hand. That is, Liu’s theory anyway, if I’ve got it right.
Thanks Tom, that’s an interesting link with more interesting follow-ups.
Thanks Tom for the two links (Rajiv Sethi and Liu).
“Overcapacity” in what sense ?
Too much global supply relative to global demand, creating economic, political and social imbalances. Liu contends that poorer countries are competing to supply the richer ones, and this leads to demand deficiency in the poorer countries so that investment doesn’t flow to domestic production there. In addition, currency concerns require these countries to dollar save (dollar hegemony).
Consequently, there is widespread malinvestment in the sense of that investment creates global imbalances — huge US deficits/debt and corresponding capital surplus, domestic austerity in the emerging countries, and poverty and displacement in the Third World, with overproduction for the rich countries, much of which involves frivolity to satisfy manufactured demand, and underproduction domestically in other countries. It’s basically a distribution problem that can only be resolved by distributing demand globally. Then a lot of the “problems” go away, although the rich countries would no longer get to live off the fat of the land. Neoliberalism and neoconservatism = neocolonialism.
we used to have long discussions on all this maybe 15 years ago
Tom,
What would it take to get Geithner to change out foreign currencies collected by US exporters for a pre-agreed upon exchange rate. It would seem to me, if the Obama Admin wants to become and I quote: “the worlds largest exporter”, all they would have to do is change policy to one where Treasury agrees to save/accumulate in foreign NFAs. Do you think John Deere would/could sell some more farm equipment in India if when they got back from delivery with a big bag of Rupee, they could get it changed out for USD by US Treasury in accordance with a pre-arranged exchange rate?
It seems all of the ‘imbalances’ are created because while other exporting countries (Japan/China/Mexico/Germany) have no problem ‘saving’ in USD NFA, and in the process supporting their export industries, we dont reciprocate. We dont support our exporters (free market!). Then we let our workers get thrown out of their jobs in the preyed upon industries while being stingy with the unemployment benefits. If we cant get a JG passed, I may not have a political problem with our govt ‘saving’ NFAs in (at least) the following currencies: Pounds, Euros, Yen, Loonies, Rupee, Peso, Aussie; if it meant US at close to full employment. Resp,
Matt, there’s probably a lot of things that the US could do if it were interested in increasing demand in emerging countries by helping them grow their domestic economies, at least theoretically increasing US exports to these countries. But the US is not, Liu, claims.
Liu holds that the US intentionally engineered dollar hegemony, because it allows the US to run the continuous deficits necessary to support an super-sized war machine and huge oil imports, especially petroleum, which is denominated in UD$. The US has been gobbling up ~25% of the world’s energy production, and it remains the sole superpower, which the rest of the world considers the biggest global threat to security.
Foreign countries have to buy US tsy securities if they want to export to the formerly insatiable US market with the US running a persistent CAD. If the US cannot generate a capital surplus, then the export-your-stuff-to-the-US game is over.
Dollar hegemony is needed for US imperialism, and US imperialism is necessary to secure vital resources like petroleum. Liu is telling China that this is not in China’s interest. Rather than accepting dollars and parking them in tsy’s, China should require its exports to be paid for in yuan and it should invest this in expanding the domestic economy. Otherwise, China is just a vassal state of the US. Liu knows which buttons to push.
Liu is telling China that this is not in China’s interest. Rather than accepting dollars and parking them in tsy’s, China should require its exports to be paid for in yuan
If China buys its oil or exports to other countries in yuan, its no shirt off our back. But China is too smart to ask Americans pay imports (or borrow) in anything but dollars. The political backlash would be catastrophic.
plus they know that by hoarding $ financial assets they promote exports which helps the exporters who support them.
Beowulf, it seems that Liu’s point is that if the US runs a persistent CAD, it needs to be counterbalanced with a CAS, and the if China were selling to the US in yuan instead of US$, hence under no compunction put those $ into US tsy’s, then the US would have to fund its CAS some other way and China could be growing its domestic economy. In that case, demand would increase in China, and China would have to export less and could keep its resources at home.
This is actually what the US is encouraging China to do. Greenspan’s jabbering about the global savings glut was meant to encourage saving countries to become consumers by building up their domestic economies, increasing domestic demand, and exporting less and importing more, so that world trade could become more balanced.
Well, I agree with Liu that China (or any country) shouldn’t be running a mercantilist policy, but this idea that the US intentionally engineered dollar hegemony is just crap. Our leaders barely understand our own monetary system, and they’re going to trick every developing nation on earth into running trade surpluses with us?
I don’t even believe this dollar hegemony stuff. There is nothing terribly special about the US except that we have free markets and the government will actually tolerate significant trade deficits. The consequence of that is the ROW builds up dollar assets as reserves. The same could happen for the yen too if the Japanese government didn’t try to engineer trade surpluses.
Lui has the casuality wrong. It’s not the dollar’s reserve status that allows the US to run sustained trade deficits. It’s the sustained trade deficits that allow the dollar to become a reserve currency.
By the way, nothing would change if the Chinese denominated all of their export products in yuan unless they allowed the yuan to float against the dollar. I find the global chatter about moving away from pricing oil in dollars to some other currency to be hysterical. It would have almost no effect, except that fx trading desks would be talking to a new set of clients.
yes
Here is the core of Liu’s contention if you are interested in seeing his argument, although he has also written more about it in other articles.
China vs the almighty dollar (2002)
ESM,
Michael Hudson wrote about the consequences of the US going off the gold standard in 1971, in Super Imperialism: The Economic Strategy of American Empire. He said that the American government didn’t quite understand it at the time, but he was smart enough to figure it out. And he gave a presentation at some conference that was also attended by Herman Kahn, who agreed with him and consequently brought him to the Hudson Institute.
Hudson published a second edition in 2003
http://www.amazon.com/Super-Imperialism-Origin-Fundamentals-Dominanc/dp/0745319890/ref=ntt_at_ep_dpi_1
It’s also available online.
http://www.soilandhealth.org/03sov/0303critic/030317hudson/superimperialism.pdf
<i?And he gave a presentation at some conference that was also attended by Herman Kahn, who agreed with him and consequently brought him to the Hudson Institute.
Sad case, then they made Michael change his last name to Hudson. :o)
Seriously though, I’m curious on how Hudson’s economics differs from the MMT theory. He was Kucinich’s chief economic adviser when he ran for president in the ’08 race, and apparently Kucinich is a fan of 100% reserves bank reform.
http://www.americanfreepress.net/html/monetary_reform_needed__176.html
Would interested in your take on it, Warren, it you have time and inclination to go into it. What do you see as the MMT solution?
Liu seems to accept fundamental MMT principles, but he also seem to accept things like crowding out that MMT does not agree with, so I’m not sure of what to make of him overall. Any illumination appreciated.
I agree. He always had his own ideas that I couldn’t quite follow
Can anyone point me to a definitive text, or set of texts, that sets out the Modern Monetary Theory?
Glad you showed up. See Soft Currency economics under the mandatory readings tab above. That is a seminal paper by Warren.
see ‘mandatory readings’ and ‘the 7 deadly innocent frauds’ and the highlighted books on this website.
Warren,
In “Soft Currency Economics”, you state:
“When people and physical capital are employed productively, government spending that shifts those resources to alternative use forces a trade-off. For example, if thousands of young men and women were conscripted into the armed forces the country would receive the benefit of a stronger military force. However, if the new soldiers had been home builders, the nation may suffer a shortage of new homes. This trade-off may reduce the general welfare of the nation if Americans place a greater value on new homes than additional military protection. If, however, the new military manpower comes not from home builders but from individuals who were unemployed, there is no trade-off. The real cost of conscripting home builders for military service is high; the real cost of employing the unemployed is negligible.”
There is a trade-off. Assume the unemployed person is receiving unemployment benefits B. Assume the wage for a military position is W. Let the difference the two be D. D = W – B. This represents the extra purchasing power of the person after he joins the military. The person now has access to more resources than before, through the additional purchasing power D, which leaves less resources for everyone else.
There is a second trade-off, which is the cost of employment of the person – insurance, equipment, uniforms etc. These need to be supplied from the resources of the nation, leaving less for the people.
There is third trade-off. While the person is serving in the military, he has no incentive, or even opportunity, to do his own work. He has no opportunity to exhibit entrepeneurship. He has no opportunity to start a small business that will create resources. Therefore the resources of the nation are diminished further.
These are the trade-offs that should be considered when employing someone in a government position. Sometimes it will be worth it and other times not. But let’s not pretend there is no trade-off.
my take:
This represents the extra purchasing power of the person after he joins the military.
Apart from the fact that someone now has been given a meaningful task and has become a respected member of society, the added purchasing power is precisely what is economically beneficial. That is opposed to just handing out money which a: does not have the social benefits associated with work and b: is unproductive and hence more inflationary.
The person now has access to more resources than before, through the additional purchasing power D, which leaves less resources for everyone else.
You divide the world into those who deserve access to resources by virtue of being employed and those who don’t because they haven’t found work. On what moral grounds?
There is a second trade-off, which is the cost of employment of the person – insurance, equipment, uniforms etc. These need to be supplied from the resources of the nation, leaving less for the people.
Same as before, you divide the world into the deserving and the undeserving. And again, the additional demand for other services and goods is economically beneficial. If there is a shortage of any finite commodity, this will reflect in prices and can also be regulated.
While the person is serving in the military, he has no incentive, or even opportunity, to do his own work. He has no opportunity to exhibit entrepeneurship.
That person had enough incentive to do so before he / she was hired by the military. Obviously to no avail – probably because the private sector did not provide enough demand for his/her skills. Back to point 1.
The only sense in which I see a trade off is in some theoretical future crowding out of skills. In the sense that, if demand picked up sufficiently there may be other, more useful opportunities which this person is less inclined to pursue if he / she is already employed. But where does that demand come from and why isn’t it here already? I personally see more sensible things for govt. to do than to teach people how to kill badies.
He has no opportunity to start a small business that will create resources. Therefore the resources of the nation are diminished further.
So, government and the unemployed use up the resources while the employed and self-employed create them with their businesses? What would your wife say? And do you envision a world in which everybody is an entrepreneur where there is no formal employment? What kind of enterprises would these be? The vast majority of unemployed, and I don’t mean to sound condescending (I’ve been unemployed twice), are those with the least education and with comparatively low social status. Numerically, you’re not looking at vast untapped pools of potential Bill Gates or Warren Buffets who happen to be on holiday and just need to be kicked in the butt sufficiently to start churning out marvellous inventions.
“Apart from the fact that someone now has been given a meaningful task…”
The fact that a meaningful, i.e. productive task is now being performed is positive side of the trade-off. I didn’t say government spending was all bad, just that there is a trade-off.
“ and has become a respected member of society, the added purchasing power is precisely what is economically beneficial.”
There is no total addition to purchasing power, unless the job being performed adds more real value than it consumes. A new military job might add value by making everyone more secure, or it may not. If it does, then great! If it doesn’t, a small amount of purchasing power is shifted from the rest of the population to the person in question. The person in question now has a greater claim on resources than before, and everyone else has a little less. i.e. it benefits our person and costs everyone else.
“That is opposed to just handing out money which a: does not have the social benefits associated with work and b: is unproductive and hence more inflationary.”
Yes if W=B, and the job is even mildly productive I agree. However if W > B, then the cost needs to be weighed against the benefits.
“You divide the world into those who deserve access to resources by virtue of being employed and those who don’t because they haven’t found work. On what moral grounds?”
I believe all should have access to a base level of resources. Those who work productively need to be rewarded in proportion to their production, relative to those who do not produce. The proportion of resources donated to unproductive people needs to be managed carefully as there are physical limits to how far this can go, and there need to be sufficient incentives for people to work.
There is a second trade-off, which is the cost of employment of the person – insurance, equipment, uniforms etc. These need to be supplied from the resources of the nation, leaving less for the people.
“Same as before, you divide the world into the deserving and the undeserving. And again, the additional demand for other services and goods is economically beneficial. If there is a shortage of any finite commodity, this will reflect in prices and can also be regulated.”
The additional demand is only beneficial if the job is productive. If the job is not productive, then fewer resources are added to the economy than are consumed.
“That person had enough incentive to do so before he / she was hired by the military. Obviously to no avail – probably because the private sector did not provide enough demand for his/her skills. Back to point 1.”
Every day of unemployment is a chance to be creative and find a way to add value. Every day spent as an employee is one less chance. If I spend six months unemployed, I have half the chance of inventing something than if I spend twelve months unemployed. Necessity is the mother of invention. No necessity, no invention. Invention made the US great. Unemployed people are generally not hopeless. They won’t all be entrepreneurs, but maybe one in a hundred can start a new business, compete, bring prices down and add value for everyone.
“The only sense in which I see a trade off is in some theoretical future crowding out of skills. In the sense that, if demand picked up sufficiently there may be other, more useful opportunities which this person is less inclined to pursue if he / she is already employed.”
Yes, that is another trade-off I didn’t mention.
“But where does that demand come from and why isn’t it here already? I personally see more sensible things for govt. to do than to teach people how to kill badies.”
Demand comes from people’s needs and wants. We all have them. Most of us are capable of satisfying them in one way or another (even the unemployed). Those that are not capable need to be looked after, but that is a small minority.
He has no opportunity to start a small business that will create resources. Therefore the resources of the nation are diminished further
“So, government and the unemployed use up the resources while the employed and self-employed create them with their businesses?”
Both the government and private sector produce resources. I believe the private sector produces them much more efficiently due to the profit motive, but I don’t deny that the government has a large role to play. As mentioned above, all government jobs need to be justified by the trade-off of benefits versus costs. My point is that there is a trade-off, whereas Warren’s paper claims there is none.
“Numerically, you’re not looking at vast untapped pools of potential Bill Gates or Warren Buffets who happen to be on holiday and just need to be kicked in the butt sufficiently to start churning out marvellous inventions.”
Perhaps. However it doesn’t take a Bill Gates or Warren Buffet to start a small enterprise.
“I believe all should have access to a base level of resources. Those who work productively need to be rewarded in proportion to their production, relative to those who do not produce.”
Is it reasonable to think that CEO’s are worth multiples in the hundreds of what workers are? If that fair to workers and shareholders?
What I am saying is, what does “in proportion” mean? There is a lot of disproportionality in the economy in over-rewarding as well as under-rewarding. I’m all for “proportionality” and meritocracy but to presume that the market is doing a good job of it seems like a big stretch to me. In fact, no small part of the disproportionally seem to be engineered, e.g., by compromised and complicit boards.
“I believe all should have access to a base level of resources. Those who work productively need to be rewarded in proportion to their production, relative to those who do not produce. The proportion of resources donated to unproductive people needs to be managed carefully as there are physical limits to how far this can go, and there need to be sufficient incentives for people to work.”
Failure of enterprises in the first year is estimated at 90%, and that is including the good times. That’s a lot of equity down the drain and probably quite a bit of debt defaulted on, too. It’s not realistic during hard times.
“Failure of enterprises in the first year is estimated at 90%, and that is including the good times. That’s a lot of equity down the drain and probably quite a bit of debt defaulted on, too. It’s not realistic during hard times.”
Yes but the 10% that succeed generate more than enough to cover the losses of the other 90%. This is the basis on which venture capital works.
These times do not compare to the times suffered by the pioneers and by many who struggled to make the US what it is. These are not hard times by comparison to those times. There were truly brilliant people amongst us then, and there are truly brilliant people amongst us today.
Paul,
‘there are truly brilliant people amongst us today.’
Get them a Job Guaranty they can fall back on as way of providing a true means of subsistence for themselves and their families and they will even more certainly be able to “try, try again”.
Resp,
“Is it reasonable to think that CEO’s are worth multiples in the hundreds of what workers are? If that fair to workers and shareholders?
What I am saying is, what does “in proportion” mean? There is a lot of disproportionality in the economy in over-rewarding as well as under-rewarding. I’m all for “proportionality” and meritocracy but to presume that the market is doing a good job of it seems like a big stretch to me. In fact, no small part of the disproportionally seem to be engineered, e.g., by compromised and complicit boards.”
No it is not fair. Shareholders need to be far more active. Taxpayers need to stop bailing out banks.
The market is not doing a great job, but there are many distortions. For instance forced saving for retirement creates a lot of “lazy money” that people don’t look after. Institutions are left to invest this and don’t look after it properly, because it is not theirs. Corrupt managers invest in dodgy “assets” in return for kickbacks.
Government sponsored enterprises such as Fannie Mae and Freddie Mac have distorted the housing market.
Leaving these distortions aside, I am not saying that a totally free market is the answer. The economy is like a game, and any good game needs rules. Rules that are enforced. I think the lack of rules around private credit creation have created many of the problems we see today.
I believe sensible government spending, up to a reasonable limit of total debt to GDP, is a good thing. I just think there are trade-offs – we have to make sure as far as possible that government jobs add more resources than they consume. Today I think there is a lot of waste. So let’s focus on reducing the waste and creating a productive government rather than continually expanding the public sector purely in the hope of reducing unemployment. This will free up resources that will make the private economy more productive.
“There were truly brilliant people amongst us then, and there are truly brilliant people amongst us today.”
These relatively few highly talented, motivated, energetic, and knowledgeable people are not the ones that are going to be taking advantage of a JG anyway. You don’t make it as an entrepreneur unless you have the right combination of qualities, and they are way above the mean.
OK, “enterprising” folks without these qualities could comb the trash, garage sales, and thrift shops, and sell some stuff at a bit of a profit on eBay, but you really think that things like that are going to make a difference in unemployment?
The way unemployment works in pull back is the less skilled/employable people get crammed down the ladder, with the left-overs being consigned to the ranks of the unemployed. They would either join the military or end up on the dole. Since the military cannot absorb all of them, the contention is that something productive is better than the dole — and in MMT, it provides an anchor price, the floor wage.
“I believe sensible government spending, up to a reasonable limit of total debt to GDP, is a good thing. I just think there are trade-offs – we have to make sure as far as possible that government jobs add more resources than they consume. Today I think there is a lot of waste. So let’s focus on reducing the waste and creating a productive government rather than continually expanding the public sector purely in the hope of reducing unemployment. This will free up resources that will make the private economy more productive.”
What is the criterion that determines a “reasonable” debt/GDP ratio. What empirical evidence justifies that criterion?
Please enumerate what you mean by “a lot of waste.”
Exactly what resources will be freed up and how will this make the private economy more productive?
This is all pretty vague to me.
” I think the lack of rules around private credit creation have created many of the problems we see today.”
Agreed.
Tom,
“What is the criterion that determines a “reasonable” debt/GDP ratio. What empirical evidence justifies that criterion?”
I believe the market will determine what is reasonable, and I will give my reasons in a separate comment soon. For now, my point merely was that I am not arguing against government deficits per se.
“Please enumerate what you mean by “a lot of waste.””
More than an acceptable amount. Meaning that it is worth looking for and cutting unproductive spending programs rather than increasing the deficit.
“Exactly what resources will be freed up and how will this make the private economy more productive?”
Nearly everything that is now used for unproductive activity. To name one of many examples, the commodities used to make weapons to fight the war in Afghanistan, the brain-power being used to wage war, the oil to power the war machine. All of these, if freed up, would naturally lower real prices for those goods, allowing productive enterprises to be more profitable, which would create more jobs and so on.
“These relatively few highly talented, motivated, energetic, and knowledgeable people are not the ones that are going to be taking advantage of a JG anyway. You don’t make it as an entrepreneur unless you have the right combination of qualities, and they are way above the mean.”
I’m sure there are many brilliant people in the military. If there were no leaders the military could not function. There is necessarily one leader for every X soldiers. Back home, perhaps that leader would be an entrepreneur employing X workers.
In any case, even if we disagree on trade-off 3, can we agree that there are trade-offs, contrary to Warren’s paper?
Well, I’ll let Warren respond to criticism of his work on his site.
I look at it in terms or opportunity cost. The cost of achieving full employment/full capacity with price stability is relatively small, the cost of choosing not to do so (as some propose or even to do so less than sufficiently (as now) is huge in comparison. It simply makes no sense economically, let alone morally, at the macro level. Of course, there will inevitably be some trade-offs at the micro level that are not perfectly efficient. But that is a small price to pay for the macro result, IMHO.
“I believe the market will determine what is reasonable”
Well, that’s a practical answer, but the question is, of course, is whether the market is always reasonable. That is an ideological presumption that is controversial nowadays.
“Meaning that it is worth looking for and cutting unproductive spending programs rather than increasing the deficit.”
We’ve been talking about this since Reagan and it is still not clear what this amounts to because one person’s “waste” is another person’s “need.” Obviously, the “biggest and baddest” military is the darling of the right, which thinks that the only worthwhile government spending is on the military.
“Nearly everything that is now used for unproductive activity.”
A noble aim, but given US interest politics, quite impractical. This would involve redesigning the US form the top down. The people in charge are not looking at macro efficiency but micro efficiency, limited to their own bailiwick, and micro efficiency at the bailiwick level doesn’t add up to macro efficiency, in fact it often contradicts it as interests collide.
“Back home, perhaps that leader would be an entrepreneur employing X workers.”
I have served in the military. It is the antithesis of the entrepreneurial spirit. Military people don’t think at all like entrepreneurs and they should not. MIlitary leaders can be good leaders and can make good managers in transitioning to the private sector. But entrepreneurship is something entirely different. Even excellent managers aren’t necessarily entrepreneurial material. I have known several good managers that couldn’t hack it as entrepreneurs. They went back to managing chastened.
Adverse times do spur some unlikely people to entrepreneurial success who would otherwise probably not discover this ability. I am not saying it cannot or does not happen, but the relatively few exceptions prove the rule.
Paul,
In writing about tradeoffs, Warren is focused on the total output of the economy both before and after, as well as the output of the private economy before and after. The former is increased (counting military power as being a good/service), and the latter is unchanged to first order. So your first tradeoff example is not a real one. The distribution of consumption is not the focus under MMT. It is left as a political question.
I concede that your other tradeoff examples are real ones, but I think they are second order effects.
The point is that if the job is not productive, you are reducing the resources available to the entire economy with the exception of the employee. You are giving resources to someone who is not producing enough to replace them. The output of new resources is less than the consumption of existing resources.
If the country’s only resource is apple trees, and there is 90% employment, and each person can live on five apples a day, and each person can cultivate an orchard that produces six apples a day, and there are a million employed, the gross output is six million apples, the net output is one million apples. If they all get together and decide to employ a military of 100,000, and pay them five apples a day, but the military is ineffective and of no value, the new gross output is still six million apples. Net output shrinks to 500,000 apples.
If the military is very effective, and people can stop wasting time defending their orchards, their productivity might go up. They might start producing seven apples a day each, giving a gross output of seven million apples and a net output of 1.5 million apples.
The trade-off is the productivity of the military – i.e. the jobs have to be more productive of resources than their cost in resources.
It doesn’t matter whether distribution of consumption is a focus of MMT. If the paper claims there are no trade-offs, this needs to be demonstrated or defended across the entire range of trade-offs.
Paul, I agree with many of the points that you have made, but in your apple tree example, you are leaving out an important consideration.
Suppose the excess apples cannot be stored for the future. Suppose they rot within a few days. That excess apple harvesting capacity goes to waste, and it doesn’t matter if the next output is 1MM apples or 500K or zero (it would matter if it was negative of course!).
In that case, the apple growers are getting the military for free.
Another consideration is that you’re going to be giving apples to those unemployed people anyway. Perhaps not five apples a day, but maybe three or four. Our society is just not going to let people starve, and, accordingly, we already have many social safety nets in place. So the marginal cost of employing the unemployed is much less than the amount you pay them (even less than the dollar difference because they will certainly save some of the excess money they earn).
On the point about the inability to store excess apple production, keep in mind that this is not just a theoretical problem. More than 70% of our economy’s output can’t be saved for future use, so lack of immediate demand leads to slack, which is a deadweight loss to our average standard of living.
True, there are flaws in the example as it is over-simple.
The leftover apples could be used for seeds to ensure a steady future supply, etc. etc.
Some of the 10% unemployed might discover the orange.
We could probably go through a few iterations of changes but I think the underlying message is clear. It is net output that matters, not gross output.
“So the marginal cost of employing the unemployed is much less than the amount you pay them (even less than the dollar difference because they will certainly save some of the excess money they earn).”
To reduce the problem of unemployment to marginal cost is, well, reductionist. It ignores the foregone opportunity of lower GDP, as well as the short and long term costs of unemployment in terms of effects on human resources. MMT has a much different (macro) way of looking at the cost of unemployment and its effect on the economy than the marginal approach (micro).
Well, there’s that too, but I don’t think that mitigating the social costs of unemployment are at the heart of MMT.
Rather, MMT focuses on the unemployment rate because it is a very useful measure for slack in the economy, in addition to the obvious one — inflation. The central problem for fiscal policy is to determine when aggregate demand is too high or too low.
MMT proposes a very elegant way to combine the two measures into a single automatic stabilizer for the economy, i.e. peg the value of a dollar to the value (to the worker) of an hour of government guaranteed labor through a government job guarantee (JG).
The elegance of this is compelling, and depending upon where one sets the value of a dollar (that is, what the government pays as an hourly rate), you can fine-tune a ceiling on unemployment to any level you choose. Where one sets that unemployment rate ceiling can be debated (I don’t think it should be 0%, and I’m sure Paul would agree with me), but you can remain agnostic on the social costs of unemployment and still believe that MMT is correct and that a JG is an intriguing and potentially powerful idea.
ESM, that may be your conception of MMT but Bill Mitchell, one of the founders and chief contributors, profoundly disagrees with that viewpoint.
Modern Monetary Theory – a personal note
Tom, thanks for the link, but I disagree with Bill and it appears that I’m not alone. Just because he helped develop or promote the theory doesn’t mean he has the final say on what it entails. It is called a “monetary” theory after all, and not an “employment” theory. If he can copywrite the name MMT and include full employment as one of its core proposals, then I’ll have to start calling my understanding of MMT something else.
This isn’t just quibbling over semantics. There are some things that are obviously true as a point of logic and operational reality and some things which aren’t. The net benefit of a 0% unemployment rate JG is certainly not something that is obvious to me. Arguing about that gets into the realm of economics which as you have admitted is something of a pseudo-science.
What Bill saying, I believe, is that “MMT” is a specific macro theory with policy implications. It is built on a foundation that contains many blocks, such as Abba Lerner’s functional finance and Wynne Godley’s approach to stock-flow consistent macro models. One of those blocks, which was developed by MMT’ers is the use of the JG as a price anchor in their specific approach to achieving full employment and price stability.
One can separate aspects of MMT, like its operational description of the monetary system, but Bill would say that it is misleading to call what is just a part, “MMT.” It confuses the prat with the whole, and it’s not consistent with the way the economists who developed MMT and published extensively on it use the term.
That’s the way I understand it anyway. Scott or Warren can correct me if I don’t have it right in their view, since they are initial developers, too. In fact, it would be good to have a history of the development of MMT, if anyone capable of writing it is listening.
Bill writes the following in his conclusion section:
“Second, I have often made the point that an understanding of MMT doesn’t preclude you from advocating mass unemployment if that is your policy persuasion. But then you are naked because you cannot rely on the usual ploys and dodges that mainstream economics uses to cover up the fact that they prefer mass unemployment for ideological reasons to advance the interests of capital.”
His wording is tendentious, but he is admitting that you cannot logically derive full employment policy prescriptions from the principles of MMT.
Bill’s general argument seems to be: (1) MMT shows that the government has the power to reduce unemployment to zero; (2) unemployment is really bad, and besides, the US government has committed itself in the the UN Charter (!) to full employment; therefore, (3) if you’re the President, and you understand MMT, then you should implement a JG program with a goal of 100% employment.
But I think it’s possible to question whether a government run JG would work well without being a cold-hearted taskmaster for the rich.
Tom, I wrote the above post without seeing your latest response, although it’s not a total non-sequitur.
ESM, as I said, Bill holds that MMT is a macro theory with policy implications. Economics is not a pure science or if it pretends to be, it is severely deficient, lacking a normal paradigm. Economics is a branch of poli-sci, both of which I would call branches of social and political philosophy. Economics has scientific aspects (fact-based) but its competing theories are also ideological (norm-based). The fact is that a JG is presented by an integral aspect of MMT, not only by Bill.
BTW, the solution to employment AND price stability was addressed by Abba Lerner with David Colander in terms of functional finance. They added a fourth principle of functional finance to the first three, as well as a solution that does not involves a JG. The JG is an MMT solution. See Beowulf’s comments with citation at billyblog here and here
“But I think it’s possible to question whether a government run JG would work well without being a cold-hearted taskmaster for the rich.”
Well, we already know that NAIRU is a cold-hearted task master that undermines the bargaining power of labor to control inflationary expectations, which primarily benefits those interested in preserving the value of money as a store of wealth. I presume that is predominantly the rich.
I do think that the economic “holy grail” of efficiency and effectiveness at the macro level is full employment, implying full capacity utilization, along with price stability. This has to include growth (investment) sufficient to accommodate population growth in order to maintain full employment over time. I believe that this is the stated objective of MMT. The JG integral to MMT as a macro theory, at least until someone proposes something else to replace it. I don’t know that MMT’ers would hold that it is exclusive of alternatives.
MMT’ers just claim that they have an option that works according to the numbers and that it fits into the overarching institutions of liberal democracy and market capitalism, with a few tweaks. That is to say, MMT’s JG doesn’t involve “socialism” anymore than the Fed setting rates implies a command economy. We have a managed economy already. It behoves us to manage it efficiently and effectively by balancing public and private purpose.
i always start with ‘why would a govt levy a tax that causes people to seek work paid in that currency-create unemployment- if it didn’t want to hire the unemployed the tax created?
“growth (investment) sufficient to accommodate population growth in order to maintain full employment over time. I believe that this is the stated objective of MMT.”
I asked Warren and Sada years ago on the old BBS it all leads to demographics, where are the birthing policies like China has to manage the babies and population levels? Isn’t that THE CRITICAL number that dummy USA is leaving to chance? On the HOPE that Sada and her peers will CHOOSE to have lots of babies instead of managing it from the central government and forcing her to breed if she chooses not to on her own? Or if she overbreeds to implement birthing policies to cut baby production like china. At least taking some eggs and putting a testtube like they did in that movie logan’s run if you don’t want the women to suffer forced birthing. A lot of people cannot make this breakthrough tom hickey, but I think you are a big enough intellectual to see the star trek BORG way of managing population levels makes just as much good economic sense as managing money supply and other MMT ideas. I don’t get these people that tell me OH NO good lord, we can’t tell sada mosler how many babies she can or cannot have, lets just manage MMT and however many babies are born or not born we will just leave up to CHANCE! How CRUDE, barbaric and ancient of a meme, we live in modern managed socieities, why baby management can’t be considered a viable option of central planning amongst enlightened economists is as silly as irving fishcer in 1930 saying the country was doomed if we didn’t did more holes in the ground. It turns my stomach.
ESM,
(I got this from a Tom comment a while back) MMT of a FFNC currency identifies how by definition a FFNC removes the capabilty of the non-govt sector from itself achieving full employment. ie (at least theoretically) if we were now under a private money gold standard, we in the non-govt sector could employ some of our people to go out and dig up gold and convert it to get the NFAs we desire and achieve full employment (and I know that may still not be a highly likely outcome but I think it is at least theoretically possible). Under a FFNC, this is for sure not possible unless the sovereign adopts full employment as its policy. So when we the people granted this monetary authority to the govt, we also gave up any non-govt sector autonomy to achieve full employment, this was in exchange for a commitment from the govt now to maintain full employment with price stability; this is indeed by law the Fed mandate (Its NOT “price stability with the lowest simultaneously achievable unemployment levels” which is how they run it, imo they are breaking the law)…they just dont know how to do this due to they are corrupt morons stuck on Quantity Theory/incompetence/politics take your pick. MMT thankfully is a framework that shows them how to do it, (they should thank the Elite MMT thought leaders!), it includes a Job Guaranty (that sounds like ‘full employment’ to me!).
This is the way I have been viewing the JG from a legal standpoint lately, (for your consideration)
Resp,
Very good discussion guys
If I may chime in.
ESM, if by 0% unemployment you mean everyone working then I agree with you. What is generally meant by 0% unemployment is no one who wants employment not being employed. There will always be people who arent seeking work for various reasons BUT Bill Mitchell argues that anyone who wishes a minimum wage job shall have one. No INVOLUNTARY unemployment. There is only involuntary unemployment when the private sector has no use for you. The currency issuer has no need to “make profits” so it can fund a job for you always, the only argument being about the wage level.
I beleive Bill argues that “full employment” is an unemployment rate around 2%.
Can you argue with the idea that everyone who seeks employment as access to currency should be able to have employment?
” A lot of people cannot make this breakthrough tom hickey, but I think you are a big enough intellectual to see the star trek BORG way of managing population levels makes just as much good economic sense as managing money supply and other MMT ideas.”
Hey, we import everything else, why not human resources. That’s what immigration is all about. Let the people that want to reproduce do so, and we’ll take the one’s that make it here through all the flak. If they survive the trip, they must be resourceful.
“if we were now under a private money gold standard, we in the non-govt sector could employ some of our people to go out and dig up gold and convert it to get the NFAs we desire and achieve full employment”
Hey Matt, that’s what mining claims and prospecting was all about in the old days. Go find that gold, boys. It populated California and gave a lot of people employment in addition to the prospectors.
Tom, thanks for preemptively making my point. I mentioned in the first link a 1962 proposal by President Kennedy, “for Congress to grant him standby authority to cut tax rates during times [of] high unemployment”. That was actually a proposal from the 1961 report of the Committee on Money and Credit, sort of the anti-cat food commission (Hyman Minsky was a consultant). The Committee also recommended the US go off the gold standard and that the statutory debt limit be eliminated. Excusing the “socialist plot” commentary, the best description of the Money and Credit report is from this conspiracy book.http://www.modernhistoryproject.org/mhp/ArticleDisplay.php?Article=InvisibleGov04
What’s even more interesting is seeing that the Committee was itself a project of the Committee for Economic Development, a group of corporate supporters of Keynesian economics (though for political reasons, they didn’t like using the K word) founded during World War II. New York Fed Chairman Beardsley Ruml, who famously wrote that taxes for revenue was obsolete, was a member. I won’t even bother linking to CED’s present-day website, its too depressing (hint, one of its current trustees is Peter G. Peterson). But check out this article from 1944, discussing the CED’s economic proposals for the post-war economy. Its jarring how these corporate Republican sound more economically progressive than modern-day Democratic senators.
http://books.google.com/books?id=Wk8EAAAAMBAJ&pg=PA30&lpg=PA30&dq#v=onepage&q&f=false
There is a trade-off. Assume the unemployed person is receiving unemployment benefits B. Assume the wage for a military position is W. Let the difference the two be D. D = W – B. This represents the extra purchasing power of the person after he joins the military. The person now has access to more resources than before, through the additional purchasing power D, which leaves less resources for everyone else. Also true every time I buy a gallon of milk.
There is a second trade-off, which is the cost of employment of the person – insurance, equipment, uniforms etc. These need to be supplied from the resources of the nation, leaving less for the people Not when there is slack in the economy, which is the point. Think of it this way. If all of the unemployed people created their own uniforms from unused materials, its a net gain in real GDP.
“Also true every time I buy a gallon of milk”
Assuming you earned the money to buy the gallon of milk, you produced something approximately equal to the value of a gallon of milk. If you worked in a profitable enterprise you probably produced something of greater value, enough even to cover taxes. So in that case there was a net increase in output.
If you were given the money, that is the situation I am describing above, if the military job is not productive.
“Not when there is slack in the economy, which is the point. Think of it this way. If all of the unemployed people created their own uniforms from unused materials, its a net gain in real GDP.”
I agree, if they produce their own uniforms and the uniforms are of greater value than unemployment benefits, if any, that is a net gain in output. I’m not sure of the connection though to resources needed to employ people though.
A major problem in measuring productivity lies in quantity vs quality. Quality is generally excluded from consideration because it cannot be quantified precisely, so there are huge distortions in economic data relative to actual conditions in society. For example, the private sector is divided into the for profit and not for profit sectors. The for profit sector deals primarily with productivity that can be quantified. Quality is left to the not for profit sector. I have spent most of my life in the not for profit sector precisely because I think that quality of life is more important socially than quantity of stuff.
some good points but in any case those are costs of the military regardless of whether you take someone from the unemployment line or a homebuilder.
Assume the unemployed person is receiving unemployment benefits B.
You’ve already gone off the rails, “Majority of US unemployed receive no unemployment benefits.”
http://www.usatoday.com/money/economy/employment/2009-04-09-unemployed-but-no-benefits_N.htm
Beowulf, that makes my argument stronger, not weaker.
Warren,
In “Soft Currency Economics”, you refer to Figure 1a, 1b, 2a etc. but they don’t appear to be included. Do you have a reference to the original so I can see the figures?
Michael Pede, webmaster, will try to find out what happened to them. check out http://www.mosler.org and see if it’s complete there, thanks.
Warren,
In “Soft Currency Economics”, you state:
“The imperative behind federal borrowing is to drain excess reserves from the banking system, to support the overnight interest rate. It is not to fund untaxed spending. Untaxed government spending (deficit spending) as a matter of course creates an equal amount of excess reserves in the banking system. Government borrowing is a reserve drain, which functions to support the fed funds rate mandated by the Federal Reserve Board of Governors.”
So the above says: The need to support the overnight interest rate mandates the draining of excess reserves, which mandates federal borrowing.
The full causal chain is: Deficit spending and the Fed’s mandate to maintain a funds rate causes the need to support the overnight interest rate by the draining of excess reserves, which mandates federal borrowing.
In other words, Deficit spending causes federal borrowing, so long as the mandate is in place.
Earlier in the paper you argue that debt monetization is not possible due to the mandate, so we end up with the tautology: Deficit spending causes federal borrowing unless debt is monetized.
Later in the paper you argue that people who are concerned about the level of government debt should not be: “All of this over a simple reserve drain!”. This is incorrect, as the reserve drain is merely an operational step in the accounting for new debt. Therefore you have not demonstrated that people have no valid reason to be concerned.
Paul,
Try taking out wherever you write ‘federal borrowing’ and substitute ‘issuance of Treasury Securities’. Thus:
“So the above says: The need to support the overnight interest rate mandates the draining of excess reserves, which mandates
federal borrowingissuance of Treasury Securities.”“the reserve drain is merely an operational step in the accounting for new debt.”
I look at this entire process (including
debtTreasury securities issuance) as just a non-primal accounting record of the execution of the primal lawful govt appropriation. IOW, once the govt appropriation is signed into law, all the rest is just accounting for it.The looks of this process can be deceiving. The mainstream of economics/mainstream media portrays this process as govt ‘borrowing’, imo to the broad detriment of all outside of the financial sector.
Resp,
Matt,
Warren uses the words “federal borrowing” in the paper.
My point is that the paper mischaracterizes federal borrowing / Treasury Bond Issuance, as a mere reserve drain, when what causes the need for the reserve drain is the deficit spending.
Whether this is more accurately perceived as a) “appropriation” or b) borrowing from private banks that may or may not be willing to lend, depends on whether you accept Warren’s argument later in the paper “What if noone buys the debt?” – I will write more on this later.
Paul – almost 600 comments for you to read here 🙂
http://moslereconomics.com/2010/05/14/marshalls-latest/
Paul, I agree that “federal borrowing” sends the wrong signal and reinforces the myth that the government needs to finance itself when it does not under the present monetary regime.
I would argue that the the deficit spending does not “cause” the need for a reserves drain because this can be handled differently. (See my comment below at 11:22.) The excess reserves created by budget deficits result in the need for neutralization if the cb wants to hit its target rate.
Deficit spending results in excess reserves, which need to be neutralized unless the cb is willing to let the overnight rate fall toward zero, but it can neutralize them in other ways than Treasury issuance. So deficits do not in themselves “cause: the need for a reserve drain. Treasury issuance is specific to current political requirements not financial constraint or operational necessity.
What “causes” the need for Treasury issuance in the US is politically imposed rules designed to mimic the gold standard and give bond markets economic and therefore political power than they would otherwise not have, in the name of imposing market-side financial discipline. Much of the present kerfuffle arises
Paul, you may want to take a look at Eric Tymoigne’s post, The CBO’s misplaced fear of a looming financial crisis. He lays out the basics of monetary and fiscal ops pretty well and goes through a lot of the relevant Fed/Treasury operations in terms of current examples. There are some objections in the comments and Eric addresses them there.
he’s a graduate phd from umkc
🙂
Ramanan,
“Paul – almost 600 comments for you to read here :)”
Oh! Will go there.
Tom: “I would argue that the the deficit spending does not “cause” the need for a reserves drain because this can be handled differently. (See my comment below at 11:22.) The excess reserves created by budget deficits result in the need for neutralization if the cb wants to hit its target rate.”
The second sentence echoes what I wrote, that the Deficit Spending, together with the fed mandate (to hit target rates), results in the need to drain reserves. In other words, until the fed mandate is removed, Deficit Spending causes the need to drain reserves.
I will take a look at Eric Tymoigne’s post and maybe comment there.
It seems clear from the 600 comments that when MMTers talk about “current operational realities” they really mean “potential operational realities if the law was changed”. When they say “all a government needs to do to spend is change a number in a database”, they really mean “change a number in a database which will then force them, by law, to borrow from the private sector”.
It seems so simple – just change the law and all will be well, we can spend our way back to prosperity. But what if that law is what holds the whole financial system together? Has that been sufficiently considered by MMT people? Has the lure of an easy fix blinded MMT people to the potentially fatal consequences?
If the US changed the law to enable them to issue currency without issuing Treasury Bonds, demand for Treasury Bonds would decline, lowering the value of existing Treasury Bonds. Many banks and businesses world wide hold vast quantities of US Treasury Bonds on their balance sheets. A sudden decline in the value of these bonds would be disastrous.
The bid-to-cover ratios of auctions have never fallen below one at least in the recent history. So I really can not get the issue of whether someone is borrowing or someone else is investing. To me it looks like someone is investing and they want MORE of that, not less.
Shall we get causality right first before we get to laws, databases and other related claims?
a ‘reserve drain’ is nothing more than offering an interest bearing account/tsy sec. doesn’t matter if the funds in the reserve accounts actually switch to the tsy secs. just that they are offered.
and, of course, as today, the fed can simply pay interest on reserves, which are nothing more than one day tsy secs, functionally
Right. There are various ways of doing the accounting operationally. The cb could just purchase the securities directly from the Treasury for its own books to account for the reserves it supplies the Treasury to disburse into the economy. This is leaves excess reserves in the system that need to be neutralized if the Fed is to hit its target rate. In order to do this, the cb can pay interest on excess reserves equal to the target rate.
This is not permitted politically in the US, because the Fed is prohibited from buying securities directly from the Treasury and the Treasury is prohibited from running an overdraft. Therefore, tsy issuance to drain the excess reserves is needed, unless the Fed is willing to allow the overnight rate fall toward zero when there are excess reserves.
The basic idea is that a monetarily sovereign government that is the monopoly provider of a nonconvertible floating rate (fiat) currency is not financially constrained and has no need to fund itself with taxation or finance itself with borrowing.
The current political requirements in the US make it seem that the government is funding itself with taxation or financing itself with borrowing, when this is just an accounting fiction whose structure is imposed voluntarily by law.
If the law were changed, then this would be obvious and everything would remain the same, other than the subsidized free parking place in Treasury securities, which would disappear as unnecessary, inefficient, expensive, and favoring an interest group.
The Federal Reserve is prohibited by law from adding to its net position by direct purchases of securities from the Treasury—that is, the Federal Reserve has no authority for direct lending to the Treasury. As a consequence, at most the Desk’s acquisition at Treasury auctions can equal maturing holdings.
(emphasis added)
Understanding Open Market Operations, MA Akthar, p37
http://research.stlouisfed.org/aggreg/meeks.pdf
“If the law were changed, then this would be obvious and everything would remain the same, other than the subsidized free parking place in Treasury securities, which would disappear as unnecessary, inefficient, expensive, and favoring an interest group.”
If the law was changed, the value of existing Treasury Bonds would drop dramatically, which would have devastating effects on the entire system.
This from the latest Press Release from the BD community’s industry association SIFMA (shows how the true ‘term of art’ is “Treasury issuance”):
SIFMA Survey Expects Total Net Treasury Issuance Increase as Economic Recovery Slows
New York, NY, July 29, 2010—The Securities Industry and Financial Markets Association (SIFMA) today issued the results of its Quarterly Government Securities Issuance and Rates Forecast. The median survey response forecast total net Treasury bill, note and bond issuance to be $399.0 billion in the third quarter of 2010, compared with the net $343.6 billion issued in the second quarter of 2010 and the net $392.5 billion issued in the third quarter a year ago. The quarterly projected increase may reflect increasing worries regarding stagnant unemployment, a cooling economic recovery, deflationary pressures and the potential need for additional stimulatory measures by the U.S.”
Link here.
The word ‘debt’ doesnt appear until the very last word of the second paragraph. Poor form of propoganda. I guess the flunky copy writer of this Press Release will have to be reprimanded now for not including more words such as ‘borrowing’, ‘debt’, ‘lending’, ‘auction’, etc. that help reinforce the ongoing charade ;).
But in seriousness, this is perhaps more indicative of how true professionals view this (Issuance vice ‘borrowing’). Only when moron doomy media types, or moron politicians/pundits get involved do we start to hear the terms that are more appropriate to a household such as debt/borrowing, etc. Looks like the professionals dont primarily view it that way. Resp,
Matt,
It really doesn’t matter. Treasury Issuance is Treasury Bond Issuance, which is the selling of new Treasury Bonds to the private sector, which is borrowing from the private sector.
Paul,
Treasury Bond issuance is not borrowing. It is the sale of a security to which the subscriber receives a set coupon payment until the redemption/maturity date at which point the security is redeemed in full at face value. It is not lending/borrowing in which there is both an interest and principle payment made until the loan amount is paid off thru the sum of the principle portion of the payments. A T security does not work as a loan. Its fungible. Non-callable. Guaranteed by a Sovereign. Its very unique.
To your other point about suspension of issuance causing a price reduction; if the govt stopped issuing Treasury securities, that would cause what is called a ‘Supply Shock’. Supply Shocks cause price increases, not price reductions. Think oil. If OPEC stopped issuing petro, the price of oil would not go down.
If issuance was stopped, current holders of Treasury Securities would rightfully expect that the outstanding securities they hold would pay their coupons and be redeemed iaw the terms of the securities. Upon redemption, holders would have their bank accounts credited for the face value. No big deal.
Resp,
“Treasury Bond issuance is not borrowing”
I am happy to agree to disagree on this one, and leave you in peace. Much of what we might have to say to one another won’t make sense if this is what you believe.
“if the govt stopped issuing Treasury securities, that would cause what is called a ‘Supply Shock’”
You have this the wrong way around. When someone issues a bond, they are actually purchasing funds. The cost of the funds is the interest rate payable over time. The net flow of funds over the entire life of the bond is to the lender, not the borrower. i.e. from the government to the private institution. This is the opposite of oil, where the net flow of funds is to the oil provider.
If the government stopped issuing Treasury Bonds, this is equivalent to the Treasury suddenly stopping their purchase of private sector funds. i.e. there would be a reduction in demand for private sector funds – a demand shock.
The purchase of an existing Treasury Bond is a different matter. Supply and demand are balanced by the current market price of the bond. If there are no new bonds, this will not affect the price directly in the supply or demand sense, just as the fact that there are no new bonds being issued by the government in the next five minutes will not affect bond prices during the next five minutes.
The market price would however be affected by the increased supply of reserves that can no longer be used to buy newly issued Treasury Bonds. This would be inflationary, and reduce the value of existing bonds.
However the most dramatic effect would be the loss of confidence in the USD as a whole, due to the undermining of normal Central Bank disciplines.
Paul, if the US, say under a Kucinich administration with Michael Hudson as White House Chief Economic Advisor and Randy Wray as Treasury Secretary announced that as soon as the newly elected Progressive Party Congress that had a filibuster proof majority (following GD II), the Fed, formerly “politically independent” and wholly owned subsidiary of the financiers, would folded into Treasury and the Treasury would no longer be issuing interest-bearing securities, the financiers would be howling while at the same time they were scrambling to figure out another way to make a buck, now that the jig was up for them. Those of them they were not very busy figuring out how to stay out of jail, or else fleeing the country.
Tom,
I agree with most of that, except the implication that all financiers belong in jail.
So it seems you agree that the Fed is currently politically independent and a wholly owned subsidiary of the financiers. That doesn’t seem to be the view of most MMTers.
Paul, of course, “all financiers belong in jail” is hyperbole. But many should be investigated. So far there has been virtually no accountability. Perhaps there will be, but I am not holding my breath. The Democratic Establishment since Clinton is a wholly owned subsidiary of Wall Street. That’s where they get their funding.
The work of Bill Black, Frank Partnoy, Elliot Spitzer, Janet Tavakoli, and others pretty well documents the sorry record and the lack of enforcement of existing law. These people were on record long before the crisis hit.
According to Black the problem was not economic but forensic. Wall Street was a gigantic crime scene where CEO’s were involved in what he calls “control fraud,” running their companies as Enrons on steroids. Instead of being held accountable, they were bailed out and the government is creating conditions favorable for their recapitalization and recovery, while making debtors and the unemployed (the middle class and poor) pay the price.
The leading figure in this crusade publicly is Bill Black who also teaches at UMKC. While not an MMT’er is is another close ally. Take a look at his appearances with Bill Moyers on PBS, for example.
I don’t think that most MMT’ers have a high opinion of the Fed, but I can’t speak for them. I am definitely more radical and outspoken than most of them are, at least publicly. But Bill MItchell, who mixes in quite a bit of policy opinion on his blog is pretty open about calling them out, too. Now, Michael Hudson is another story. He really lays it out in no uncertain terms.
Speaking of Bill in this regard, he is out with a pretty caustic post today. 🙂
The old line back to free market ideology still intact
Paul,
“You have this the wrong way around. When someone issues a bond, they are actually purchasing funds. The cost of the funds is the interest rate payable over time. The net flow of funds over the entire life of the bond is to the lender, not the borrower. i.e. from the government to the private institution. This is the opposite of oil, where the net flow of funds is to the oil provider.”
I see what youre saying here technically, but I still submit that these very unique govt securities for sure posses commodity-like characteristics. They are sought after like commodities. Prof Bill Mitchell has reported on how, 10 years ago when the Australian govt was running large surpluses, the financial sector (Sydney Futures Exchange) actually lobbied the Australian Treasury to issue govt securities anyway, because they were having a hard time obtaining the bonds to conduct a physical delivery for their bond contracts! And they oliged them! If this does not prove this is a racket, I dont know what will. This is all you really need to realize for me, says it all.
“If the government stopped issuing Treasury Bonds, this is equivalent to the Treasury suddenly stopping their purchase of private sector funds. i.e. there would be a reduction in demand for private sector funds – a demand shock.”
This is also an interesting point, I have to think about it some more but I’m not sure that the demand extends to “private sector funds” or likely stops right at settlement balances within the banking system due to T bonds role in monetary policy setting.
“The market price would however be affected by the increased supply of reserves that can no longer be used to buy newly issued Treasury Bonds. This would be inflationary, and reduce the value of existing bonds.”
Paul, this looks like Quantity Theory and I reject it entirely. Check out the St Louis Feds RESBAL chart on FRED, it is a $1T+ hockey stick chart straight up and now going on two years…and we are in deflation. The QT is a fiction in a FFNC world, the people that make their careers off of it just cant admit it.
Resp,
Paul: “It seems clear from the 600 comments that when MMTers talk about “current operational realities” they really mean “potential operational realities if the law was changed”. When they say “all a government needs to do to spend is change a number in a database”, they really mean “change a number in a database which will then force them, by law, to borrow from the private sector”.”
As you saw, it is hotly debated whether the government “borrows” from the private sector, in that it does not finance itself with Treasury issuance. The current issued by deficit spending increases nongovernment net financial assets, which are then saved as Treasury securities. There is no “borrowing” in the sense that occurs under a convertible fixed rate regime, where the government competes with the private sector over a fixed amount of loanable funds, crowding out the private sector with its borrowing. That doesn’t happen when the government increases nongovernment net financial assets and they requires that they be saved as tsy’s. Total different in the macro accounting.
Paul: “It seems so simple – just change the law and all will be well, we can spend our way back to prosperity. But what if that law is what holds the whole financial system together? Has that been sufficiently considered by MMT people? Has the lure of an easy fix blinded MMT people to the potentially fatal consequences?”
Sound money people hold that the law holds everything together. MMT gives good reasons why that is not so. The presumption of conservatives is that without the brake of the bond vigilantes, the politicians will go wild. MMT holds that there are real brakes in the form of inflation versus economic contraction domestically, and floating rates externally. Well-managed money creation is evidenced by an economic that runs efficiently and effectively, with full employment and price stability.
Paul: “The second sentence echoes what I wrote, that the Deficit Spending, together with the fed mandate (to hit target rates), results in the need to drain reserves. In other words, until the fed mandate is removed, Deficit Spending causes the need to drain reserves.”
From what I understand of existing law/regs, the Fed doesn’t need to use bonds to drain reserves. It could accomplish the same thing. by paying interest on excess reserves equal to its target. In fact, it is already paying interest above the FFR on excess reserves.
Paul: “If the US changed the law to enable them to issue currency without issuing Treasury Bonds, demand for Treasury Bonds would decline, lowering the value of existing Treasury Bonds. Many banks and businesses world wide hold vast quantities of US Treasury Bonds on their balance sheets. A sudden decline in the value of these bonds would be disastrous.”
It can just as well be argued, and it is more likely, I think, that if the Treasury announced it was no longer issuing bonds, the present bonds, becoming scarce, would increase in value. I don’t see that ending Treasury issuance would have that much of an effect other than ending a subsidy.
It can be argued that Treasury issuance is just soaking up funds that would be better employed in the economy in productive investment. It can also be argued that government intrusion into capital markets is anti-capitalistic, and that its interest payments are socialistic.
The real disaster is financial capitalism run amok. Michael Hudson it explains it in simple terms to the Chinese hereand here. Must-read. This is where the real problem is, and if it is not solved, then we, our children, our grandchildren and their children will be living in a society dominated by debt peonage. MMT is a key element of that solution, IMHO. It’s not just the subsidy from Treasury issuance. It’s economic rent, as Hudson explains.
“As you saw, it is hotly debated whether the government “borrows” from the private sector, in that it does not finance itself with Treasury issuance. The current issued by deficit spending increases nongovernment net financial assets, which are then saved as Treasury securities.”
If it increases nongovernment net financial assets then it increases government net financial liabilities.
“It can just as well be argued, and it is more likely, I think, that if the Treasury announced it was no longer issuing bonds, the present bonds, becoming scarce, would increase in value”
See my explanation above of why this is incorrect.
“Sound money people hold that the law holds everything together. MMT gives good reasons why that is not so. ”
I have pointed out some fundamental flaws in one of the seminal MMT works. If there are other definitive works that do not contain these flaws I would be interested to read them.
Paul,
Too immature of you to have made this conclusion. You don’t know what you will miss if you continue thinking like that. Let me recommend this paper by Scott Fullwiler who is in the MMT camp.
“Setting Interest Rates in the Modern Money Era”
http://www.cfeps.org/pubs/wp-pdf/WP34-Fullwiler.pdf
“If it increases nongovernment net financial assets then it increases government net financial liabilities.”
In a fiat system all money, including saved money as securities, is a government liability. That just means that the government accepts its liabilities in payment of obligations to it, i.e., taxes, fines, fees, etc.
“See my explanation above of why this is incorrect”
Your explanation is not sustainable.
“I have pointed out some fundamental flaws in one of the seminal MMT works. If there are other definitive works that do not contain these flaws I would be interested to read them.”
You have pointed out one instance of possible ambiguity. No “flaws.”
Paul: “It seems clear from the 600 comments that when MMTers talk about “current operational realities” they really mean “potential operational realities if the law was changed”.
Hey!
Paul gets it.
There is an ambiguity in the use of “current operational reality.” It can mean operational reality under the current fiat monetary regime, independently of politically imposed restraints of various countries, and it can also mean how the existing system functions in a country with the political restraints that are presently imposed, as in the US at this time.
These meanings are not the same, this is not always clear the way “current operational reality” is used. It needs to be specified to obviate ambiguity.
On one hand, MMT’ers hold that it would be more efficient and effective to remove the political restrictions and use the potential of a fiat currency. On the other hand, they argue that even with restrictions, it is possible to use the potential of a fiat currency to better advantage than is being done under present policy or is presently being contemplated in the mainstream.
Moreover, as Marshall’s Latest discusses, there are also workarounds available, and people like Alan Greenspan have admitted as much. For example, there is no financial reason for the US to default under the present system; a US default would have to be a political choice. That would not the case were the national debt actually borrowed, e.g., under a gold standard, where the government had to pony up in specie instead of currency issuance.
Well said as usual, but I don’t think there is any ambiguity in the phrase “current operational reality”.
The ambiguity arises when one fails to distinguish between the following:
a) current operational reality (e.g. bonds)
b) potential operational reality (e.g. no bonds)
c) a complex characterization that positions a) operationally distinct from b), but acknowledging that an operational switch to b) is the ultimate backstop for the operational failure of a); i.e. that reflects the strength of the underlying power of the government to invoke the contingency of b); (e.g. “to use the potential of a fiat currency to better advantage than is being done under present policy or is presently being contemplated in the mainstream”; and the workarounds are largely a reflection of this – e.g. default is always voluntary because the government doesn’t have to deliver gold to pay for bonds but also because it can default in a different way by switching operationally to b) if there is a ‘catastrophic bond auction failure’ for example
– c) is another way of saying what I said in the 600
meant deliver gold to pay for bond maturities
Once you admit that a) and b) are operationally different, you begin to question some of the very fundamental propositions of MMT for their operational accuracy; e.g. “governments are not revenue constrained”; otherwise you come to a contradiction in attempting to describe the operational differences between a) and b); either that or you revert to claiming a) and b) are operationally identical, which is obviously wrong; with either route you’re in trouble
“Once you admit that a) and b) are operationally different, you begin to question some of the very fundamental propositions of MMT for their operational accuracy; e.g. “governments are not revenue constrained”; otherwise you come to a contradiction in attempting to describe the operational differences between a) and b); either that or you revert to claiming a) and b) are operationally identical, which is obviously wrong; with either route you’re in trouble”
I see it differently. MMT describes operational reality under a fiat regime. It admits that governments can restrict this to whatever degree they wish politically. For example, a constitutional balanced budget amendment (which some would like to see in the US) would preclude any budget deficit, hence any creation of nongovernment net financial assets. That is a political choice, not a financial necessity. Different countries have instituted different restrictions and also relaxed them.
So it is correct to say that under the present monetary regime, monetarily sovereign government that are the monopoly providers of a nonconvertible floating rate currency are not financially (operationally) constrained and do not need to fund themselves with taxation or finance themselves with debt issuance, although they may adopt political restrictions for ideological reasons that alter what they could otherwise do, given the existing monetary system.
Where’s the problem here?
MMT correctly points out the potential of operational reality under a fiat system and shows how differently countries have chosen to use this. MMT’ers agree on this. Different MMT’ers may make different policy recommendations based on MMT principles depending on their political proclivities.
Good points Anon as always.
I think I can summarize (right or wrong) the MMT description as follows:
The public sector is defined as the government and the central bank. Its liabilities are currency notes, HPM, Treasury securities. These appear as net assets for the private sector.
-When the government needs to spend, the central bank does an open market operation
-This increases the HPM of the private sector and due to this transaction, it is in the lookout for an interest earning asset.
-The government offers a Treasury security as an alternative to the non-interest earning HPM. (Assuming interest paid on reserves is 0). The private sector will automatically buy the Treasuries using HPM balances since it is interest earning. If they don’t it’s a loss for them. Also if the government doesn’t offer the securities, it leads to a crowd-in and hence it is an interest rate maintenance.
-The government can spend without bounced cheques.
-The HPM to purchase the government securities came from the government sector itself.
I think the confusion comes from the term ‘operational’. MMT distinguishes between an operational reality (an underlying necessity or minimally required framework) and a politically motivated add-on which guides or limits the potential of the underlying ‘operating system’. Bonds are such an add-on (i.e. they are not operationally necessary). Personally, I think e.g. the Maastricht criteria, fixed exchange rates and indeed to some extent the gold standard can be considered add-ons, albeit rather a rigid ones. Tinkering with the gold standard rather defeats the point of calling it so. One could rename it the gold substandard, I guess. ‘Operational’ describes the basic framework without the voluntary legal edifice stacked on top.
It’s a bit like describing human operational reality as possessing a ‘free will’ to choose ones path in life. The gold standard or bonds are comparable to a religious belief that forbids certain behaviour, formerly believed to be harmful. Which isn’t to say that any such human could not shed his/her belief and become ‘free’. MMT asserts that bonds are hold-overs from more religious times which are not essential to the functioning of the system. It also asserts that the terms ‘bonds’, ‘debt’ and ‘borrowing’ are misleading because they signify operational necessity and are moralising. Renaming them is a first step to leading a more fruitful and less fear-guided discussion about the pros and cons of their existence.
An example from the human world would be monogamy. It is not technically necessary for us to lead monogamous lives, and as soon as we can agree that there is no god who will punish us if we don’t, we can talk about the virtues of upholding it as a standard and the possible consequences of abolishing it, morally, legally and in practise.
… Operational reality is such that we can and do rid ourselves of this moral constraint occasionally at will and the world has not come to an end because of it.
But then maybe I’m misrepresenting the MMT case…
The point is to argue with mainstream in their own language. Use language such as “borrows”, auctions etc. Tell them that the price in auctions is independent of the size etc. (those words are used by MMTers themselves) but at the same time clarify the difference bewteen “a)” and “b)”
“… Operational reality is such that we can and do rid ourselves of this moral constraint occasionally at will and the world has not come to an end because of it.”
It is not a moral constraint but a legal one.
We have never rid ourselves of it. Reserves are created then soaked up soon after, as the law requires, and this has never been contravened.
I think MMTers should stop talking of the “current operational reality” as it implies that what they are recommending is already taking place.
It seems clear that MMT is recommending that the key constraint of Central Banking be removed. I characterize this as moving from a debt-backed fiat currency to a pure-fiat currency. The Central Bank under this system would be a mere facade.
MMT should come straight out and say this rather than hiding behind ambiguous assertions.
Ramanan: it is the change in language that needs to be attained more than anything else. The word ‘borrowing’ in its colloquial definition implies that government has a shortage of money and therefore has to borrow from willing lenders. This moral implication is false and is being misused by the fear-mongers to have it their way, no matter the consequences! Language is vital in changing the perception of underlying issues. It would feel strange if a GOP politician addressed the crowd with ‘comrades’ for example just as it is wrong to speak of ‘sodomy’ because the implications have biblical proportions and are moralising to the bone. Language matters!
Paul: I was referring to my monogamy example when I talked about moral constraints, although there are numerous legal constraints to enforce it as the norm too.
It seems clear that MMT is recommending that the key constraint of Central Banking be removed. I characterize this as moving from a debt-backed fiat currency to a pure-fiat currency. The Central Bank under this system would be a mere facade.
All fiat money is a form of debt, whether accompanied by the issuance of securities or not. There is nothing to back fiat but more fiat! And if not, it ain’t fiat… All MMT is proposing is, that this be acknowledged and applied appropriately to maximise what it defines as public purpose.
While I am not an economist and can’t claim to be an MMT’er, I am recommending not only no bonds but no independent cb setting interest rates for social and political reasons. Interest is a pillar of economic rent.
These are the some of the tools that financial capitalism uses to dominate the globalization and extract disproportionate wealth parasitically. I’m not exaggerating here. Read Michael Hudson on this, e. g., the links I cited above.
While Hudson is an MMT’er, he is an ally and teaches at the center of MMT in the US, UMKC. Hudson is carrying on in the tradition of Minsky, and MInsky is one of the chief influences in MMT. Randy Wray studied under Minsky. So I would definitely lump this in broadly with MMT.
Oliver, I like your religious analogy, too. Bill Mitchell often criticizes the neoliberal ideologues as moralizers — I mean, “moralisers,” of course. There is no economic substance to such arguments and portrayals.
“It Seems Clear That Mmt Is Recommending That The Key Constraint Of Central Banking Be Removed. I Characterize This As Moving From A Debt-Backed Fiat Currency To A Pure-Fiat Currency. The Central Bank Under This System Would Be A Mere Facade.”
The key purpose of the cb under a fiat system is to act as the lender of last resort by providing liquidity for settlement. It really the only thing that it actually needs to do.
Treasury securities do not “back” the currency. LIke currency, they are paper issued by the government. The only “backing” is that one from of paper can be exchanged for another form of paper of equal amount, like making change. Fiat currencies, by definition, are not backed by anything other than themselves, i.e., you can exchange one form for another, and it amounts to the same thing, because there is no independent backing. A failure of one form is a failure of the other.
Read the Michael Hudson articles I cited above and you will see that the real façade is fictitious capital. Financial instruments are at the core of this. If fact, it is often called “funny money” on account of the way it behaves both on the upside and the downside, and also the tricks that can be done with it.
MMT is a theory which aims to describe an abstract concept which applies in the broadest possible range of cases in reality. So while governments are definitely not constrained there still should be someone who has to push the button when time comes. Whether there is someone or button is irrelevant from the theory point of view.
Pretty much to the same extent as it is irrelevant for the relativity theory to really see that time slows down as one approaches the speed of light. If we get there then we can clearly say whether the theory is right or not. But the fact that _operationally_ (i.e. from current practical positions) can not get there does not mean that relativity theory is wrong and any mentioning of speed of light and time slowing down should be purged from the theory because it is not what our current practice tells us. No, speed of light and its effect of time is the _crucial_ point of the theory.
“MMT is a theory which aims to describe an abstract concept which applies in the broadest possible range of cases in reality”
On the contrary, MMT makes specific recommendations and is being used to try to justify increased government spending, here and now.
The theory of relativity doesn’t recommend that we do anything. It merely says what would happen if we did do something. (By the way, please take my recommendation and do NOT attempt to accelerate yourself to the speed of light – doing so will definitely have unintended consequences).
This is an extremely wrong conclusion.
MMT-people have always recognized and emphasized that it is up to political consensus to come up with specific policy recommendations. MMT is policy neutral but MMT-people are not. Please do not forget it.
“MMT is policy neutral”.
This is from “Soft Currency Economics” by Warren Mosler, claimed to be one of the seminal MMT works.
The conclusion states:
“It is to say that the full range of fiscal policy options should be considered and evaluated based on their economic impacts rather than imaginary financial restraints. Current macroeconomic policy can center around how to more fully utilize the nation’s productive resources. True overcapacity is an easy problem to solve. We can afford to employ idle resources.”
This is clearly not policy neutral. The mere assertion that financial constraints are imaginary is in itself a policy prescription.
I am ready to accept that this document misrepresents the theory. If so, please point me to a definitive work that describes the theory and is policy neutral.
It is a pointless and time-killing debate to prove that round is square.
MMT is 100% happy with 10% or any other arbitrary number of unemployment rate as long as political consensus is happy.
And as a proper theory MMT can also objectively tell you what you should do to get to this number.
“MMT is 100% happy with 10% or any other arbitrary number of unemployment rate as long as political consensus is happy.”
I don’t think that is quite correct, Sergei. Economics is about efficiency and effectiveness. MMT points out that running an economy below its potential when that is unnecessary is inefficient (costly in terms of foregone opportunity and wasted/degraded resources) and ineffective (relative to both public and private purpose). MMT recommends certain courses of action based on purely economic criteria that virtually all economists generally accept as applicable standards for evaluation.
Tom, “virtually” all does not mean all and neoliberals (quite a big lot today) do not accept it 😉
So “recommends” is different from being able to explain or guide in case of recommendations driven by external considerations which contradict internal logic.
“Tom, “virtually” all does not mean all and neoliberals (quite a big lot today) do not accept it 😉
So “recommends” is different from being able to explain or guide in case of recommendations driven by external considerations which contradict internal logic.
”
Sergei, this is why I claim that economics is not a science, nor even scientific. It is “prescientific” in Kuhn’s terminology. It lacks a normal paradigm and is a hodge-podge of competing ideologies with different norm that determine criteria. Where criteria are in dispute, rational debate stops.
Economics is not pure science like theoretical physics. It is not even an applied science like engineering. It is a branch of social and political philosophy, with all that implies about reliance on arbitrary foundations that are not empirically testable. Moreover, economic models are insufficient to handle complexity.
Economics is used to justify policy positions, largely on ideological grounds, buttressed by economic reasoning, which as an epistemologist, I can tell you is severely deficient because virtually none of it looks sufficiently outside the field for relevant information about human knowledge and behavior. The various ideologies ares also insufficiently informed about debate on key issues that has been talking place for millennia.
As far assumptions go, economists mostly just make things up.
Tom, I do not agree with this approach.
We should split, as Putin once said, flies from meat. I believe we try to charge and load economics too much with our values so that we ourselves render it useless. Economics is a science because it gives you answers to questions which one can ask or solutions to tasks one can have. It is exactly in the same way as nuclear physics shows how to build nuclear weapons but nobody expects theoretical physics to say whether it is good or bad to employ these weapons. Why do we expect and even require economics to do it?
Make it impartial. And then it will be too difficult to argue against it. That is precisely the way neoliberalism developed itself into mainstream. It is extremely mathematical which puts any human judgement out of equation. And that is why it is so difficult to argue with it because, you know, 2+2 equals 4. Or are you crazy?
Sergei,
There are two problems with neoliberalism. First, the assumptions are arbitrary and not empirically justified. In fact, knowledge gained from other fields speaks against these assumptions. Secondly, the math may correct but the models don’t fit reality. This is an indication that neoliberalism is an ideology more than a science. If it were a science, all economists would be arguing within this paradigm as the normal paradigm, but they are not. MMT’ers such as Bill Mitchell have copiously articulated this position. Other heterodox economists such as Michael Hudson have, too. Even New Keynesians like Paul Krugman and Brad DeLong severely criticize neoliberals for not knowing their economic history and making the same errors that were refuted long ago.
Tom, argument was not about neoliberalism. I used it as an example of good strategy and good implementation despite shaky grounds. Why did they succeeded?
I also do not agree with Bill though I completely share his values. And the key word here is values. Once you share common values you already agree on them and do not need any theory to justify your position.
If economics wants to become a science it should get rid of values which are by definition subjective. What is correct for Christians can be wrong for Japanese however economics in both countries does comply with the same set of laws as we all know. So if people in the US dispute full employment that is fine but it does not mean that they live in the different universe in terms of economic reality.
In physics there is theoretical physics and practical physics (sometimes referred to as engineering). In mathematics there is mathematics and applied mathematics. So maybe we should do the same in economics and split it into theoretical and applied economics? Different topics, different universities.
Sergei, about the only thing I see economists agreeing on is accounting identities. But then they disagree about what these identities imply, as well as over the data that is input.
When there are disagreements in the hard sciences, there are criteria that all agree on as the arbiter. Yes, there are disagreements even in the hard sciences, but they are within the normal paradigm. Anomalies also arise in the hard sciences, and these ultimately provoke questioning that leads to a different way of seeing the problem.
That’s not happening in economics. The mainstream is now acting as if the GFC never happened and nothing went amiss with their models.
As far as constructing economic theories that are independent of norms (values) goes, the result is amoral, and when this is applied as social and political policy the result is amoral. For example, when efficiency is taken to be the overriding criterion, human rights often get violated. That is unacceptable legally, ethically, and morally.
“Efficiency is doing things right and effectiveness is doing the right thing.” (attributed to Peter F. Drucker, although I have not been able to run down a citation to his work)
The key question is the meaning of “right.”
I should have added that effectiveness implies purpose and purpose implies ends. Macro includes public purpose, for example, and social and political thinkers generally agree that an economy operates for a society’s benefit, not a society for the economy’s benefit.
However, neoliberals and Austrians often presume that public purpose is limited to security of person and private property, that that societies exist for economies, especially when they argue based on efficiency as the chief criterion.
Tom Hickey, you will like this article.
Are the American people obsolete?
The richest few don’t need the rest of us as markets, soldiers or police anymore. Maybe we should all emigrate
By Michael Lind
Salon Have the American people outlived their usefulness to the rich minority in the United States? A number of trends suggest that the answer may be yes.
http://www.salon.com/news/feature/2010/07/27/american_people_obsolete/index.html
This is what all aristocrats have thought, often with surprisingly dire consequences for them. Financial capitalism could easily backfire on them, since they are greatly in the minority. It takes a bit to get the people fired up, but when they get fired up, watch out. They will take down the current government and replace it with another and another until they get something that works for them. The one thing that trumps corporate cash in politics is voter wrath and nothing provokes voter wrath more than hard times in which the rich are doing well. Schumpeter could turn out to be right in the end about capitalism, socialism and democracy. But the proximate cause won’t be the failure of productive capitalism, but rather financial capitalism.
Tom I used to ask mish 10 years ago if he was so upset with the government and the GINI coefficient, what would it take for him do to what the founding fathers did? And by that I would ask how much slavery, oppression, financial ruination would he have to personally experience before he would pick up a gun and start shooting? He couldn’t even define at what point he would pick up a gun. I know you are more intellectual than mish though and have defined for yourself at what point you will pick up a gun and start refreshing the tree of liberty with the blood of patriots right? But you are unique, I think the vast majority of americans are satiated to just go home and surf the net and chat on finance blogs, or watch some tv, and the thought of EVER picking up a gun to revolt has never seriously entered thier heads, we are a LONG way from revolution. I think the aristocracy can squeeze the middle class far more than they have, we aren’t even at the tip of the iceberg I think. I don’t it matters how many times we vote out incumbents, the system is so corrupted, new politicians will quickly be corrupted, and I don’t see the government being restructed to having 5000 seats in the house and senate to be more beholden to each voter.
Tom,
They might be smug right now that the ugly stabilizers have kicked in and helped the SPs recover from 666 to 1200 or so, got their portfolios out of the toilet, and they got Paulson to bail them out so they didnt immediately get thrown out of their jobs…but they are in deeeep do-do now. Their future is indeed cloudy.
The May adjusted 267,000 housing start number is absolutely pathetic, it is probably Great Depression numbers and I dont think Im exaggerating. At 200k per home that is a measley $53B annual mortgage debt origination level. We absolutely dont need at least half (or more) of Wall Street/Banking Sector if this is all we are going to do. This has backfired on them. If they dont get the govt to divert to a balls-against-the-walls employment/income policy and pronto, they themselves are going to have to start looking for new employment soon imo.
Resp,
Straw, I have experienced a lot of angry people on the Mall in DC, complete with tear gas, illegal detention, and the rest of what happened. People were shot at Kent State. It can and does happen here. The draft and Vietnam did it then, but a GD II would have a similar effect, I think, if conditions get really bad for a lot of people. The Tea Party folks are an early symptom.
There is already social unrest in Greece, and the radical fringe has declared war on the government, threatening anarchy and warning tourists not to come to Greece. This, too, is a harbinger.
I really don’t think that the people at the top, or even those that are doing well, get the anger that is rising across the land and around the world. A lot of people are fed up with business as usual. The tinder is there, all it is going to take is some sparks. I don’t think that the ruling class realizes yet that it is playing with fire.
Tom, I do not agree. Every science is what we make it to be. A while ago physics said that Earth is flat and people could not agree what would happen once you get to the edge. And chemistry was making artificial gold. It was all full with ideology and values. Same things applies now to economics.
I completely agree with you and Bill when you say that accounting identities are the basis but I disagree when Bill said that there is not much to add. If economics really wants to become a science it should get rid of such judgements. We all now know that some people favour unemployment. So why don’t economics study what one has to do to get unemployment? We also know that MMT has strong focus on inflation. So why don’t it study what we should do to get inflation and hyperinflation? Yes, economics is a special science in the sense that future is difficult to forecast but economics could study, for instance, different institutional structures and their effects on unemployment and inflation. And then once someone jumps out screaming hyperinflation and unemployment economics could say this is the most efficient way to get there. I.e. you want 10% inflation? Here is the best solution. You want 2% unemployment here is another best solution or even two.
How can you argue then with these propositions? Your theory is free of values and offers objective solutions to any requirement. This also means that your theory does not fight against anybody. On the contrary it makes everybody happy.
So just call economics a young and pre-mature science but the goal should be to become mature and not just to fight with other paradigms.
SErgei, I think that the disagreement is semantic. When you say,
“A while ago physics said that Earth is flat and people could not agree what would happen once you get to the edge. And chemistry was making artificial gold. It was all full with ideology and values. Same things applies now to economics.”
I would say that at this stage physics and chemistry were “prescientific” in Kuhn’s sense. There was no normal scientific paradigm. They had not yet branched off from “natural philosophy” and were stil under Aristotelian influence. That is about where economics is now. It is proto-science mixed with superstition and dogma. See Robert H. Nelson, Economics As Religion: From Samuelson to Chicago and Beyond (2002).
However, I would also say that the physical and life sciences are essentially different from the social “sciences,” including economics. Efficiency in the physical and life science is reducible to the law of least action. Not so for the social sciences, science as yet there is no bridge that closes this gap.
The physical and life sciences are unable to explain human behavior in terms of physical processes. Cognitive science and consciousness studies are still in their infancy. As a result there is not yet a science of psychology with a normal paradigm. Without a developed science of psychology, there cannot be a developed science of economics.
When it comes to human functioning, economics makes assumptions. Many of these assumptions are just made up. They have no empirical basis, and they do not accord with what research in other fields suggests. This is a deep problem.
Richard Feynman wrote a book about this entitled Every science is what we make it to be. A while ago physics said that Earth is flat and people could not agree what would happen once you get to the edge. And chemistry was making artificial gold. It was all full with ideology and values. Same things applies now to economics.. In it, he states what he sees as a physicists. His conclusion is that humanity is still in the dark about most of what really matters.The chapter headings give the idea: “The Uncertainty of Science,” “The Uncertainty of Values,” and “The Unscientific Age.”
Similarly, David Sloan Wilson is in the process of writing a series of blog posts on evolution and economics, in which he severely criticizes economics as a pseudo-science. Economic anthropologists points out similar things. Economists just make things up. That’s ideology, not science.
Sure, there are a lot of attempts to be scientific (empirical) and rigorous (math). But overall, there is no overarching view of how things work that is able to describe, explain, and predict with any great degree of accuracy. A broken clock is correct twice a day.
Should economists be trying to do better? Of course, but without a better understanding of how human beings function and the ability to model this, it is going to be very hit and miss, and the misses are gong to exact a lot of dissatisfaction and even suffering when these ideas are applied to policy as through they were dogma.
This is the real problem with contemporary economics. The various schools are dogmatic, and the one that gets the politicians’ ear is the one whose dogma gets enacted as policy. So far, none of what has been tried has worked very well at all, and the crises get bigger and bigger. What is worse, we don’t seem to learn that what doesn’t work, doesn’t work, and we keep on repeating the same or similar mistakes, often not even because of ignorance but because of “institutional effects,” meaning because certain powerful people profit from it.
Ooops, Feynman’s book is entitled, The Meaning of It All. It’s a quick read.
Tom, I am very much with you on difficulties but my argument was rather skewed towards future and not past or present. In this sense the question is “Why should MMT play the typical economics story and not change the playing field?”. At the end of the day MMT does change the playing field of economic theory. So why not target a bit higher? Why should MMT limit itself to changing just playing field and not the whole landscape? Only by charging higher MMT has a chance of becoming a science which it will become very difficult to argue with. Otherwise one can forever be doomed in discussions of what is operational constraint and whether some unemployment is a good thing. I do see that MMT has potential to shift gears in any economic discussion. But at the same time I do not understand why MMT deprives itself of this opportunity.
An example: many people are scared of debt ratios and want inflation. Fair enough. And this is what MMT has on offer. And as soon as majority of population becomes scared then this solution can be implemented.
Another example: many people think that a fair share of unemployment is beneficial because it makes people do this and that. Great! Here is what MMT can offer. Ready to execute?!
Yes, there are complexities and uncertainties with economics as a proto-science and MMT is no exception. But economics will never become a real science if it does not try to. And because MMT is flexible enough to accommodate any given or broad enough political requirements I am sure it can lead this charge. It is in this sense that I argued that MMT is policy neutral. It can easily become if it wants to but for some reason it does not want to. However with the academic firepower of neoliberals I am sure it will become it simply because there is not much to study in the accounting identities.
And thanks for the reference to the Nelson book. Looks like I have to read it.
Sergei, I agree that MMT is on the right track by minimizing assumptions and emphasizing operational description and stock-flow consistent macro models. But even with that there are problems. One of the chief problems is with data. Globally, economic data is not so good. Even in the US, where there is a lot of effort spent on data collection and processing, there is a way to go. One of the difficulties is that economists don’t collect and process data themselves. It is too expensive, for one thing. They are dependent on governments to do this.
The largest problem facing MMT is that is depends on fiscal policy, which is in turn dependent on politics. For example, in the US now the Bush tax cuts are coming up for expiration and there are almost no economists willing to say that they should be extended because they will be beneficial and essentially pay for themselves. The only one I know of is Art Laffer, who we know from Warren, understands the MMT operational descriptions. So this knowledge can be perverted ideologically, too.
Their will be no real change in the US as long as both parties are wholly owned by the plutocratic oligarchy, and this situation has just worsened exponentially by the Supreme Court’s Citizens’ United decision, giving corporations the right to fund political campaigns since they have first amendment protection of free speech as legal persons. There is a reason that mainstream economists are in power. They carry the water and tow the line, and are handsomely rewarded for their trouble.
There are two other problems with the MMT view also. One is that it does not sufficiently address what I believe are the fundamental problems facing the world today — externalities, energy constraints, and financial capitalism. Scientists are now saying that we have until 2015 to get control of carbon emissions; if not, catastrophe is coming to a place near you. Here is an article by Stirling Newberry laying out the energy contraints here. (Warren admits that the Saudis control the price of petroleum.) I have already provided links above to MIchael Hudson on financial capitalism’s parasitic extraction of economic rent.
I don’t see any real forward motion until all these problems are solved. Full employment with price stability is a great goal that I wholeheartedly support, and I commend MMT’ers for their solution, even though I see it as politically impractical at present. But there are a lot of other pressing economic problems, too. We need a comprehensive economics for dealing with the problems we face arising from the challenge of globalization.
If we had a normal paradigm for economics that fit with a normal paradigm for the social sciences, which is also lacking, that fit with the normal paradigms of the physical and life sciences, then I would say that a scientific solution is possible. Humanity is still a long way from there, and right now we are flying with blinders on.
It is like a horizon. Humanity will always be a long way from there. But I am optimistic 🙂
I agree, humanity has come a long way and has a long way to go. It has not even eradicated slavery yet.
Paul,
Since we do not know our future, some decisions have to be taken which have an effect both in the short run and the long run. If one truly believes that fiscal policy has a tremendous impact on growth, what is there to prevent him/her from giving views about policy decisions ?
Economics is also a theory of employment and if decisions taken are not consistent with providing full employment and price stability, someone has to speak out.
I didn’t say one should not give views. I was pointing out a flaw in Sergei’s analogy.
This is clearly not policy neutral. The mere assertion that financial constraints are imaginary is in itself a policy prescription.
Every theory asserts something and therefore implies certain policies if one assumes the same underlying political aims (say full employment and price stability). And while mainstream practise boils down to ‘ya can’t have it both ways so let’s settle for maximum price stability because even small amounts of inflation will lead straight to Zimbabwe’, MMT asserts, that under realistic political and economic assumptions this will not happen, neither now nor in future so there is no excuse for muddling around.
Basically, what MMT says is that mainstream theory unwittingly deprives itself of the possibilities at hand by shrouding empirical and logical evidence with vague imagery of Sodom and Gomorrha lurking around the corner, that its simplistic models predict and its anachronistic choice of words reinforce. It is therefore neither more nor less prescriptive than any other theory, but, so the story goes, more realistic in its predictions and therefore less ideologically biased and less corruptible in outcome.
Paul [August 2nd, 2010 at 8:14 am]:
A very thoughtful exchange. You are making a number of interesting points.
It looks as if some MMT proponents make truly bizarre statements, such as “Treasury Bond issuance is not borrowing”, or mixing “current operational realities” with “potential operational realities”, or ignoring liquidity importance for bank operations and going as far as to say that deposits are not needed for commercial bank operations. I tried to discuss the dangers of ignoring liquidity importance, especially in the light of the ongoing financial crisis, at another MMT site, http://bilbo.economicoutlook.net/blog/?p=10866#comments , with little success.
Initially, I became interested in mmt’ers works that tried to analyze IOU flows as in Godley&Lavoie’s SFC matrix , but as I tried to discuss some, in my opinion, controversial MMT claims, I became quite discouraged by the sort of cavalier attitude I briefly referred to above and the defensive position my interlocutors assumed at the slightest attempt to question those claims. I am not sure why some MMT folks are saying what they are saying and then try to tap dance around it. Whatever their reasons are, good luck to you in trying to clarify their positions !
VJK
I’m not sure why you’re so disconcerted with the MMT folk. Your discussion over at Bill Mitchell’s seemed fairly civil to me. And don’t forget that you are in blogosphere where anybody can join in the discussion, regardless of his or her professional background or manners. You can’t dismiss a whole line of macro research on the basis that the occasional blogger may resort to hyperbole to make a point.
As regards the eternal discussion on ‘borrowing’ I think the main concern by MMT is that the term itself has a meaning in common usage that goes far beyond what it represents technically for a country with a non-convertible, floating fiat currency. It would therefore be better to give it a new name to avoid the negative connotations associated with ‘borrowing’ that in the opinion of many here are being misused to scare the public and protect vested interests.
As an example, there are various songs that have coined the term ‘beg, steal or borrow’. Begging or stealing aren’t the kind of actions one wants people to associate with central bank operations, but that is precisely what is being achieved by insisting on the term.
Much of economic language, and I can assure you it’s far worse in German, has a very strong moral and moralising component that is not representative of current operational realities (for lack of any other term) or of modern societal values. Economics is a social science, that is if it’s a science at all, and must therefore always be thought of in a societal context. The correct frame is important, which is why we’re seeing so many discussions on this subject here.
But that’s just my view as a non-professional.
VJK,
You should keep the discussion about the government debt and bank loan making separate.
I don’t think anyone said that deposits are not needed.
Ramanan, as I understand it, technically deposits are not needed for banking. Some of the largest institutions that are chartered banks under US law are not “retail” banks but they have all the privileges of banks a public/private partnerships.
Well some banks may do away by funding themselves with CDs once they issue loans and have an outflow of deposits to other banks. However, you can’t make such statements about the banking system as a whole. In fact, banks take term deposits and pay more interest on these deposits 🙂
It is true that deposits are not needed for individual banks. They are not.
Deposits are required at system level of course.
VJK thinks deposits are needed for individual banks to be able to make loan, this is not true.
loans create deposits so they can’t be avoided
Ramanan [August 3rd, 2010 at 12:19 pm]:
In the current ‘operational’ reality, T-bonds are no different from commercial bonds insofar as the government needs to borrow in order to pay for its activity in the same fashion a company does. E.g. with 10-year bonds the government and the company go to, beg and compete at the same market and thus are choices for the private investor to make who wishes (or not) to make them parts of his/her portfolio with identical effects on deferred household consumption aka savings (minus the credit risk in the case of T-Bs).
The Treasury needs to pay, not the ‘government’ as ‘the government’ sets the rules for the treasury.
the government does not need to borrow dollars, and does so only because it decides to do so, and it can alter that decision continuously as desired
VJK,
Yes in fact if you look at my comments on “operational realities” you can see that. Markets are happy to ‘finance’ the government. Government spending post borrowing raises incomes through the multiplier effect (not the money multiplier btw) and higher incomes lead to chasing government debt.
Please note however, that unlike the corporate borrowing, there are a lot of differences. The government can borrow in a much bigger scale than corporates. The Kaleckian principle of increased risk applies to corporations, but not so for the government because it has the lender of the last resort – itself.
VJK: In current reality t-bills are different from corporate bonds because their default profile is very different.
It is so funny — people are so busy focused on reality that they miss Reality
Warren: Yes, loans create deposits and so cannot be avoided at system level.
But, individual bank can make loan and not keep deposit. They can swap deposit liability for some other kind of liability.
In which case some other bank has the deposit.
Ramanan,
Good description, but it doesn’t address the issue; it begs it. The argument that the government (central bank) supplies the HPM necessary to pay for bond auctions doesn’t address the ambiguity of MMT’s operational description at all. In fact, it hoists it on its own petard.
One way of expressing the ambiguity of the MMT operational description is through the example of a catastrophic bond auction failure. A bond auction failure is consistent with the idea that potential purchasers are afraid of the risk of capital loss inherent in a fixed term instrument, due either to the misplaced fear of involuntary government insolvency, or the not entirely misplaced fear of voluntary default, or the more real immediate fear of higher term interest rates, given the presumed circumstances of high deficits and/or debt coupled with the high inflation that would be consistent with such an auction failure.
The additional supply of HPM does nothing to prevent such a scenario of failure. First, most bond auction volume is bought by non-banks. Even if non-bank deposit balances were increased as a corollary effect of central bank HPM injection, non-banks don’t care about the HPM position of banks. It doesn’t affect their decision making. Second, there is absolutely no guarantee that increases in associated broad money balances held by non-banks will necessarily be used to purchase bonds under the circumstances described. Non-banks may well prefer to hold short term money balances with virtually no risk (i.e. bank deposits) than securities with capital risk due to potentially higher term interest rates (treasuries). Third, even if bank HPM balances have increased, this isn’t categorically enough to induce banks (instead of non-banks) to purchase term securities under the conditions described. Similar to non-banks, banks may well prefer to hold HPM balances with no capital risk (reserves) than securities with capital risk due to potentially higher term interest rates (treasuries). Fourth, if the policy rate is greater than zero, and HPM injections put downward pressure on short rates, and the central bank then confirms that with a policy rate change, so be it. But that also won’t necessarily be sufficient to induce banks to buy term securities under the conditions described. That’s wishful thinking as opposed to a required logical result.
So the risk is that nobody will buy the bond auctions under presumed catastrophic risk conditions. And HPM injections won’t necessarily be sufficient to change this. The only way the government will be able to deal with the deficit under those conditions is to monetize deficit expenditures without bonds (or equivalently have the central bank buy newly issued bonds directly, or undertake some other internal bookkeeping finagle that effectively monetizes the deficit without publically issued bonds). So the entire scenario and the entire MMT proposition about government not being revenue constrained boils down ultimately to presuming the fall back position of no-bond monetary operations, which is an institutional change from today’s monetary system.
The HPM injection argument is a weak one, because it uses the very mechanism MMT insists is the one necessary for short term interest rate control to develop an argument that depend on interest rate risk factors that are beyond its control, given the actual operation of the monetary system as it exists now, with bonds and with associated term interest rates determined by the market. And here there is another internal contradiction in the MMT position. The described scenario taken to its logical limit could mean that the government injects HPM to the maximum by buying all market bonds, in an effort to pump prime the system just to absorb new bond issues. But that just results in full monetization and a no bonds result, thereby ravaging the objective of temporary HPM injections as a pump primer. The HPM injection argument is a failed response to the question of fundamental ambiguity that was raised in Marshall’s latest/longest.
BTW – since acceptable vocabulary apparently now includes the notion that “no bonds” monetize government expenditure, clearly the purchase of bonds by the central bank must also be effective monetization. This is because government bond issuance + central bank bond purchase = no bonds = effective monetization. The transitive property is operative here.
Agree.
I do not understand MMT pushback on this anon. If Govt spending is operationally unconstrained, then either you have CB make purchase, or you have Treasury account that can overdraft.
Both of these are different from formal rules today.
Whether they are different from actual informal rule (aka reality) is different question that people can debate on. It is clear in my mind, but it is OK for other people to have other opinion.
Both of these are different from formal rules today.
Whether they are different from actual informal rule (aka reality) is different question that people can debate on. It is clear in my mind, but it is OK for other people to have other opinion.
I think there is agreement on that.
Anon,
Great points. In fact the tone of my comment (to which you replied) was intentional – to make it look like it begs the questions you have raised.
Will come back with more points.
In fact I am 100% with you on your description in Marshall’s Longest :
Here’s the operational sequence in the current system:
– Government borrows
– Non government deposits and reserves are debited
– Treasury general account is credited
– Central bank injects required system reserves via system repo
– Government spends from treasury general account
– Non government deposits and reserves are credited
– Treasury general account is debited
– Central bank withdraws excess system reserves via system reverse repo
(though I will replace the last by “allowing repos to mature” instead of reverse repo)
Ramanan: Here’s the operational sequence in the current system:
– Government borrows (should read “Treasury issues securities and Fed sells to primary dealers at closed auction?”)
– Non government deposits and reserves are debited
– Treasury general account is credited
– Central bank injects required system reserves via system repo
– Government spends from treasury general account (“spending” should read “disburses.” Not all government disbursements are spent on government purchases, correct?.)
– Non government deposits and reserves are credited
– Treasury general account is debited
– Central bank withdraws excess system reserves via system reverse repo
Tom,
I don’t really agree about the change of language. What is wrong with “government spending” ? Usage of a different language will be a hindrance on how you explain these things in a more axiomatic framework.
There are genuine advantages of using phrases such as “deficit” because the usage of that phrase allows one to explain things such as “one sector’s deficit is another’s surplus”.
Ramanan, “government spending” is very pejorative in the US. It lies at the basis of the neoliberal criticism of Keynesianism, and the GOP tarring of the Dems as the party of “tax and spend liberals.” Government disbursements cover interest payments (a subsidy for the rich) and Social Security disbursements, which are very popular. “Spending” mischaracterizes a lot of what government does with its funding.
In fact I do not accept that debt monetization is “out of paradigm”. It is done in Japan plus I am sure there are developing nations where auctions fail – leading to central bank monetization of the government debt. Reserves increase and overnight rates may fall to zero but the central bank is forced to abandon targeting overnight rates to prevent a mini-crisis. And banks – they are not sure about what is happening and the overnight rates may not really fall to zero.
We have already discussed auction failure in terms of US operations. Primary dealers are required as primary dealers to take the auction, or resign as primary dealers if they don’t want to participate. From its side, the Fed buys back the bonds soon after the auction. It’s perfectly legal. The Fed just can’t purchase the bonds directly from the Treasury, but it can do so indirectly through OMO. No problem.
Under the conditions of catastrophic failure as I have described, what you have described falls under my definition of “finagle”. It’s an absurd deception away from the operational reality of last resort monetization. The catastrophic conditions I describe mean dealers have no client bids for securities. There’s no way the dealers themselves are going to take the associated bond risk on the basis of some moral commitment to buy bonds. The central bank must guarantee a full buy back of the bonds in this scenario. This is effectively monetizing the deficit, notwithstanding such circuitous deception. This scenario represents a complete breakdown of the monetary system as it is currently intended to function, and defaults its operation into the no bonds contingency that is required by implication but not admitted explicitly in MMT descriptions of operations. That’s a big problem for effective MMT communication of its analytical framework.
This is similar to what happened during GD I. FDR got Congress to end the gold standard and even order confiscation of hoarded gold. All bets are off in the scenario you describe. Could something like this happen if there is a GDII? We may get to see if we stay the present course or tighten, and deflation sets in as some (Krugman) are predicting. In that case, I would assume a “Keynesian” solution, and if we are fortunate it will be along MMT lines. Of course, the liquidationists could prevail instead, and then we would be in the really deep doo-doo of spiraling debt-deflation as asset value plunges into the abyss, causing a massive wipe-out.
Dealers finance themselves at ON and invest long-term. This stuff is risk free so no capital costs. They will be happy to buy bonds as long as Fed is ready to repo them. Which is a different issue. However at interest rate policy being a main instrument it is not an issue at all.
Amazing then that during World War II, short term bond rates didn’t move up above 0.375%, long-term bond rates never got above 2.5%, and yet there was never a “catastrophic bond auction failure”, even when the US Government was running 15% to 30% of GDP ($2 trillion to $4 trillion a year in 2010 terms) in budget deficits year after year. Go figure.
Beo,
During the time, the Fed and the Treasury decided to set the yield curve and there was debt monetization. Describe it is debt monetization instead of calling it gold standard.
I am sure Anon understands this. Don’t know why it is so difficult to miss Anon’s point.
Anon,
Completely agree on non-banks buying most of the debt and discussions around HPM and your usage of the phrase “wishful thinking”
The only explanation I am comfortable is the one which talks of private sector income and increase in income due to government spending and this leading to chasing government debt as a form of saving.
There are many other things related to auctions – such as the point in your “b)” plus markets assuming that “b)” can be used anytime plus they incorrectly assuming that governments can “print money” and/or use the seigniorage powers hence cannot default.
The reserve accounting is insufficient to prove that all auctions will be successful.
Also, as you correctly pointed out, the non-banks do not have any information about the HPMs banks hold and more importantly simply do not know about it.
Both of these are different from formal rules today.
Whether they are different from actual informal rule (aka reality) is different question that people can debate on.
Agreed.
Randy Wray on some of the things I raised in #7
http://www.newdeal20.org/2010/08/03/do-deficits-matter-foreign-lending-to-the-treasury-16389/
I am not arguing that the current situation will go on forever, although I do believe it will persist much longer than most commentators presume. But changes are complex and there are strong incentives against the sort of simple, abrupt, and dramatic shifts often posited as likely scenarios. I expect that the complexity as well as the linkages among balance sheets ensure that transitions will be moderate and slow-there will be no sudden dumping of US treasuries.
Also links to this article on Marshall Auerbach’s article on CBO’s recent paper on a fiscal crisis
http://www.newdeal20.org/2010/07/26/budgets-the-economy-the-future-and-slightly-more-on-jack-lew-15646/
My comment @Newdeal 2.0
Hi Randy,
Nice article!
However, one doesn’t need to be a deficit hawk to make a “A Cri de Coeur” which the late and great (and your friend) Wynne Godley himself did.
The US is in a very special situation because of the “hegemony” but it should be made clear that other countries cannot go on such a growth path.
Countries are severely constrained by problems with the external sector and the sadist IMF solution of going into fiscal austerity is actually “helpful” because it reduces demand and hence imports. A country cannot relax fiscal policy even if their leaders understand that the G-secs issued will not default.
As far as the US is concerned – here is what I have to say. Fiscal policy will rescue the US in the short term (the more relaxed, the better) but it will worsen the external imbalance in the long run. Another way of saying this is that “the New Cambridge approach holds in the long run”.
The more the external problems are allowed to detiorate the more painful it will be later. While there is no debate about the accounting identity, the numbers for the US suggests that sooner or later it will go on an unsustainable path. That is because the deficits should be atleast equal to the current account deficit if the private sector is to be in surplus. Of course that is also not debatable but that puts the public debt on a path where it grows faster than national income if the trade is allowed to be deficit
Here is quoting Wynne Godley and Francis Cripps from their 1983 book Macroeconomics.
“As a long-term proposition the hypothesis of ever-increasing government deficit relative to income accompanied by continuous external deficits is implausible. A full steady state could be restored by a reduction in the fiscal policy or by a rise in trade performance ratio. These are two, related sets of pressures which might cause such adjustment to occur. One is the potential difficulty in financing the government budget when increases in government debt much directly or indirectly be taken up by foreigners. The other is the probability that continuous external deficits will make the national currency less and less acceptable in currency markets, provoking rapid falls in the exchange rate for the currency”
Several thinks can be debated about the above quote. Why does the US need the foreigners to finance its budget deficit etc. A long term bet that the rest of the world will remain weaker than the United States is finally a bet.
I recently read your comment on a blog post that taxes grow fast enough because of “automatic stabilizers”. That is true in a closed economy. However, in the situation where the trade balance is endemically imbalanced the automatic stablizers are not fast enough to put the public debt within the sustainable limits.
The short term solution to solve the problems of the world is indeed through fiscal policy but let me make a statement. The world is not moving into a sustainable growth path. There is a desperate need to have a concerted action and redo everything about international trade.
As far as the currency markets are concerned, there is no need for the Chinese to dump US Treasuries for a currency fall to occur. The international money market is deep enough for any big player to cry “fire”. There is also an argument that if the dollar falls what’s the worry – exports will improve. But those processes are complex. The trade balance may worsen initially because of slow quantity adjustment of imports leading to a further fall. During these times, fiscal authorities will go into an austerity which is not really a bad policy because it is an attempt to improve trade balances and resolve the problems with the currency fall.
Then there is the question “how come you want a strong dollar and a weak dollar at the same time, why do you want devaluation?” This is a brilliant question because it brings all the dynamics in one go. The short answer is that the diplomatic talks the US Treasury is trying to have with the rest of the world is an attempt to protect a deeper fall in the future.
Devaluation will be hurtful of course because of exchange-rate pass-through effects. But it is a small step in the right direction – will allow the US to be more competitive and improve the trade situation.
However there are definitive cracks in the foundation of growth and fiscal policy alone will help short term but worsen the global imbalances.
(PS: I know the Modern Money views in reasonable detail and am neither a hawk nor a dove).
More comments:
PS-ii:
I am fully supportive of full employment. I do not believe that there is anything in this world preventing full employment except lobby groups and neoclassical economists.
One more comment at ND2.0.
This brings to me grandchildren.
For a closed economy public debt is unlike a household debt and is not a burden. The public debt is the result of an accounting fact.
For an open economy however, the interest paid to foreigners is indeed a burden.
For a nation running trade deficits for a long time, imports are no benefits. Imports reduce employment. For a given fiscal stance, budget deficits endogenously expand but not enough to bring employment back to levels in the absence of the trade deficit. Fiscal policy has to be relaxed to achieve that. In a world where the governments do not relax fiscal policy so easily, imports are bad.
When a country is running a trade deficit endemically, the interest paid to foreigners is a burden because the proportion in the national income may keep growing. Implicit in the statement that the interest payment is not a burden is the assumption that policy makers do not target public debt/gdp ratios. There are some situations where a nation can run trade deficits and grow fast enough so that public debt is sustainable but those situations are texbookish. In the real world, these situations do not arise. For a country to have its public debt to gdp ratio in the sustainable territory, interest paid to foreigners needs to be thought of as burden.
I think a lot of this has to do with how one views money and whether taxes finance the foreigners or if one views taxes being “destroyed” and interest paid to foreigners are “created”. There is a danger in the second viewpoint because if taken literally one can have many disagreements.
Also, foreigners hold a lot of private sector assets such as corporate bonds, equities and mortgage backed securities. The interest/dividend paid on this is more intuively a burden.
“For a nation running trade deficits for a long time, imports are no benefits. Imports reduce employment.”
Blasphemer! May your heart be run through with an MMT stake! Explain to me, the man out fighting snakes, heat stroke, skin cancer, and herbicide exposure out in the strawberry field why it is better for ME to pick the strawberries than some sucker in china while I sit down and chat on MMT blogs? Why is employment and exports of my strawberries something I should desire when it will kill me much faster. I think it imports of strawberries is the goal, I will live longer and get to chat on this blog more, you don’t make sense to me.
“Also, foreigners hold a lot of private sector assets such as corporate bonds, equities and mortgage backed securities. The interest/dividend paid on this is more intuively a burden.”
Look here is the operational reality, right now SUCKERS in asia are picking the strawberries and dying young, while accumulating numbers on a spreadsheet. When the time comes, the computers that the spreadsheet are on will accidentally (on purpose) reboot and lose all thier interest payments, dividends, etc etc – Why do you want me to get up and start dying by picking strawberries when there are still suckers who will do it for me thinking all the while they are going to have some claim on me or my children to FORCE me to do work! LOL! How is that china man in the strawberry field gonna take his treasury bond and come over here and make me pick strawberries for him when I reboot the computer all his data is on? You don’t make any sense padawan! The force is not strong in you sucker!
Strawb,
May 2010 Trade Deficit w China: $22B
x 12 mos = $264B annual /14.8T US GDP = 1.78% >>> BFD
Two micro transactions I participated in lately:
1. Front brakes and rotors for our 2001 Honda van.
Dealer Quote: $475 Rotors: $145 each Pads: $25 Labor: $160
My friend (mechanic) has a wholesale account at Advanced Auto Parts. He called and checked his price for me Rotors (China): 37.50 each, Pads: $10.
So US wholesale price of pads & rotors is $85, what are the Chinese getting for them….25 bucks? 25/475=5% of US GDP. (btw im doing them myself next month while listening to NCAAF!)
2. HVAC rubber fan belt broke on air handler. Emergency (100 deg F)Service call $190 Minimum, Called R E Michel HVAC wholesaler for price of belt (China):$3.87 w tax. My contractor: 190 + 25 for belt = 215. What is China getting for the belt? 1 buck? 1/215 = 0.5% US GDP (btw did it myself!)
Average a bazillion of these types of transactions across the US and you get China getting about 2% of our US business. Rubber fan belts have been around since probably late 1800’s, auto brakes since the Model T 190?.
Continue this for 10 years with the Chinese CB changing out the currency and just sitting on it and you get China govt with USD NFA of less than 20% of 1 years US GDP, I think they have amassed about $1T/1B Chinese population = 1,000 per person or about 3 weeks of Social Security payment to one of our Seniors after their (China’s)past 10 year effort.
They want this type of USD based business from us, they have noooo problem accepting our currency for their industrial components business like this, I have not figured out why other than it is part of their Job Guaranty program (idle hands).
Perhaps this would be a good question for Sec of State Clinton to ask them next time she goes over there, vice ‘will they ‘lend us’ more money’…Oye!….hang in there!
Resp,
PS the rest of our trade deficit is oil.
I just had to replace my mom’s front brakes on her 2009 chrysler minivan (supposedly made by mercedes – so you think they would have some quality), 400 dollars, you are right, the china price is much cheaper. I would have done it myself, but it is easier for me to click buttons on a trading terminal and make 10K a day than take that time to do greasy work and sweat. So even though I know I am grossly overpaying, it still better for me to let some overpriced american worker do it.
Also HVAC problem, air handler running too hot, technician wanted 90 per hour, energy company did FREE energy audit and decided momma needed more insulation, they offered to pay the first 150, it cost 175, so winds up costing me 25 bucks.
I cannot understand why we are not importing lots of chinese to places like destroit (destroyed – get it – haha) before they bulldoze all the infrastructure, it is a win win for everyone except those overpriced 100 per hour jobs that no one is going to pay for anyways, we will all just DIY.
I tried to tackle this problem personally, because I am a patriot like that, and marry and import lots of women and thier families to help my country, but now the USA state department gives me problems and say that there is a lifetime limit of 2 wives now, that is BS!! I am so ANGRY, I am trying to help my country and am being told I can only marry so many people in my lifetime from overseas and get them citizenship, who da frak does uncle sam think he is? Getting involved in my personal life like dat?!?!?
I went to my local city commissioners meeting where they are bulldozing some good houses and storefronts and said if you would tell uncle sam to get off my back about how many people I can marry, I would bring lots of smart, hard working people over who will be good taxpayers and work for cheap. No one ever listens to me.
But I am very suspect of those latest GDP numbers, I think they are garbage and not to be trusted.
US dollar payments to foreigners are not a real burden. the real burden/reduction in real terms of trade is when they spend those dollars and we export to them.
“US dollar payments to foreigners are not a real burden.”
That is true if the “public debt/gdp ratio is just a number”.
The MMT argument for imports being benefits is that when you import, you enjoy the import and have the option of relaxing fiscal policy without hitting capacity constraints. My stand is exactly the opposite. To defend your currency, you have to do the opposite. There are more complications – the currency markets may not move much if you expand fiscally, but that is not sustainable. The later the adjustment, the more painful it is. The strategy to import and compensate it with fiscal expansion is equivalent to saying that public debt/gdp can be allowed to go to whatever value. Except the US, no other nation can even think of such a strategy, however brilliant their economic advisors maybe. And the US … cannot keep doing it forever and bet on the hegemony.
The lateral thinking – “taxes do not finance anything and taxes are destroyed” is too dangerous 🙂
The closed economy analogy that interest paid on government debt is not a burden does not carry in such a straightforward manner to the open economy.
it’s not that you import more, it’s that they export more.
seems we differ on causation?
it’s the nation that desires to export that has to net save your financial assets to do that.
you can’t decide to run a trade deficit if no one wants to net save your financial assets.
it’s only when they want to save your financial assets that you get the opportunity to run a trade deficit.
Thanks for engaging Warren.
Yes we differ in causation.
My decision to buy an iPod is not due to the desire of Americans to save in rupee. Its because the nation is not competitive enough to manufacture an iPod. Likely Citibank reduces its rupee liabilities and hence doesn’t “desire to net save”. The trouble is with the word save itself :). If the Indian government goes into a fiscal austerity mode, it very reduces the trade balance without any decision of the external world to save in rupee.
On the other hand, capital inflows into a country could be a bit beneficial because it improves the balance of payments position and the government can push demand a bit to allow more imports.
This debate of trade balances is incredibly difficult to resolve. It involves almost everything from behaviour of various actors of the economy to the ultimate question “What is Money” to questions about sustainability and value of the currency and the dynamics of currency movements. It also has to do with the word “borrowing”
Here is Wynne Godley in 1995:
Refuting the “All Investment Is Good” Argument
It is sometimes said that the external deficit is harmless because it is nothing other than investment in the United States by foreigners and that this can only do good. Indeed, Table 4.1 of the NIPA labels the balance of foreign transactions as “net foreign investment.” (This argument was used extensively in the United Kingdom during the ill-fated “Lawson boom” of the late 1980s when a rapid expansion of demand, as a result of tax cuts and credit deregulation, led to a large external deficit.)
This argument has no substance. A decision by foreigners to invest in the United States is beneficial to the extent that it creates productive assets here that would not otherwise have been created and that have the effect of raising productivity, thereby generating additional exports at least large enough to cover any addition to profits flowing abroad. But the U.S. deficit in goods and services, which accounts for the bulk of the overall current account deficit, cannot possibly be said to have been caused by decisions of foreigners to invest in the United States; rather, the deficit was caused by decisions of U.S. residents (individuals and corporations) to purchase imported rather than domestically produced goods and by the relative weakness of US exporting industries. Of course, an external deficit, generated in this manner has to be financed, which means that, by hook or by crook, foreigners have to be induced—perhaps by higher interest rates or by depreciation of the dollar to the point where the expectation of subsequent appreciation brings the money in to lend on a sufficient scale. But it is misleading at best vacuous – to call such inflows “foreign investment.” Indeed, as shown in Figure 5, the net value of direct foreign investment in the United States has been more or less stable in recent years, so the whole recent deterioration in the net asset position has taken the form of increased ownership by foreigners of financial assets. Such assets (that is, equities and bonds) do nothing at all for U.S. productivity, but do generate negative income streams in perpetuity.
Footnote: This point is an answer to those who quibble that the United States should not be called a “debtor” nation just because the net asset position is negative.
Before someone even takes offence about higher interest rates and so, I refer him/her to Wynne’s 1983 text where he is seen to assume the central bank setting the whole yield curve (of govt securities) in many of his models.
Of course a criticism of the phrase “net foreign investment” but one can replicate this.
A nation cannot be assumed to be in trade deficit forever. Sooner or later, it leads to exploding interest payments to foreigners leading to a currency fall. Only in a laissez-faire economy can one assume the currency to adjust smoothly. To defend the currency, you need to increase interest rates in order to save your currency, whether that works or not.
That brings me to the question – if you are worried about a fall don’t you think that exports will increase when the currency falls ? Doesn’t work in practice. Secondly you have imported inflation as well. Thirdly, however brilliant the economic advisor or policy makers may be, the nation has to go into a fiscal austerity – in order to bring down the trade deficit.
The other question is if you are really worried about the currency then why do you want your currency to depreciate etc. I have answered that point elsewhere.
There are various things which can be said about “the central bank sets the rates”. It doesn’t mean that it can set it to anything it want independent of whatever is happening in the other sectors. It can decide whether it is 5% or 6% or some basis points here and there. In normal circumstances it is more flexible of course.
A finally a funny question – if economics were so simple, how come people missed it. Surely there must have been countries which understood that fiscal policy can do good and overdone that!
“My decision to buy an iPod is not due to the desire of Americans to save in rupee.”
That’s a micro point, of course. The macro point remains- India won’t be net exporting unless it is net accumulating fx financial assets, one way or another.
“A nation cannot be assumed to be in trade deficit forever. Sooner or later, it leads to exploding interest payments to foreigners leading to a currency fall.”
Only if those interest payments are spent might that be the case.
Americans can swap their net rupee assets for dollar assets. No shortage of dollars out there. It’s still a desire to net save.
Not sure what you mean. If you mean increase in saving of Americans in the accounting period, yes it increases because of the export. No debate about that.
The point of debate is “net saving in the foreign currency”. If the Americans reduce their rupee liability because of an export, would you call it a desire to save in rupee ?
The Saudis export oil to India and India pays in USDs. Who is “desiring to net save in what currency?”
The debate is not about S in the identity G – T = . . . if you think that is what it is.
An exporter net saves in the currency in which the export is invoiced in, e.g. rupee.
The exporter can then adjust the currency composition of that net financial asset by using the foreign exchange market, e.g. rupee for dollars.
The exporter chooses the invoice currency and his subsequent portfolio strategy.
Net saving in the currency of invoice becomes a net financial asset in the subsequent currency of his choice.
Who’s saying otherwise?
I don’t see what your issue is here.
I do not disagree at all. But you may ask “what is the debate then”
If I buy a book from amazon.com, here in India, amazon doesn’t “exchange it” -its automatic. Citibank (a US firm) passively reduces its rupee liabilities. It doesn’t “allocate” rupees.
How about seeing it that way instead of a US citizen buying a Chinese car where the Chinese exporter gets paid in dollars itself. The Chinese exporter may purchase US assets or exchange it at the PBoC (indirectly) in which case the PBoC purchases more US Treasuries. There is a great relation here between the US and the Chinese, except that it leads to unemployment in the US and a weakening of some industries. (The MMT argument/solution/demand is relax fiscal policy etc).
If I do not use a multinational firm’s debit card and if the transaction with amazon happens through a correspondent banking system, then my bank’s dollar assets fall and its rupee liabilities decrease. amazon.com’s income has increased. It doesn’t care to net save in rupees.
Now you may not disagree with this, you may ask “what are you debating then ?”
In all these transactions, it is important to keep track of the decisions of every actor in the economy. For example, a poor African nation doesn’t run trade deficits because foreigners want to save in their currency. They end up saving in their currency, say by purchasing government bonds. (Accounting transactions flows must finally ‘add up’). Do the foreigners readily purchase government debt of the African nation ? Can an African nation running continuous current account deficit set the interest rates at any level it wants ? No worries about the exchange rate? Fiscally expand to increase imports ?
The MMT argument about trade deficits interprets the sectoral balances identity as govt deficit = domestic private sector net saving + saving of the rest of the world in that currency and gives it the behavioural dynamic – trade deficit (the second term) is because of the net saving desire of the rest of the world in that *currency*. The foreigners may not be net saving in your currency. The adjustment may happen because you lose foreign currency. Even at this accounting level there are some ambiguities. Add behaviour and you end up meeting all kinds of complexities.
“Citibank (a US firm) passively reduces its rupee liabilities. It doesn’t “allocate” rupees.”
It’s not passive.
Citibank doesn’t run a short rupee fx position in anticipation of trade flows that give it offsetting longs.
Global banks actively manage their fx positions. They’re not passive.
And I think with respect you’re making the mistake of confusing liability management transactions for passive flows. That’s not the case any more than it is for asset transactions. There is an allocation in both cases, to use your word connoting activity.
BTW, a good deal of the CA deficit issues you’re interested in may be confirmed by operational understanding of international accounts in banking.
Not sure what you mean here Anon. The whole point I am making is that there are accounting transactions and behavioural aspects. If one neglects behavioral aspects, its really difficult to see many things.
If Citibank reduces its rupee liabilities when I purchase an import, what happens next, can you tell me?
Yes global banks manage their fx positions – never denied that. But my points also illustrate the complexities in all this. If you do not like the Citibank transaction, you can forget that and consider the transaction which involve Indian banks only.
Since you talked of liability management, you can then maybe see that. The foreigners do not wish to purchase Indian IOUs. If the banks want them to go into Indian IOUs, they have to induce them into it. Indian banks regularly induce Non-resident Indians into term deposits because they acquire dollars or the central banks asks them to do so. (Some banks are State owned).
The most important point I am trying to make is the volitional decision of citizens to purchase imports rather than domestic products.
You are arguing the way because you are conditioned in this blog to think like that.
The whole thing is a bit similar to government borrowing. No attention is paid to the lender and the demand for government bonds. It is perfectly possible that the Public Sector Borrowing Requirement is growing faster than incomes causing increase in rates/yields. However it fortunately doesn’t happen.
I am really not arguing with you on CA deficits. Its an argument against MMT. There are complicated things happening out there from a behavioral perspective. I haven’t disagreed with things you said, but I am just asking you to consider the complications.
On the other hand, the questions is not if CA deficits are a problem. Its an argument about sustainability of CA deficits. Its an argument against the MMT stand that fical policy can resolve problems associated with CA deficits.
I have brought the transactions a couple of times to highlight the con trick with Americans buying a Chinese car. There are zillions of assumptions there.
fiscal policy can sustain domestic full employment and not worry about the current account per se.
Anon,
You noted at Billy Blog during Marshall’s Longest that:
“Many institutions issue US dollar money liabilities – the Federal Reserve, US domestic banks, and foreign banks issuing US dollar credit. The focus on “monopoly issuer of currency” obscures the breadth of these sources.”
I am actually trying to go in that direction!
When I thought about my arguments, it appeared to me that those are very close to arguments around the MMT description I summarized to which you rightly pointed out “…it begs the question” You then descibed the details on balance sheets of banks and non-banks and the points about nonbanks’ lack of information about the HPM position and their indifference toward it. Similarly, households do not care about banks. The exporter got paid in dollars and is happy. The bank may react to its reduction of rupee liabilities and an increase in dollar liabilities. I have not denied it. It comes after I have done the book purchase.
Now the comparision to the case is different because in the case of government bonds, the transaction is financial and in the case of trade deficits, it is on the current account but I do see a few analogies.
I have nothing against trade deficits – but many things to say about endemic trade deficits. To exaggerate a bit, MMT stand on the sectoral balances is that the domestic private sector and the foreign sector lust to net save in the currency and hence the numbers and Treasuries are alternatives to HPM. Of course, you more than anyone knows the trouble with this and know that it is important to make slices in the private sector instead of treating them as one.
A country is said to be not borrowing from foreigners because … “where did the dollars come from in the first place”. It is this point which sounds intuitive but it leads to a conclusion that a nation cannot be a debtor to the rest of the world if the liabilities are in the same currency. On the other hand, poor nations have to INDUCE foreigners to purchase their IOUs in order to obtain foreign currency to buy some imports. Its also similar in nature to the points about HPM and there being something automatic about the private sector exchanging HPM for Treasuries. Some amount of causalities are also involved. Money is created at the banks but then you have someone mentioning “public private partnership”.
Going back to imports, it may happen that the local bank goes into an overdraft position or is targeting some amount of foreign currency and hence has to induce the foreigners to be offered deposits.
“Alluring foreigners by hook or crook” is not discussed. Instead it is seen as automatic. Similar to the case where the private sector purchases Treasuries.
When I used the phrase “passive”, I did not mean passive in the broad sense. What I meant was that the bank did not have a say in my decision to import. My decision depends on my income and the choices available in front of me. Whatever the bank does happens after that. Amazon is open to sell me the book but its decision was not due to its desire to save in my currency. It got paid in dollars.
It is similar to government bond purchases. If you live in the US and purchase government bonds, neither the HPM nor the bank induced you to purchase government debt. You purchase it and the bank acts passively. It has to do something of course, but it comes later. (Comparing financial transactions with sales and purchases of real goods, but there are some similarities)
Ramanan,
Thanks for your thoughtful response. You put much effort into thinking things through, and I appreciate your references to my earlier comments.
I’m not disagreeing with you so much as probing.
I think MMT describes operations mostly correctly – either as they actually are, or as they might be 🙂
These operational descriptions apply to domestic and international transactions.
There is behavioural complexity beyond that as you say.
“You are arguing the way because you are conditioned in this blog to think like that.”
Yikes. Hope not.
“When I used the phrase “passive”, I did not mean passive in the broad sense. What I meant was that the bank did not have a say in my decision to import. My decision depends on my income and the choices available in front of me. Whatever the bank does happens after that. Amazon is open to sell me the book but its decision was not due to its desire to save in my currency. It got paid in dollars.”
Well, the bank offered you the exchange rate. And in return, it took on a long rupee/short dollar position. You’re happy, and Amazon is happy, but the bank does have a foreign exchange exposure at the margin. It really doesn’t matter if it has a pre-existing gross rupee liability that it offsets. It’s still a net foreign exchange exposure at the margiin. And so it has to pass that hot potato on or absorb it.
Which brings me to another point – it appears in this example that the bank itself is the one doing the “net saving” in the foreign currency, so long as it holds on to the FX exposure. But that’s not the case at all, of course. The bank isn’t saving or net saving. It’s doing financial intermediation, which is not saving. The corollary to this is that, given the correct economic definition of saving, I’m not even sure it’s right to talk in terms of currency specific net saving. The currency specificity shows up in the follow up portfolio adjustment via various types of FX transactions. Those are not net saving transactions per se; they are follow up net and gross portfolio adjustments. And the idea that net saving per se is not currency specific is consistent with the idea that the GDP identities that give rise to the net saving concept ignore the substance of finance and financial intermediation.
P.S.,
You probably noticed this elsewhere from Wray:
“Does MMT apply only to the US–the issuer of international reserve currency? NO. Does US enjoy an advantage? YES. It is not likely that many other nations can run current acct deficits on a sustained basis at 8% of GDP with little impact on the currency. But the analysis I presented still holds. It still takes two to tango. If Mexico runs a trade deficit it supplies pesos to someone willing to hold them. That will continue as long as both sides want to tango. Many currencies have been added to international diversified portfolios (pension funds, sovereign wealth funds)–creating external demand for them that is somewhat similar to demand for the dollar as reserve currency. Those nations can conceivably run persistent trade deficits.”
From: http://moslereconomics.com/2010/07/26/the-political-genius-of-supply-side-economics/comment-page-1/#comment-24348
(Not necessarily an endorsement from me; just fyi)
Sorry, wrong link above.
Correct: http://www.newdeal20.org/2010/08/03/do-deficits-matter-foreign-lending-to-the-treasury-16389/#comment-8073
Anon,
Thanks for some nice words.
“Yikes. Hope not.”
Okay maybe that was about myself till recently 🙂
“The corollary to this is that, given the correct economic definition of saving, I’m not even sure it’s right to talk in terms of currency specific net saving. The currency specificity shows up in the follow up portfolio adjustment via various types of FX transactions.”
Yes – its a bit close to what I was trying to argue.
The reason that arguments such as Chinese saving in the US currency is used to defend the dynamics behind the external world is that its the best example of trade deficits and the US doesn’t have to induce the Chinese. Its forgotten that “alluring foreigners” is important in the discussion, someway or the other. Instead of saying the trade deficit is financed, it is said that Chinese are net saving.
I have some issues with some MMT statements. Its difficult to disagree with the statements but the implications may be differently interpreted. For example, “two to tango” is difficult to disagree with and so is “imports are benefits”… It makes one feel like saying “Yes, but wait … ” .
Yes saw the comment on ND2.0 – the US can run trade deficits for long, but as long as the government doesn’t reduce its fiscal policy, demand will be low. So are imports costs or benefits ?
It’s a bit like saying house prices will increase as long as people keep speculating. But you don’t want it to happen. When it falls its painful. Similarly, the external debt position of a country increases its financial fragility. If it is denominated in foreign currency, the fragility is high. If it is in its own currency, its lower but still there.
Back to your point about currencies. The debate about currencies can go into all debates possible – public debt to central banks to “What is Money”. My definition of the last question is the value is driven by “international acceptance”.
Btw, digression. I found a comment of yours interesting. It was about debt issuance at all maturity instead of issuing 3m T-bills in as much quantity as the public demands and letting the rest remain as reserves. You said that such a strategy was not prudent. I found something on it. It maybe a bit neoclassical but interesting. It is usually said that the government pays a term premium etc. There are many things going on if you think carefully. The government may deflate its public debt because of growth and/or inflation.
This Fed article
Accounting for the federal government’s cost of funds
http://www.chicagofed.org/digital_assets/publications/economic_perspectives/1997/epjulyaug97b.pdf
Not sure what the paper says. But my intuition is somewhat like this. As the nominal numbers increase – both gdp and debt, the government is paying coupon on its previous debts but that debt was smaller. Something like that.
…government doesn’t reduce its fiscal policy
should be
…government doesn’t relax its fiscal policy.
the US can run trade deficits for long, but as long as the government doesn’t reduce its fiscal policy, demand will be low. So are imports costs or benefits ?
It’s a bit like saying house prices will increase as long as people keep speculating. But you don’t want it to happen. When it falls its painful. Similarly, the external debt position of a country increases its financial fragility. If it is denominated in foreign currency, the fragility is high. If it is in its own currency, its lower but still there.
I guess the MMT point is there is no reason for govt. not to relax it’s fiscal policy. Under that stance, and by assuming it is sustainable indefinitely, imports are only benefits. That also means that the debt position of a country, no matter whether external or internal (ESM’s point), but so far as it’s denominated in local currency (MMT prerequisite), does not increase the fragility of the system. Government is speculator of last resort :-). But, as you said before, adjustments may not be smooth and increase in severity. Maybe potentially even more so for the US than for smaller countries that continuously import inflation.
Not that you need any explaining on MMT matters – and certainly not by me. Just a quick recap for my own understanding…
I think the idea is that due to the accounting identity relating the government sector, domestic sector, and external sector, running a persistent imbalance (deficit or surplus) in any of these is eventually going to have consequences in at least one of the others that may lead to instability if this is not corrected by policy changes.
MMT simply says that the consequences depend on conditions relating to real resources and participants’ interests (desires/aversions), as well as shocks and surprises (uncertainty). MMT holds only that accounting identities, which are tautologies, predict the future only insofar as sectoral balances must adjust accordingly.
Government has some control over these changes through monetary and fiscal policy. While a great deal of attention is often paid to cyclical effects like unemployment/price stability, MMT is also concerned with structural effects of economic policy that affect real resources and sectoral balances.
“Under that stance, and by assuming it is sustainable indefinitely, imports are only benefits.”
Big assumption if you are assuming it is not balanced by exports.
The public debt accounting can be manipulated to arrive at an equation.
d(t) – d(t-1) = def(t) – g/(1+g)d(t-1)
This can be refined further to include interest payments to foreigners.
When the public debt/gdp hits 1 or 100%, any deficit above growth rate implies an ever increasing debt/gdp ratio. When a country is importing, it puts a downward pressure on demand and the deficit should atleast be equal to the external imbalance.
So we have a situation where the government does not have enough fiscal room.
An ever increasing public debt/gdp ratio can be sustained as long as the currency markets allow it. At some point however – because debt/gdp ratio keeps increasing – a crisis is likely to be triggered.
again, it matters a lot whether the interest is spent or not spent.
OK, so we have a scenario drawn up by you where the domestic private sector is a perennial net saver (since the deficit is larger than the external balance). So, we have little risk for a Minsky-style crisis in the domestic private sector.
We also have the fact that the govt, as currency issuer under flexible fx, can set the interest on its own debt service, which therefore doesn’t have to rise with the debt ratio. This is the criteria for fiscal sustainablity even in the neoclassical sense. And it holds.
Let’s also assume that these govt deficits have been run in a “functional finance” style, where the economy is maintained at full employment and there is domestic price stability at least to this point, as that is the only type of deficit MMT’ers would be in favor of in the first place. Note also that the fact that imports and interest on the external balance are endogenous simply reduces the multiplier effect of govt deficits–as long as the multiplier effect of govt deficits is >0 there is a finite deficit that would be run in a given year to achieve full employment (that is, Detroit Dan’s comment at the end of RAndy’s ND20 blog is incorrect).
Given those assumptions about the nature of the scenario, you want to now make the assumption that currency markets will “likely” trigger a currency crisis because of the spiraling debt/GDP ratio.
To that we would say, “maybe,” but there would seem to be ample possibility for this not to be the case. The domestic private sector is net saving. The govt’s fiscal position is sustainable even by neoclassical standards. The economy is at full employment with price stability to this point, and absent a crisis like you are suggesting there wouldn’t seem reason for this to change. Given these, it would seem that there is a range of possible outcomes that could rather plausibly include a far more gradual adjustment of the fx in the eventual case that int’l net savings desires change (particularly given flexible fx, so there would be no artificially pegged overvalued fx in the first place to speculate against).
Scott: “ Given these, it would seem that there is a range of possible outcomes that could rather plausibly include a far more gradual adjustment of the fx in the eventual case that int’l net savings desires change (particularly given flexible fx, so there would be no artificially pegged overvalued fx in the first place to speculate against).”
Yes, the way I understand the twin deficit (budget and external) hypothesis is that the resulting domestic surplus will necessarily be inflationary or that currency markets will gag on the debt/GDP ratio, and the correction is liable to be sudden, resulting in crisis.
As Scot observes, with the knowledge of MMT provides, there are no good reasons to expect this, and there are good reasons tthat it is implausible.
Not suggestion that a crisis will be triggered with certainty equal to 1.
Nothing neoclassical really about the equation, though you also say that.
There is price competitiveness as well as non-price competitiveness.
Simply because the exchange rate devalues doesn’t mean that a nation will automatically start net exporting. The monetary dynamics is demand-led but there are supply factors such as wage rate etc. Exports or competitiveness of a nation is a supply factor. During the currency adjustments, quantity adjustment of imports may not be so fast (the J-curve) – people still need to go to the office for work. It detiorates the current account and then you have another round of nervousness in the markets.
Yes there are many possibilities which may happen.
The fact that the central bank can set the interest rates at its discretion doesn’t mean it can set it to anything it wants. Other central banks’ rates are also important. Even in the present world, as opposed to a hypothetical world, the Treasury issues debt at maturities till 30 years in the US and in some nations it is even higher. You cannot expect a central bank to set the interest rates to zero when there are currency problems.
Yes I understand the MMT style argument that import is just a demand leakage and reduces the multiplier effect of the government expenditure. However, increase government expenditure ends up increasing imports as well. This is because imports are reasonably proportional to the national income. The exports – can’t be expected to move if the rest of the world demand isn’t high. When there is some sort of problem, the government has to go into austerity, however brilliant its economists may be.
Here is from Mccombie and Thirlwall’s 1994 book: (Page xxiv)
It has been argued by some commentators that there is no need to be concerned about the current account deficit since the level of overseas borrowing is now determined by the private sector on the basis of commercial calculations about the costs and benefits of such a course of action. The only difference between borrowing domestically and abroad is that a risk premium is attached to the latter because of the volatility of the exchange rate. Any excessive borrowing overseas will be self-correcting as the cost of borrowing rises with an increasing risk premium as the deficit grows. The problem with this argument is that the resulting adjustments are neither smooth nor gradual. As the overseas debt to GDP ratio increases, the world financial markets become increasingly nervous about a collapse in the exchange rate with the consequent capital losses; once the exchange rate starts to fall, speculative actions are likely to be destabilising, leading to a rapid fall in sterling with the possibility of a vicious inflationary-depreciation circle occurring. The use of high interest rates to defend sterling has an externality effect of pushing the domestic economy into recession with adverse effects on investment and employment, even when there is existing unemployment. The Period of floating exchange rates from 1971 saw a number of spectacular examples ot the balance of payments constraining domestic macroeconomic policies. The sterling crisis of 1976 comes readily to mind, when the Labour government’s attempt to reduce unemployment in the face of excess capacity foundered on the balance-of-payments deficit and the collapse of sterling. Between early March and early June 1976, the effective value of sterling fell by a little over 12 per cent. Nevertheless, the government tried to keep interest rates low to encourage an increase in investment. As a result, sterling fell by a further 9 Per cent between early-September and mid-November. The fall in the exchange rate eventually caused a volte-face in economic policy; the minimum lending rate was raised from 9 Per cent in April to 15 Per cent in November 1976 and severe cuts in the PSBR were agreed with the IMP. Other examples include the failure of the ‘Mitterand experiment’ in 1982 at boosting growth, and the problems of the Italian economy during 1980-1981. The 1980s have also shown that even the US is not immune from pressures engendered by a balance-of-payments deficit.
Also http://www.telegraph.co.uk/news/1399693/A-history-of-sterling.html in case there is some confusion if it was fixed.
the cb has then entire term structure of risk free rates under its direct control. not that it fully understands this
fiscal policy can sustain full employment through any crisis
tony seemed to have modified his thinking after I spoke with him, but can’t say he didn’t backslide since.
“Yes I understand the MMT style argument that import is just a demand leakage and reduces the multiplier effect of the government expenditure. However, increase government expenditure ends up increasing imports as well. This is because imports are reasonably proportional to the national income. The exports – can’t be expected to move if the rest of the world demand isn’t high. When there is some sort of problem, the government has to go into austerity, however brilliant its economists may be. ”
It’s not MMT. It’s a standard Keynesian expenditure multiplier from most any Econ 101 textbook. Hold exports constant if you like. If “imports are reasonably proportional to the national income” then that’s the same thing as a fixed marginal propensity to import. All that does is reduce the multiplier. And net interest sent abroad reduces it slightly more. But if the multiplier is still >0, then you still have a finite deficit that can sustain full employment GDP in any given year.
“The fact that the central bank can set the interest rates at its discretion doesn’t mean it can set it to anything it wants. Other central banks’ rates are also important. Even in the present world, as opposed to a hypothetical world, the Treasury issues debt at maturities till 30 years in the US and in some nations it is even higher. You cannot expect a central bank to set the interest rates to zero when there are currency problems. ”
Here, again, you are assuming a currency crisis is already occurring when you just agreed it won’t happen with probability=1. And I wouldn’t grant that you necessarily need to raise the cb’s target rate in the case of a currency crisis, at any rate. (And we’ve read McCombie/Thirlwall, as I noted before, and have never found it convincing or even applicable for the scenarios/policies we are proposing. Quoting them won’t help you if you are trying to convince us. Might help convince others, though.)
Maybe Econ 101. A stock-flow consistent analysis and the Harrod Mutiplier is certainly not Econ 101.
That is okay if it doesn’t convince you or “not applicable to some scenarios”. Good to keep that in mind when you talk about a policy or a proposal to someone. More than a proposal, a lot of people are interested in the description.
“Here, again, you are assuming a currency crisis is already occurring when you just agreed it won’t happen with probability=1.”
I said “Not suggesting that a crisis will be triggered with certainty equal to 1.” which means I won’t be betting a farm on a currency crisis. Is not supposed to be taken as “it won’t happen”. Was talking of “in-liers” in that context.
You’d get the same result in an SFC model. SFC models like Godley/Lavoie have the same sort of multipliers. Fairmodel does, too, just with more variables.
Thats okay. Just saying such things are not Econ 101. And most of the models – including the Keynesian multiplier – assume perfect foresight. So one doesn’t know if they are correct. When you do not use perfect foresight, you get similar results in the long run but there are many differences.
Ramanan or to anybody else of similar expertise. It seems I often read that Chinese and other countries who run trade surpluses with the US are collecting their US$ not primarily as potential claims on future US output or equity but to secure access to future energy reserves by the oil producing countries, most of which only export in exchange for US$, although I understand some have changed to Euro lately.
If there is any merit to this story (is there?), this would mean that oil is a main, if not the main driving factor behind the US CA imbalance. What would change if the oil and gas exporters could be somehow forced to accept more than one currency, say Yuan, Yen, Euro, US$, GBP, etc? Would that work or help? Is that what’s behind the idea to have a basket of currencies as global reserve instead of the US$? Is the word reserve currency actually a euphemism for oil-reserve currency? And if so, is there any plausible way to achieve this and wouldn’t that eliminate the need for a reserve currency altogether? Or am I hallucinating up the wrong tree?
thanks
Oliver,
Good points.
Nations try to run trade surpluses to avoid any issues with their ‘balance of payments’. Many countries have the resources but do not grow well because they run into a balance of payments crisis. To avoid any such issues, developing nations have adopted the strategy of export-led growth. One tends to think of Chinese accumulating US dollars in exchange for their products. However, it is forgotten that it creates higher incomes in their currency as well.
I do not know international trade well to comment if oil is the main hindrance etc. It is possible. Looks like that to me. If that is the case, alternative sources can be a big driver of growth.
I guess if the accumulation of US$ assets is primarily to support employment at home, the oil is less of a factor. Energy exporting nations would have to be forced to accept only the currency of the buying nation to have any effect. Doesn’t sound very realistic to me. Oh well…
Its both. The developing nations acquires dollars and improves employment. There is a catch however, the government keeps the demand low and its not so straightforward.
Henry C. K. Liu thinks that this is a pillar of dollar hegemony. It also is a feature of Petrodollar warfare. Trouble with this rationale now is that according to it the US should be pursuing a strong dollar to keep petro-import cost low. But the Bush administration jawboned a strong dollar and instead weakened it and left the Obama administration no wiggle room to strengthen it by decreasing deficits.
Increasingly scarce vital resources are an important supply-side factor in the structural problem that the global economy is facing, although the chief factor is demand. Stirling Newberry looks at this here.
The world is also growing short of formerly abundant natural resources like water and land owing to climate change. This is going to have as great an impact as shortages of vital resources. For example, in the not to distant future it is projected that 10% of Mexicans will have to emigrate to the US to survive. Similarly, a lot of nations in the area of the Sahara will have to emigrate, too. This will put pressure on the both North American and Europe to absorb them.
From what I can gather, technology is not yet available to deal with the scale of the problem. So something’s gotta give, and that often means war.
Not to worry, though. The Pentagon is out in front on this and has been gearing up. I kid you not.
Thanks for the Newberry link, but it’s nothing more than a rambling screed. I still don’t understand why liberals are so upset with Bush’s budget deficits. We’re running deficits 3x higher currently, and they’re still not high enough. Well, actually, I do understand. They didn’t like the modest tax cuts for the “wealthy.” But continuing to frame the tax cuts as causing irresponsibly large budget deficits is completely dishonest.
The point that I was interested in is the relation between the value of the dollar and the price of oil in dollars. For example, as the US allowed the dollar to fall, the price of oil doubled, raising the cost of fuel in the US, which ate up the stimulus. If the price of oil had remained where it was while the numbers were being computed, the stim would have been a lot bigger in real terms. What Newberry is claiming is that deficits do matter with respect to the value of the dollar relative to oil, since the Saudis control price and set price in relation to changes in the value of the dollar. As long as the US remains petro-dependent with a suburban commuting economy, then domestic fiscal policy is affected by deficits, which affect the value of the dollar relative to oil.
“The world is also growing short of formerly abundant natural resources like water and land owing to climate change. This is going to have as great an impact as shortages of vital resources. For example, in the not to distant future it is projected that 10% of Mexicans will have to emigrate to the US to survive. Similarly, a lot of nations in the area of the Sahara will have to emigrate, too. This will put pressure on the both North American and Europe to absorb them.”
what a load of crap
Life is a crap-shoot. Place your bets. Those who see inflation as imminent are short long bonds and long gold/equities. Those who see deflation coming are long cash/bonds and short equities.
Similarly, if you think climate change is in the cards, you are getting out of places where water shortages are predicted and buying where water will still be available. If you think that’s crap, you are buying up all that cheap RE in Phoenix.
that’s right toms hickey. tribespeople who scratch together living in saharan africa are saying “oh global warming so bad! sahara was verdant field just two years ago”.
And those poor mexicans. never mind that mexico is run like crap, and has huge murder rate. it is warmer summer that will make them move to US or they will die.
I guess this mean that anyone who move from Boston, where it is cold, to Arizona where it is warm, instantly dies as well, because if temperature goes up by 2 degrees it becomes uninhabitable by humans.
Tell me Tom, can people who live in chicago live in Boston, or will they die the minute they step off plane into Logan because heat kills them?
Zanon, there are two major effects to consider if the planet warms. One is the effect resources such as water as glaciers that supply the major rivers melt and water sources decrease and eventually dry up.
Secondly, the temperature quoted is a mean, and swings can be large. Humans cannot survive if the temperature rises too high. The elderly, frail, and children are affected first, then everyone.
Toms Hickey: Please go live in Chicago in February and then take plane to Mexico. You will see dramatic temperature swing but I think you will survive experiene.
Or go live in Chicago in February and stick around until August. Once again, temperature swing will be dramatic and people seem to survive it just fine.
I believe both old people and young baby are alive and well in both Chicago and Mexico. Some even travel between them and manage to not die as they go from -20 to 90 degrees.
As for water being scarce resource, sure it is. So price it higher and conserve it more. It is wasted big time now. And we have no idea if global warming net make planet wetter or drier.
i have lived in places very abundant with water and places that are very dry. they are different but both perfectly habitable.
Zanon, this is about the science, not anecdotal evidence. But if you want to focus on anecdotal evidence, what about the glaciers that are melting worldwide. I’m quite sure that Ramanan will tell that India is acutely aware of this, and the water shortages that are already in evidence there.
Tom Hickey:
If global warming was about science i would take it more serious. it is about 1) money, 2) computer model, 3) fake data. I guess you did not hear about “scientist” using “tricks to hide the decline”.
i know what science is from personal experience unfortunate for you. it is something that you can do experiments to falsify. Global warming fails this simple thing. it is cargo cult.
And I am very well acquanted with probelsm subcontinent has with water. pakistan is in generation flood right now. Some of us have traveled farther. Ramanan would also tell you india has all sorts of problems for quite some time and currently have bigger issues than whether temperature 0.5C hotter in 50 years.
i point out very simple fact which is, human being happily exist at vastly different temperature. Chicago, Boston, DC, Miami all have human.
The guess for global warming is smaller than flight from Chicago to Boston. But for some reason, activity that people do every day with no issue becomes fatal when 1) simulated on garbage computer and 2) made much smaller
it is nonsense. it also has nothing to do with MMT but you are just one brainless gusher of noam chomsky regurgitation. can you use bathroom without screaming “dollar hegemony” as you seem incapable to doing anything else without it? why don’t you save this drivel for kos
Tom, North America has sufficient energy and water resources, the constraints are solely political. It means taxing gasoline and subsidizing synthetic petroleum production. At least a third of US oil imports could be replaced simply by the US Government retrofitting existing coal plants with the same Fischer-Tropsch technology used by Nazi Germany and Apartheid South Africa (there are newer, less water-intenstive technologies such as Global Resources Corp.’s microwave process).
http://www.fischer-tropsch.org/DOE/_conf_proc/USDOE-INDLIQ/91010533/de91010533_gray.pdf
Electrifying the US rail network and cutting petroleum use with a 55 mph speed limit, expanding mass transit, car pools usage,telecommuting increasing auto fuel efficiency and alternative fuel usage could fill the other two-thirds of oil imports. Of course, the more nuclear plants we have (the Navy could build them out and sell the power just as the Army builds dams and sells the hydropower), the larger fraction of coal that can go to synthetic fuel.
The other key resource is water and the political constraint involves our neighbor to the North. The greatest infrastructure proposal of the 1960’s (oh who are we kidding, of all time!), The North American Water and Power Alliance, would provide Canada, the US and Mexico more fresh water than what we’d know what to do with (but we can leave that problem to our children and grandchildren to figure out). To get from here to there will involve bribing our Canadian friends into cooperation. I direct your attention to the most awesome youtube video ever.
“I guess you did not hear about “scientist” using “tricks to hide the decline”.”
You are behind the times. That was investigated and debunked.
Beowulf, I am not saying that the world will end. I am saying that the world as we know it will end. There are deep resource constraints that will force profound structural changes.
Americans, especially on the right, hate the idea of conservation, for example. They think that the world has unlimited resources that human can use as they want without consequences. That is not true, and prices will begin reflecting it. Americans can adapt to higher gas prices, but that will have a wide-reaching effect on nominal aggregate demand, with less left for discretionary spending and saving. Of course, the economy and lifestyles will adjust, but even $5 gas would mean big changes. There is a reason that all available tankers are filled with crude, waiting for the price to rise. There is also a reason that China is buying up prime farmland in Africa. The handwriting is on the wall.
I am a proponent of Bucky Fuller’s idea that there are plenty of resources to go around and make life plentiful if humanity uses them wisely, IAW existing knowledge and technology, and continues to innovate as population grows. Of course, this would involve eliminating waste, too.
The US (5%) cannot continue to use a quarter of the world’s energy permanently. BTW, the Chinese just surpassed the US as the #1 energy user. Now we have two US’s. This is going to lead to pressure that will induce change economically and politically. The Pentagon recently announced that the Chinese have developed a missile that is precise enough to take out super-carriers, and this has denied the US of control of the seas. Lots happening these days. And then there is India coming on line very quickly, too.
I am not saying that we cannot work this out. I am just saying that it is unlikely that we will do so in a way that doesn’t change present practices dramatically. I also think that this is going to happen in fits and starts, and there will be a lot of challenges on the way, since old patterns will be difficult to break and vested interests will stand in the way of change. But we are headed toward “one planet, one people.”
debunking has been debunked
As I pointed out elsewhere on this thread, the currency in which a product is denominated (oil was my example in fact) is of no consequence. Changing the payable currency only means that fx trading desks will end up dealing with different people.
I think that a lot of people here are missing the forest for the trees when discussing foreign trade. Expanding a closed/domestic economy to include another person who we will call ROW doesn’t really change any of the MMT analysis. ROW may be big, he may be very productive, he may have large savings desire, and he may have an easier time avoiding tax obligations (although maybe not since he can be taxed on anything he sells or anything he buys), but I can’t see any way in which he would affect the situation in a fundamental way.
In its deals with ROW the US finds its currency value rising, falling, or remaining stable relatively, depending on changes in trade balances. When the dollar falls, petroleum rises and, since energy is the motor of the economy, all petro-dependent prices rise eventually, but fuel price increases almost immediately. This is the present fear about a fragile recovery that will be strangled by rising fuel costs. As far as I can tell, economists are chiefly concerned by deflation, on one hand, and fuel prices strangling recovery, on the other.
The status of the dollar as global reserve currency and de facto global numeraire is also a factor that distinguishes it from other currencies. While it is true that everything is immediately exchangeable into everything else in the highly liquid fx markets, the dollar does play a special role in the current monetary system, entailing advantages and disadvantages.
Even granting that there is no great monetary/economic difference among currencies, global politics thinks that there is, and right now it is becoming a hot button issue that is leading to dissension and calls for change.
So I don’t think that this is something that can be shrugged off as irrelevant.
Suppose that the only country in the world is the US. And then suppose that we let Texas and Alaska secede from the union and create a new country called ROW. How would things change economically? Would things change economically?
Well, ROW would not be using all the petroleum that the US is now, so we are presuming an economy running on a different source of transportable energy. Texas is out of oil and Alaska doesn’t have enough. That would mean that the US would likely be using some combination of natural gas, coal, solar, wind, tide, geothermal and nuclear energy, and petroleum would be scarce and expensive, used only for high priority reasons. Some natural gas would be have to be imported, too, since TX now supplies about 30%. AK and TX would have to survive largely by exporting oil and natural gas, so it would be necessary for them to keep prices as high as possible by regulating supply.
Things would definitely change economically, since suburbia depends on abundant, cheap transportable energy. The trend would be toward higher prices and greater conservation of transportable energy through a variety of measures. For one thing, a lot more people would not be commuting to the office with one or two people in the car.
There would be deep structural changes in the economy to adjust to energy needs and pricing. This could be accomplished wisely through the development and deployment of alternative energy technology, or not so wisely, by relying mostly on carbon, chiefly coal, and nuclear.
ESM: This is excellent example.
Terms of trade between US ex-TA, T, and A may get better or worse depending on bargaining power of those two against US ex-TA.
For example, of T and A collude, they can do better. If US ex-TA can play T and A against each other, the maybe US ex-TA do better.
Also, movement of dollar by itself tell you nothing about oil price in dollar. Dollar may fall because economy go to hell, oil consumption fall, oil price fall. or dollar may fall but oil price go up. Or Saudi change plan, dollar stable, oil go up or down depending. There are many factor.
I am with ESM.
Let me a bit more specific about my hypothetical. The world consists of the United States and some oceans and that’s it. There is enough oil and other stuff being produced such that our standard of living is roughly equal to that which we currently enjoy (perhaps it is 10% lower because we don’t have hundreds of millions of workers in developing countries slaving away on our behalf — but it’s comparable). Most of the oil being produced, however, comes from Texas and Alaska. Of course, most of the wheat and corn being produced comes from the Midwestern states, cheese mostly comes from Wisconsin, and most of the cranberries come from Massachusetts.
Texas and Alaska secede from the union, form a country, and call themselves ROW. They form a republic and perhaps even create their own fiat currency. My question is, what has changed from an MMT perspective for the rump United States? My claim is “not much.”
Alaskans and Texans aren’t subject to income and property taxes imposed by the US, but the US dollar is still valuable to its residents/citizens for the same reason that tax-exempt people in the US still find the dollar valuable. They will still trade goods and services for dollars. So has anything changed? Do we care about the trade deficit the US runs with the new country of ROW any more than we cared about the trade deficit run between the other 48 states and Texas and Alaska prior to secession?
And I am contending that this doesn’t have as much to do with price as it does with the availability of real resources.
Toms Hickey: Yes
ESM: So, what will negotiating position of ROW be vs US? What terms of trade will there be? Will ROW collude and jack up price? Or will it be divided and conquered?
That is the dynamic that changes.
But trade deficit is just as it is now — demand leakage that should be plugged up by less taxes/more spending
ESM
Currently, the US as I see it, faces 2 opposing forces within the ROW. There are the competing producers who are trying to sell the US manufactured goods to prop up their domestic labour markets and / or hoard petrodollars. Among these, especially China has been accused of keeping its prices artificially low. This puts pressure on the US to keep its own currency cheap, if it wishes to counteract that tendency. The other group consists of those countries that run the monopoly racket of selling their carbon resources. Since the US is dependent on them, it is in its own interest to keep the US$ high. The question is, if the need for the exporting countries to accumulate $ were reduced because they could use their own currency to buy oil, could the US then focus on raising their purchasing power without constantly driving up the trade deficit? The answer depends on the exact motives of the exporting countries to accumulate US$. And a further question, possibly the more important one, is whether the demise of the status as global reserve currency would not put stronger downward pressure on the US$ than all others factors together?
I may be missing 99% of everything that makes up the fx business, but just lumping the ROW into one big black box and saying it doesn’t matter seems very crude (pardon the pun) to me.
“I may be missing 99% of everything that makes up the fx business, but just lumping the ROW into one big black box and saying it doesn’t matter seems very crude (pardon the pun) to me.”
Well, that’s what I’m driving at Oliver. I’m using my “crude”/toy example to determine why or how the ROW is different from Texas, or from Bill Gates, or from the Mashantucket Pequot tribe that runs Foxwoods casino. Ramanan keeps arguing (without any evidence that I can see) that a closed, domestic economy is different from an open economy that has foreign trade.
When you and Tom and even Zanon talk about terms of trade and oil this and oil that and dollar hegemony, I think it is missing the forest for the trees.
Let’s try to simplify ROW into a single entity that is part of our domestic economy. ROW is very, very rich. ROW is very, very productive. ROW produces $1.7T of goods and services a year and sells them to other people in the US, and ROW purchases $1T of goods and services from other people in the US. ROW is happy (for his own reasons — perhaps he wants to be #1 on the Forbes 400 Richest People List) to accumulate $700B of net financial assets per year.
Does it make you feel any better if ROW is a United States resident? A citizen? A person, corporation, or a state subject to the jurisdiction of the US? If so, why? If not, then why aren’t we worried about the various trade deficits among and between US states, or US cities, or US neighborhoods, or US families?
I just wanted to address your comments on oil briefly. As Warren has pointed out many times, Saudi Arabia has modest control over the world price of oil (not total control — they couldn’t make it $300 per barrel or $30 either). It is not a monopoly producer, but it is a swing producer. This situation arises in many areas of the economy, and there is nothing special about the oil market. Oil is an extremely versatile commodity. Almost any kind of oil can be extracted, transported, and refined (for a price!) and the refined products can be uses in thousands of different ways (with varying opportunity costs). As such, oil is an elastic commodity, and world demand and supply will adjust fairly quickly to create balance and alleviate shortages. I am not concerned one iota about running out of oil. We will not run out. The price instead will rise and new (now economically feasible) methods of extraction will be employed, and on the demand side there will be (now economically feasible) substitution. Sure, our standard of living will decline as the price rises, but oil consumption is less than 5% of our GDP, so how big an effect can it really be?
I am no fan of the Saudis, but I do not begrudge them their swing producer status. I only wish that we would tax oil appropriately to pay for the free protection our navy is giving the super oil tankers as they ply the Persian Gulf.
Zanan,
Didn’t mean to lump you in with the others as missing the forest for the trees. The collusion aspect is an important consideration for the secession example. Presumably, the US government has the power to prevent collusion for residents under its jurisidiction, although I believe that power is limited. In any case, in the real world ROW is made up of hundreds of different countries, so collusion is probably impossible, although obviously legal. In reality, ROW is colluding to keep the dollar strong, so in fact they are colluding to give us better terms of trade. I doubt that Texas/Alaska would be quite so dumb.
“Ramanan keeps arguing (without any evidence that I can see) that a closed, domestic economy is different from an open economy that has foreign trade.”
The point is if I give out examples, someone will drop a news item showing that the central bank tried to intervene etc and it was not a floating currency.
The point is that if I give out example, it will be told that the government didn’t relax its fiscal policy etc.
The economic system is not so straightforward. There are a lot of smart people out there working in central banks who haven’t figured out things.
The point is that I will be told that its gold-standard thinking. Here is something to surprise you – money was not exogenous in the gold-standard era!
ESM: I brought up collusion simply because negotiating power alters terms of trade, which is real consequence of what is in US and what is in ROW (in your example).
In real life, this is reflected by questions like — how powerful is OPEC? ASEAN? Eurozone vs individual europe state? All may impact real ToT.
But, it is the real ToT channel that is material, not anything else. We are agree.
Ramanan,
My central point is that the consequences of the US trading with a foreign country which behaves in a mercantilist fashion is indistinguishable from an increase in savings desire from people in Texas because, for example, Texas created tax-advantaged retirement accounts, or because it enacted a hefty sales tax.
You care if the Chinese create aggregate demand leakage for the US economy, but you don’t care if Texans do. Why is that?
Zanon has pointed to the fact that the federal government can at least stop people in Texas from colluding in order to raise the prices of goods and services they offer to people in the rest of the US. This is true to some extent, but that hasn’t stopped states from subsidizing the purchase of certain goods and services by its own citizens (which is equivalent to raising the price for goods and services for out-of-staters). Also, I think it is hard for the ROW to collude in such a way to hurt our terms of trade. It is somewhat easier for them to collude to help our terms of trade!
Another possible point you can make is that there is freedom to relocate within the US. So people are free to move from Michigan to Texas if Texas is running a big current account surplus and all of the jobs move there.
Are those the distinctions you think are important?
As to the existence of endogenous money under a gold standard, of course, money is credit and anybody can create credit. I even think Warren makes too much of the insolvency vs inflation distinction.
Under a gold standard, the risk is that the ability or the will of the government to maintain a fixed ratio between a dollar and an ounce of gold will be undermined. As the government’s creditworthiness decreases, the value of a dollar drops versus gold. We say that the dollar is dropping because of the risk of insolvency, but is that really distinguishable from the risk of inflation from the government spending too much and taxing too little? The really important difference, of course, is that under a gold standard the value of a dollar is tied to the supply and demand of a stupid, useless, yellow piece of metal rather than the aggregate demand for goods and services and the capacity of the economy to produce those goods and services.
“But, it is the real ToT channel that is material, not anything else. We are agree.”
Yes, this was Newberry’s point in the post I cited.
Availability of resources in not growing proportionally to global demand, especially when the global economy begins to recover. China and India are already coming on line and other large countries will follow in the not distant future.
This is has three significant effects. First, when supplies are tight, even marginal producers have price-setting power. Secondly, China is cornering supply for its own use through ownership contracts, and restricting exports of vital resources like rare metals necessary to technology. Thirdly, the existing structure of the US economy is dependent on vital resources, like oil, that must be imported. As far as the US goes, this is going to mean profound structural changes, involving reduction or standard living, drastic change of lifestyle away from the wasteful consumer society, or technological innovation that produces less expensive resources, especially energy.
This is not just an adjustment in the fx market, where altered prices of resolve the distributional problem. The US cannot afford to run a consumer-oriented, suburban-based society on $10-15 per gallon gasoline without making drastic and wide-spread changes. Rare metals are essential to much of the cutting edge consumer electronics. Etc.
This is not to mention the externalities associated with carbon-based fuel. Leaving climate change aside, air pollution is becoming increasingly menacing and costly to health. When this is included the true price of carbon-based fuels are much higher. And that’s not considering the cost of the free protection service that the Pentagon provides to US industry, especially the energy industry, either.
“Thirdly, the existing structure of the US economy is dependent on vital resources, like oil, that must be imported. As far as the US goes, this is going to mean profound structural changes, involving reduction or standard living, drastic change of lifestyle away from the wasteful consumer society, or technological innovation that produces less expensive resources, especially energy.”
No offense, but this is just completely wrong. The US economy isn’t dependent on anything except the Constitution, the rule of law, and competent government. And two out of three ain’t bad.
Our standard of living is not going down. It is going up. It would go up faster if somebody in power understood the slightest thing about MMT and if Congress would pass a payroll tax holiday and then go on holiday itself, but it’s still going to go up fairly rapidly over time. The fact that 400MM formerly unproductive Chinese are now extremely productive is a blessing for them and for us.
“The US cannot afford to run a consumer-oriented, suburban-based society on $10-15 per gallon gasoline without making drastic and wide-spread changes. Rare metals are essential to much of the cutting edge consumer electronics. Etc.”
I think as little as five years ago, most people thought the US couldn’t tolerate $3.5/gallon gas either. Go figure. Gasoline isn’t going to $10-15/gallon any time soon, but you know what, it wouldn’t even be that big a deal. We’d drive less, use more public transportation, bicycle and walk more, and within a few years you would start to see articles in the NY Times about how much money we’re saving on health care costs because everybody is so much healthier.
Your pessimism reminds me of the people who fretted about overpopulation in the 1960s or global cooling in the 1970s or global warming in the 2000s.
with $15 gas is the govt would scream ‘inflation’ and the ‘cure’ would be the real problem
ESM, I admire your optimism, but obviously I think you have your head in the sand. We’ll see.
I do have my head in the sand. I’m expecting to find oil. :^P
and wind up eating the sandwiches (sand which is) there…
🙂
Strawman,
Still deciding if I should appreciate your sense of humor
All I know is a couple years back the chinese tried to buy some interests in an american oil company and was told no, I think it had something to do with national security. So what good is all these US notes and IOU’s and promises to pay, when you go to buy stuff they say nope, we aren’t taking your cash? Now if the chinese had been smart, they would have used thousands of shell companies and organizations to accumulate the control they were wanting and then staffed it with chinese loyalist businessmen.
I mean really, think about it, folks like bernie madoff had whistleblowers exposing him left and right and nobody did anything, he was able to sucker lots of government types, but the chinese try to go in and buy some oil company and the national alarm bells go off everywhere, they could have been much smarter about that and employed more deception and subterfuge, pathetic, a nation of 1 billion people trumped by madoff 🙁 The chinese and saudis can accumulate hundreds of trillions of our IOU’s, but that does not gaurantee that the future purchasing power of that stash will buy a bridge in brooklyn does it?
As Warren has repeatedly pointed out, it is the guy with the gun to your head wanting warren’s business cards that is your real problem, and I don’t see any chinese or saudis holding a gun to my head, no matter how much of a sucker I make out of them with IOU’s they will never collect on. Until our military is dwarfed by the sauds or the chinese, I am gonna sit back and take it easy.
http://www.businessinsider.com/foreign-ownership-of-us-assets-2010-8
Ramanan, it doesn’t look so bad. If we are gonna leave those Russia, China guys holding the bag, we got to get them to buy more paper from us than it looks like they have.
Ramanan: “The MMT argument about trade deficits interprets the sectoral balances identity as govt deficit = domestic private sector net saving + saving of the rest of the world in that currency and gives it the behavioural dynamic – trade deficit (the second term) is because of the net saving desire of the rest of the world in that *currency*. The foreigners may not be net saving in your currency. The adjustment may happen because you lose foreign currency. Even at this accounting level there are some ambiguities. Add behaviour and you end up meeting all kinds of complexities.”
This is the crux of it. The accounting identities are not in question. It’s what happens in the real world with real resources involving real people.
While the accounting identities are universal, data differs widely different over time and space. Data is condition-dependent, and it is not possible to generalize about shifting conditions over time in one place, let alone in different areas.
The relevant accounting identities force certain changes relative to conditions, so that it is not possible to prescribe a universal solution or to assume that the change that accounting identities force will be practical. Countries have gone to war because of “accounting identities.”
It seems to me that assuming the fx market will maintain equilibrium at optimal efficiency is naive when it’s obviously not happening. One can say that it’s an imperfect market because not all countries are running floating currencies or are otherwise gaming the system.
But that is pretty smilar to the neoliberal claims about free markets as the equilibrium solution when markets are imperfect. Why would one ever presume that markets will become perfect at some time in the future? We have to deal with existing conditions. Indeed, when government are involved, as they necessarily are, markets are never perfect. So why go on about in-built automatic self-correction? Am I missing something here?
Dropped a longish comment here – if someone’s interested. My continuous attack on MMT 🙂
http://bilbo.economicoutlook.net/blog/?p=11057&cpage=1#comment-8926
Ramanan,
You write:
“Its easy to see now how interest paid to foreigners is a burden even though interest income paid by the government to its citizens is not!”
It isn’t easy for me to see. Can you explain? Why is it not a burden for the government to pay interest to Bill Gates, but it is to pay interest to Li Ka-Shing?
ESM,
Complicated I think. When interest is paid to citizens, they consume a part of it keeping the circular flow of income in good shape. Of course, rentiers may hoard a lot of money and hence you see a lot of talk about taxing the money hoarders.
I think that’s getting closer to the actual problem – if indeed it is a problem. It isn’t nationality but propensity to spend and savings preferences that influence the path of debt issuance. The question is, how can one target specific large lumps of hoarded money, black holes as Tom Hickey likes to call them. without impeding savings desires of others? I have a feeling there is no ‘one size fits all’ solution. One would probably need something like a progressive savings tax on govt. papers on a per person / legal entity basis. Probably complicated and I guess Warren would prefer taxing consumption / hoarding of real resources instead.
Ramanan,
I’m still having problems in understanding exactly what you’re criticizing.
Can you point me to a particular MMT blog that says fiat currency issuers can’t experience foreign exchange crises?
(as far as I can tell, that seems to be the implication of your criticism)
There’s no difference in the “burden” of government interest paid to domestics and foreigns. Both represent non government saving. That IS just accounting.
Isn’t coupon payments a burden for a corporation ? Its saving for some other sector, if one wants to look at it that way. That logic can be used to argue that there is no such thing as burden. Growing external debt matters for a nation matters for the same reason as it matters for an organization – it generates a growing debt burden.
Of course, you can argue – if the debt is in its own currency – whats the problem ? In other words, one can service the debt by being more indebted. And the creditor is bound to accept payments in the debtor’s currency because that was in the contract. But such things cannot continue forever because there is an assumption that nothing happens to the value of the currency or that it changes smoothly.
The reason the coupon payments are a burden for a nation is because they include private sector payments in addition to government payments. In other words, there would be no burden if the government were the only issuer of debt to the foreign sector – no burden in the sense that insolvency or default to the foreign sector would be a voluntary choice – and that would show up in the exchange rate. It is the mix of government and non-government liabilities that introduces the risk problem for the foreign sector.
That’s reality, but again, where does MMT deny this? Who is saying what specifically that you are criticizing?
And who is saying that the currency always changes smoothly? Where’s the blog on that?
right,
I always say it changes continuously.
My bringing in “organization” is for analogy purposes only. I am saying that interest payments to foreigners on government debt is also a burden 🙂
Why? How? How can you possibly say its a problem without referencing the portfolio effect of private sector liabilities to foreigners? In other words, in my imaginary scenario where foreigners only hold government liabilities, how could it possibly be a problem?
MMT allows that fiat currency issuers can default voluntarily under hyperinflation.
So it should allow for that default as well if foreigners only hold government bonds. And the hyperinflation risk will show up both in bond yields and the fx rate.
It’s consistent. Where’s the problem?
fiat currency issuers can default voluntarily anytime. the US congress voted to default in the mid 90’s and only Ruben’s ‘finding’ some funds somewhere prevented it.
and under hyper inflation govts rarely default and investors don’t care anyway as the debt isn’t worth enough to fool with.
Anon,
Okay, one can come up with “where did we say that?” However you keep finding statements “exports are a cost” etc.
Its about the whole dynamics. There is no statement anywhere that a nation cannot keep running trade deficits and that it has to return to balance. It sounds neoclassical, but I suspect the opposition is simply because it sounds neoclassical. Yes MMTers would say that they never said that the currency moves smoothly, but they haven’t described the dynamics either. It moves in complicated ways of course, but a result of imbalances is a depreciation of the currency someday or the other. That brings in imported inflation but MMT says one time price rise.
In the case of the US, the current account is never blamed – just the government policy on fiscal deficits with statements such as imports are benefits.
Interest on government debt is a burden because as a nation, the income is less than the expenditures. Of course, the argument there would be – government can increase the income through fiscal policy etc. Such a strategy leads to an increase in national income of course, but because it widens the trade deficit, and leads to a greater indebtedness to the rest of the world. But then there is an argument that its saving for the rest of the world and that imports are benefits and that the government just credits the bank account 🙂
No attention is paid whatsoever to what happens to the value of the currency. Try to imagine the above situation in your head and keep track of all the variables. Difficult, but worth the try.
for the US the real burden is when foreigner’s income is spent on US goods and services.
like servicing all those foreign tourists.
a long time ago i remarked that it’s all over when US peasants are selling trinkets to foreign tourists.
“that it has to return to balance”
well, that’s just outright false as a generalization
there’s nothing preventing a nation from running a perpetual current account deficit of sufficiently modest arithmetic proportions in comparison to its economic growth rate
one works specific nation cases and specific arithmetic proportions and specific combinations of trade and service deficit back from that generalization
but there’s nothing sacrosanct in general about returning to balance per se
btw, exports are a real cost is just the tautological inverse of exports are a monetary benefit
Anon,
I will take a break on this because our hosts will be seriously upset because i) It diverts attention from other discussions & ii)they may think that I have gone crazy.
Yes I agree with you about “perpetual current account deficit of …”. If you see the discussions above, there was a G&L paper which showed this. However, I think that these examples are exceptional. It does not happen with numbers we see in the real world. Don’t ask for a proof. In their paper as well, they have made some assumptions, which of course, they are aware of very well.
“they may think that I have gone crazy”
a little late to be worried about that isn’t it?
🙂
OK, break quite understandable
Although I thought you might be turning this into “Ramanan’s longest”
Bottom line is I think there are some basic generalizations that are specific to CA deficits, but far more specificity is required beyoind that than is the case for closed economy budget deficits. So I agree with the thrust of your thesis; just that one can still extract some basic MMT tautologies in the case of CA deficits as well, which must then be put in context of economy specific details.
Anon: Bottom line is I think there are some basic generalizations that are specific to CA deficits, but far more specificity is required beyoind that than is the case for closed economy budget deficits. So I agree with the thrust of your thesis; just that one can still extract some basic MMT tautologies in the case of CA deficits as well, which must then be put in context of economy specific details.
Here is what I posted over billyblog on this:
In defense of Ramanan, he has been investigating this for some time and has brought some interesting points to the table in previous posts. I believe that he has legitimate questions. They are not unique to him, although he has ferreted them out.
A basic question is over the contention that floating rates function automatically to adjust currency relationships without creating “stress” that can manifest in a variety of ways. “Stress” is intended here in the broad sense of economic, financial, or political difficulties. Ramanan has specified previously that he regards this eventuality as unlikely in the case of a country like the US in the near term, but it is a constant concern of more weakly positioned countries, which have to obtain foreign reserves to pay for vital imports, for example, and therefore they have to defend the exchange value of their currencies. Consequently, their internal policy is limited by external concerns even though they may be monetarily sovereign issuers of a nonconvertible floating rate currency.
I have also questioned whether fx markets adjustments are always automatic and orderly. This seems to me to be akin to the neoliberal assumptions about “free” markets clearing seamlessly. This is basically the neoliberal claim about “free” trade and “free” capital flows being guided by “the invisible hand” of the market.
I am not claiming that adjustments aren’t always automatic, but it seems to be a theoretical assumption that they are, since it is neither contradictory to hold that they are not, nor a tautology to hold that they are, at least as far as I can tell. What is the justification for these assumptions? The international asepct of MMT is something that I don’t understand sufficiently and would appreciate an explanation, or being pointed to a reference.
more important, you have all more than held your own and clearly prevailed against the most intense inquiry possible.
it’s all downhill from here!
congrats!!!
Tom Hickey,
Seems like a very fair summary, thanks.
“I have also questioned whether fx markets adjustments are always automatic and orderly.”
Is that in fact an inherent MMT assumption? Does MMT in fact deny that currency markets may exhibit disorderly discontinuities? It doesn’t seem realistic or even necessary for MMT to assume that. And that’s what I’m not clear on.
Anon,
Back from hibernation on this issue 🙂 Else someone may say “Ramanan is assuming that we think …”
However, it is precisely my problem – just when there are “disorderly discontinuities” – fiscal policy has to go in reverse gear. This is because of the “stress” Tom has highlighted. And the debtor nation has to make promises to its creditors whether MMT recommends it or not.
There is nothing called “pure float”. One way or the other you are indicating something.
Raghuram Rajan addresses global imbalances here. He sees the present imbalance as resulting from imbalanced domestic policy is the various countries, which they need to get in order. The problem is that these policies are not simply ill-conceived, they are designed to favor special interets in those countries.
What he doesn’t say is that this results in extending dollar hegemony, which has been benefitting the elites in the countries involved. While it has been enriching Chinese and Western elites, it has come at the expense of hollowing out the US economy and turning Chinese workers into serfs.
The current world situation is the result of the GFC; hence, I don’t think that domestic economies can be looked at separately from the global economy anymore. This is becoming an increasingly interdependent world, and what happens in one country or region affects everyone else, often profoundly.
When we speak of deficits and debt, we are speaking about numbers. But behind those numbers are data relating to real resources and real people. MMT is correct in saying that it is not the numbers that are concerning, it is the effect on real real resources and real people that is concerning.
When domestic economies are running effectively and efficiently, then their economic relations sum to the global economy, which is also running effectively and efficiently in advancing human purpose, i.e., survival and progress.
I think that we need to spend less time being concerned about the numbers and ratios as such and more about what they imply about real situations affecting people, especially when policy decisions affect people that are far-removed from the decision-making process and have no recourse. For example, when the world price of wheat increases quickly and dramatically, millions of people go hungry and many starve to death. As far as I can see economists, politicians, business and financial leaders, and the media pay scant attention to this, but instead argue over numbers, the implications of which are hypothetical at best.
The question is not so much whether US deficits or Chinese surpluses are sustainable long-term but rather what this implies for the Americans, Chinese, and the world relative to other relevant data. Where is this leading?
I don’t think this is sustainable too much longer even for the US. Americans are now perceiving the US as exporting jobs. That perception is politically unsustainable at a time of persistent high unemployment and underemployment, with the participation rate falling. Moreover, there is no way to go back to the status quo ante without generating another crisis, which will be a larger and messier one. Adopting austerity will just exacerbate the situation. There is no comprehensive economic policy on the table that shows the way of this, as far as I can see. While I agree with MMT proposals for relieving unemployment by stimulating demand, then what?
Tom Hickey,
“Americans are now perceiving the US as exporting jobs. That perception is politically unsustainable at a time of persistent high unemployment and underemployment, with the participation rate falling.”
You’re right. It’s a tragedy, but it’s going to be interesting to see how a worst case unemployment outcome will weigh politically and heavily on trade policy. Your previous comment regarding “neoliberal assumptions about “free” markets clearing seamlessly” applies to international employment tradeoffs as well as exchange rates.
Ramanan,
That was a short break.
I thought the first response to an FX crisis was FX reserve intervention rather than fiscal policy.
Ramanan, good summary of your position. I’ll hold off and see what the MMT’ers say regarding specifics, but, speaking genrally, it seems to me that it’s pretty similar to the confidence argument about the bond vigilantes and the conclusion drawn from it that “we had better not do what we know needs to be done because ‘the market’ might suddenly lose confidence in us and upset the whole apple cart.”
Tom,
A bit but not exactly because the currency markets is not in the control of the State. I make no recommendation. Its truly enjoyable to learn something when one is freed of making any recommendation or proposal. As far as viewpoint is concerned – yes of course, don’t torture people by going into an austerity and set examples for others. However, long term solutions are complicated!
More importanly, its the specifics about MMT thoughts on trade balances and the dynamics associated with it which I strongly oppose. I *exactly* know the arguments that is going to come my way and the fact that it will be really difficult to resolve. But an attempt – helped me clear a few things myself – increasing my confidence on my position!
Ramanan,
You referenced this at Bill’s:
http://bilbo.economicoutlook.net/blog/?p=10389
On re-reading, this is an incredibly good post on the nature of current account deficits, and I can’t imagine how it doesn’t address your various concerns.
Anon,
Just found this:
Try this http://bilbo.economicoutlook.net/blog/?p=5402 Modern monetary theory in an open economy a year back – It was my first intro into open economy macro. A lot of it is common to the link in your comment.
Somewhere in the middle:
“MMT recognises this problem, but doesn’t recommend the mainstream solution.”
I liked the post (you can see my comment) as it was a great intro.
So you see that some of the things I have been saying is in that post.
Now, a year later, I have a slightly better view – my obsession has helped my understanding. There is a genuine issue here – you have to put yourself in the policymakers shoes to see it.
Just read it again – excellent.
This seems key:
“Is there evidence that budget deficits create catastrophic exchange rate depreciations in flexible exchange rate countries? None at all. There is no clear relationship in the research literature that has been established.”
Also:
“As the global economy grows, there is no reason to believe that the rest of the world’s desire to diversify portfolios will not mean continued accumulation of claims on any particular country. As long as a nation continues to develop and offers a sufficiently stable economic and political environment so that the rest of the world expects it to continue to service its debts, its assets will remain in demand…Therefore, the key is whether the private sector and external account deficits are associated with productive investments that increase ability to service the associated debt. Roughly speaking, this means that growth of GNP and national income exceeds the interest rate (and other debt service costs) that the country has to pay on its foreign-held liabilities. Here we need to distinguish between private sector debts and government debts.”
Well its how it is presented. Don’t know what “clear relationship” is. It also means that its possible.
As I said its about currency falls and not about currency falls.
In 1991, India almost had a near death experience. The FM – now the PM – liberalized the capital account and this led to a relief to the balance of payments problems. India also started the export-led growth path and this was another reason the nation could solve some of its problems and change the foundations of growth.
Some nations – their export sector in particular – would have benefited from the depreciation of the currency. But they grew because of exports! So how is export a cost ?
I do not agree on the debt servicing versus growth. Not so straightforward. Whats the proof ?
The fact that I do not carry a lighter in my pocket reduces the chances of fire. Since I want to prevent fire, I don’t carry a lighter. Similarly, nations do not spur growth by fiscal policy because while it spurs demand, it widens the trade deficit as well. It will depreciate currency and the nation has to pay higher interest rates to foreigners while they are targeting some foreign reserves to gdp ratios and such numbers. Because they don’t want to go there, you see weak demand everywhere in the world.
I am pointing out the ironies instead of making any suggestions. Inflation is one issue which MMTers see as a limitation of fiscal policy. Well .. the external world is a BIG factor.
Doesn’t mean that I am saying fiscal policy is not good. Not at all. But if the reply to one’s statement that fiscal policy worsens trade balances is that imports are benefits that is not satisfying.
A nations assets can remain in demand of course. However, note the causalities. If some sovereign fund invests in a country, it doesn’t increase trade deficits. It gives it more room to improve demand and tolerate some amount of trade deficits. The trade deficit would arise if incomes grow because of increase in demand due to the government’s policy – not automatically because foreigners desire to net save in your currency.
From the blog post :
“Clearly, when an economy that experiences a depletion of foreign exchange reserves has to take some hard decisions in relation to its external sector, especially if it is reliant on imported fuel and food products. In these situations, a burgeoning CAD will threaten the dwindling international currency reserves.
In some cases, given the particular composition of exports and imports, currency depreciation is unlikely to resolve the CAD without additional measures.
The depreciation, in turn, raises the relative costs of imports, and imparts an inflationary bias to the economy. Moreover, depreciation leads to expectations of further depreciation and fuels the run out of the currency. There may be no interest rate that is high enough to counter expectations of losses due to depreciation and possible default.
In the short run there is probably no alternative but to urgently restore reserves of foreign currency either through renegotiation of foreign debt obligations, international donor assistance or default.”
Exports are a real cost and a monetary benefit. That is operationally tautological.
“If some sovereign fund invests in a country, it doesn’t increase trade deficits.”
That is operationally correct. The only capital account transactions that are net capital account transactions are those directly offsetting net trade account transactions.
i.e. the only capital account transactions that are net capital account transactions are money for trade transactions – not financial portfolio allocation flows
Anon,
Here is some sustainability stuff from Wynne Godley. http://www.levyinstitute.org/pubs/stratpred.pdf (March 2003)
The central argument of this analysis can be simply
stated. The primary balance of payments in the fourth quarter
of 2002 was equal to about 5 percent of GDP—easily a
postwar record. If, as all official documents assume, the U.S.
economy grows fast enough during the next six years to generate
some reduction in unemployment, there is a presumption
that the primary balance will deteriorate further, to at
least 6.4 percent, causing U.S. foreign debt to rise to nearly
$8 trillion or 60 percent of GDP. And if, as the ERP assumes,
the stance of monetary policy reverts to neutral so that short-
term interest rates rise to 4.3 percent, the net flow of interest
payments out of the country could well rise to $200 to $300
billion per annum, thereby raising the deficit in the overall
balance of payments to about 8.5 percent of GDP. As the
private sector’s financial deficit is likely to revert toward its
usual state of surplus, it follows as a matter of accounting logic
that the government would have to run a deficit at least as
large as the balance of payments deficit—that is, the budget
deficit would have to rise from some 3 percent of GDP as now
projected for 2003 to perhaps 9 to 10 percent of GDP in
2007–2008. For a number of reasons this is not a credible
scenario—if only because such a position would not itself be
a stable one; the rate at which foreign debt would be accumulating
would be such as to generate a further, accelerating, flow
of interest payments out of the country, requiring even larger
budget deficits in subsequent years.
The man is superb in his accounting calculations and used to do all kinds of stock-flow consistent models. I recommend his book with Marc Lavoie http://www.palgrave.com/products/title.aspx?is=0230500552
Of course a lot of things happened between 2003 and now – but thats the dynamic. There is no mechanism to stop this process from continuing. Right now, if one includes agencies, the net liabilities of the government sector (which cancels debt owed to each other) is 110 per cent of GDP or so.
You must have read about the US trade deficit report yesterday. Even Ben Bernanke thinks that the public debt is heading toward unsustainable levels. His solution – reducing the fiscal deficit is silly of course. But the US public debt will keep growing with no limits. If the Fed and the Treasury set the interest rates to zero permanently or so, the foreigners will purchase other securities. Won’t the citizens of the United States be indebted to the rest of the world then ?
Increase fiscal policy and the trade deficit widens even further.
Solutions ? A zillion dollar question.
One is to just let the US public debt keep growing without limit (i.e, debt/gdp keeps increasing till the end of time – and interest payments to foreigners too) and hope that there markets take care of it. Do you want to analyze the scenario ?
The other is to use protectionist measures. Ban imports. But that is politically and economically unwise. If the rest of the world cannot sell their products to the US, will they be willing to grow domestically ? Or use import certificates as Beowulf keeps reminding us.
Or ask other nations to devalue their currencies. Will they agree to become net importers ? What happens if they keep losing foreign reserves ?
Don’t you see the cracks in the foundations of growth ?
Sorry I meant – strengthen their currencies and not “Or ask other nations to devalue their currencies”
Not sure of the number 110 here is a reference http://www.levyinstitute.org/pubs/ppb_114.pdf
Fair enough for Lavoie to point out the nature of unsustainable deficit trajectories.
But equally fair for MMT to point out the nature of sustainable deficit trajectories.
Both are based on mathematics of GDP growth versus debt growth – unsustainable versus sustainable.
Lavoie hasn’t been the only one predicting doom. Nouriel Roubini and Brad Setser did a lot of work about 5 years ago making similar forecasts that turned out very wrong.
Yep .. its Wynne Godley who made all the projections in the US strategic analysis at Levy, not Marc Lavoie. Roubini used to quote Wynne Godley often.
I think Wynne Godley’s logic was quite right – external sector deficit reducing demand and on top of that private sector debt going into an unsustainable path. He himself knew that the timing of the recession was difficult to predict.
Roubini is neoclassical and keeps worrying of debt monetization causing inflation. And things like crowding out. But he is right about trade deficits. Haven’t read Brad Setser to comment.
But the logic is tight here. Wynne Godley had stock flow consistent models where every sector’s behaviour is modeled and there are cases where the public debt keeps increasing – there is no correction mechanism to have any adjustment.
You haven’t talked about R&R. This is interesting:
http://economistsview.typepad.com/economistsview/2010/08/more-reinhart-and-rogoff.html
From the above:
“R&R have it backwards: they are looking for broad generalizations that might be identified over large samples but have uncertain application to any particular case. A better kind of economics would be one that identified processes that, while they generate diverse outcomes with no discernible central tendency over large samples, can be applied precisely to individual cases.”
I think the MMT approach to current account deficits actually corresponds to that “better kind of economics”.
marc fully agrees with me last we spoke a year or so ago, and the time before that as well
the right size deficit is the one that coincides with desired levels of domestic employment
I know the usages of the three financial balances and how different people use it.
You may be interested in the history and the usages here:
http://www.levyinstitute.org/pubs/wp_594a.pdf
Revisiting “New Cambridge”: The Three Financial Balances in a General Stock-flow Consistent Applied Modeling Strategy
Thanks.
Started reading that New Cambridge paper and it looks really ugly.
They calculated net financial balances for an entity by including the market value of stocks on the asset side of the balance sheet and the book value of issued equity on the liability side (they don’t even include retained earnings let alone the market/book differential). I don’t see how that can be stock consistent let alone SF consistent.
A real headache just to get through that part.
Not sure.
Firms as a whole may hold stocks of other firms.
In stock flow consistent models, there are three things. A balance sheet matrix, a transaction flow matrix and a revaluation matrix.
In the balance sheet matrix, there is no retained earnings. That appears in the transactions flow matrix.
The balance sheet matrix uses market values of “equities issued” as liabilities. Book value is not used.
Its an art doing stock-flow consistency!
Flow of Funds – the Z.1 accounting does not include retained earnings in the L.tables.
My point of referencing it however is that there are many things happening with sectoral balances. Even neoclassicals use it – though rarely but then they end up using Ricardian equivalence etc. There is a bit of history as well and its important to get assumptions correctly.
Trust me, I know how this stuff works.
Flow of Funds definitely incorporates retained earnings wherever it includes equities in portrayal of stock financial claims, and uses market value to reconcile all balance sheets where equities are referenced.
I’m referencing table 1 in the Levy paper (page 7). It is a disaster. It excludes retained earnings in the calculation of the financial balance. That is completely useless.
The household balance sheet in table 2 looks OK.
One of the problems is that the paper doesn’t even define financial balances in terms of constituent accounting components.
Really badly written.
I think the authors have no accounting training.
It always comes back to accounting.
Gawd! Patience Patience!
(Incidentally I note that Z.1 uses market value of equities issued see table L.102)
Its perfectly consistent with national accounting.
The table 1 just presents two different snapshots of the flow of funds.
Okay lets do the math.
In every accounting period, firms have assets as well as liabilities. Table 1 A states the assets and liabilities in the beginning of the accounting period. And Table 1 B states it at the end. Causes are slightly different.
Just like Z.1 – it just states these are my assets and these are my liabilities.
So in table L.102 of Z.1 you see different numbers for different period. So there is a table for 2008 and there is one for 2009.
L.tables do not have retained earnings or flows such as that. It may have caused balance sheet changes but that is a different thing!
Its perfectly consistent with L.102 of Z.1
Incidentally I note that Z.1 has the market values of equities in liabilities. (Item 37 of L.102)
Sorry, you’re missing my point.
The flow of funds includes market value of equities, which by construction means the market valuation of the combination of the book value of equity issued plus the book value of retained earnings – which means it includes the value of retained earnings – which means it includes retained earnings.
The flow of funds number is just the market value of equities. If there is only one firm and it has 100 shares issues valued $2 each in the stock market at the end of the period- the entry “equities issued” in liabilities will be $200.
That’s right and that’s what I’ve been saying.
The Levy paper misses that entirely.
Don’t think so – initially it was $450 and then $490. It just means that stocks traded in the market changed such that the number $450 became $490.
I have read their papers well to know that they won’t make any such mistake.
Now I understand your point. I think the paper is still right. Remember there is retained earning and there is also new issues of equity.
Actually I don’t see anything wrong.
$40 of new equities was used to finance and it was assumed that the stock price didnt change so $450 became $490
Simple!
No, you missed it again.
The point is that they do a calculation of the financial balance of the firm as a memo item at the bottom of that table, and they exclude the 40.
That will not work on a stock (versus flow) reconciliation basis. It can’t. Balance sheets do not record the value of marketable equity claims held as assets as the internal book value of the issuer’s equity (issue equity plus retained earnings), absent the market premium over book. And note that this is not the same as the difference between book value and market value accounting for the asset holder. A few balance sheets may do book value accounting for the value of equities they hold as assets, but if they do, it’s by recording the historic purchase price of the equity – which is completely different than the internal book value to the issuer. Nobody records the value of an equity asset (using either book or market value accounting) according to the internal book value of the issuer. The internal book value of the issuer is completely different than the book value to the holder. The fed flow of funds reconciles consistently at the stock (versus flow) level by using market values.
Sorry, I got the missed numbers wrong.
It’s the $ 50 and the $ 140 that are missed in the financial balance calculations. Those are the market premiums over the internal book value of equity.
Sorry again. Those are the retained earnings numbers that are missed.
So there are two errors: using internal book, and missing retained earnings.
There is no book value of equity that has been used. Only market values. No book value used for equities at all.
Initial bank loan was $250 and new bank loans is $150 so in the end the bank loans in liabilities is $400
Initially bonds in liabilities was $150 and $50 of bonds were issued in the period, so in the end it is $200 which you can see.
Intially equities owed to others was $450, new issues totalled $40 and you see $490 in liabilities at the end of the second period.
$400 = $150(new loans) + $ $50 (bond issuance) + $40 (equity issuance) +$70 (selling some financial assets) +$90(retained earnings).
Each one adds deposits in the bank and it was used to purchase physical capital worth $400 and hence $600 worth physical capital became $1000.
I think it didn’t care to explain the part where wages are paid and there is an inflow of money from consumption, which added to profits and lets assume no dividends are paid out.
The important thing you are pointing out however, is that initially the market value of liabilities is $450, and since $40 of new equities were issued, at the end of the period, it is $490.
Again no book values of equities here.
Let us say that each stock is valued $1 by the stock market which doesn’t change. Initially the total outstanding was 450 shares and in the period 40 new shares were issued at $1 and hence the the equities issued in liabilities at the end of the period is $490.
You can redo this by forgetting bonds for a moment and looking at a much neater table http://www.palgrave.com/PDFs/0230500552.Pdf – table 1.2 – page 15 of the pdf. Thats a transaction flow matrix, shows retained earnings, new equities issued, bank loans, no bonds. There are two accounts for firms – current account and capital account. (There is a typo in the table 1.2 for the central bank but irrelevant here)
Nope. It’s all book value for the issuer’s balance sheet, which is what I’m talking about. E.g. a new equity issue sets the issue price as the book value for that entry on the issuer’s balance sheet, which will never change as a contributed equity component.
That will never reconcile with the asset holder’s balance sheet.
There are two things – the way firms do accounting and the way national accountants do the accounting. The latter is different. In some places equities are set to zero as liabilities and in some places added as a memo. In other cases it is included in liabilities – but market values.
Anon,
Page 226 – Understanding National accounts OECD
The systematic valuation in the national accounts of assets and liabilities at market prices is also open to discussion. For one thing, this “wealth” may be only potential. For example, the mere suggestion that a large holder of shares in a firm might dispose of
his holding can lead to a fall in the price of the shares capable of reducing this same holder’s potential realised holding gain. Much the same is true of the sale of property by a large institutional owner (an insurance company or a bank). For this reason, company accountants are more cautious than national accountants and apply the principle of valuation at the purchase price (except in the case of some quoted shares, for which the potential holding gain is practically certain to become a real gain). This caution leads to difficulty in interpreting total assets and liabilities in company accounts. These totals do not reflect economic reality since they add together assets or liabilities valued at very different dates. This difference in relation to the national accounts makes it difficult to
use company balance sheets in the calculation of the balance sheet accounts. However, it is possible that the two sets of accounts could come into line in the near future with the application of the principle of “fair value” in company accounts. This “fair value” puts the prices at which valuation is made on the same footing as in the national accounts. This new approach is being recommended by the International Accounting Standards Board.
change of topic:
did you see Bill’s comment in his latest?
“I will come back to open economy issues in a later blog seeing as there has been some consternation from some commentators recently.”
ha! ha! ha!
He he he !
Didn’t see – should really go into hibernation now.
The reconciliation happens because prices of equities change during an account period. Since
Change in e.p = (change in e).p + e.(change in p)
In the example p doesn’t change so no need for reconciliation.
Warren: fiscal policy can sustain domestic full employment and not worry about the current account per se.
How do you answer the argument that by running a persistent CAD, the US is exporting jobs, and if government supports the unemployed with a JG or welfare after unemployment insurance runs out, then it is also promoting underemployment as people get pushed down the job and pay ladder. The claim is that this reinforces labor arbitrage, undermine US workers’ bargaining power, and inequitably enriches the people that profit from global trade at the expense of workers, both in the US where they are being crammed down and also in emerging countries where they are being held down.
While this argument is heard on the left explicitly, it is also a growing perception among US workers, even if they don’t always articulate it clearly. But there is considerable emotion behind it, and this is shaping the political debate about trade, especially with China.
we might be exporting jobs, but creating better jobs as replacements, by definition.
as the jg pool grows that’s the signal to cut taxes until it gets down to desired levels for price stability. probably 3% of the work force or less.
but creating better jobs as replacements
I think that this is the sticking point. Without being highly visible, it not credible. The widespread perception is that people are getting laid off and then crammed down the ladder. Case in point, I was talking to an employee at IKEA in the Boston area who had lost his $50 plus an hour tech job and was forced to take a job paying less than $10 an hour to stay alive. This is not new. I have acquaintances that were downsized” back in the ’80’s, when middle management was cut out. They went from 100K a year down to ? One friend finally started painting house for his son, who was a painting contractor. Bizarre. Hard to convince people like that we are creating better jobs here.
Three points to make:
1) Our government is not acting responsibly, and therefore we have 16% unemployment or underemployment; that’s not the fault of the trade deficit;
2) Anecdotes aren’t very helpful; I could also give you anecdotes about high-paying jobs that have been created because of global trade;
3) There are dislocations that happen; just as the value of your stock portfolio or your home can go down 50%, so can the value of your skills to the marketplace; also, there are many high-paying jobs which are rentier-like (e.g. unionized auto assembly line work); some of these jobs naturally become lower-paying as the labor market becomes freer.
ESM, I’m concerned about the politics. The perception is getting ugly out there with many of the people that I talk to that either have seen their house value and their stock portfolio, which they consider their primary savings for retirement sink in nominal value by half or else have lost good paying jobs or fear losing them. The other huge factor is the perception that “the American dream” is no longer going to be available for their children and grandchildren as it was to them.
The problem with much of economics in people’s eyes is that deals with quantity rather than quality, treating individuals as numbers and overlooking what is most important to them. According to economists, the recession is over according to the definition, for example, but a great many people think that the US is in a depression instead. Economists seem comfortable redefining NAIRU to a new normal above 8%. Politically, it’s suicide to allow high unemployment and the uncertainties that come with it to continue much longer.
What I hear is that Obama “doesn’t get it,’ is “clueless,” and is “living in the Washington bubble,” and this is from people that supported him. This doesn’t bode well for Democrats and if the GOP gets back in, it will be back for another round of Reagan and Thatcher, and a bigger financial crisis next time. I have actually heard people say that they voted for Obama and the Democrats last time, but they couldn’t handle it so they are going to vote for the other guys instead. No matter what the other guys would do. May be crazy, but that’s how a lot of people think.
What I am saying is that you can’t be cavalier about this economically. People want to hear a real solution that meets their real needs. Right now, they are basing their thinking on the erroneous household-government finance analogy, not realizing that such a policy would sink the ship. The deficit hawks have a leg up in this argument because they seem intuitively to be right. Many people also reason that since business provides jobs, making the Bush tax cuts permanent is a good idea, even if it means cutting social spending on the safety net.
MMT can’t win this argument by focusing on relieving unemployment. People want to know that they can expect to find a good job in a growing economy that will restore their lost wealth so they can retire as they planned and educate their children in the expectation that good jobs will be waiting for them when they graduate.
hence, a full payroll tax holiday, a $500 per capita revenue distribution to the state govts, and an $8/hr transition job for anyone willing and able to work?
Tom, I think by now you know which side of the political spectrum I’m on. But putting that aside, how can an MMT-er be frightened of another round of Reagan? Reagan cut taxes and kept up spending (including significantly boosting defense spending – $1T extra over his two terms, which was back when $1T was a lot of money). He came as close to running optimal deficits as any president since WWII.
Obama is paralyzed because a new round of government spending is not politically feasible, and he is ideologically against tax cuts. At least the Republicans can and will cut taxes, deficit concerns notwithstanding. You might prefer spending increases, but I think you would concede that tax cuts are better than nothing.
I am truly astonished by Obama’s behavior. Unemployment at 10% is a crisis, and yet he does nothing but talk (and spend more time on the golf course than Tiger Woods).
ESM, I am concerned that the bulk of the Bush deficits went into leveraging asset values and Ponzi finance. It sure didn’t trickle down. The middle class went into extreme debt even with those deficits. In addition, don’t get me started on the military spending. That was obscene.
As far as I can see, Reaganism and Thatcherism took both the US and the UK down by suppressing wages and keeping price inflation low while letting asset inflation go wild, ultimately taking out the global economy.
Of course, Bill Clinton’s triangulation strategy, including Rubinomics, was central to the debacle, too. Obama is also implementing a triangulation strategy in the attempt to capture the center. I don’t see it working for him. His record as a corporatist is abysmal, and I don’t think that he can fool the middle class into thinking he is on their side again.
With zero meaningful financial reform and no accountability, I see us heading deeper down that path in any case, but with the GOP in power, it will just be quicker. Randy Wray’s satirical scenario is getting to look more and more prescient.
If we are sustaining demand at full employment levels- an elr pool of maybe 3%- the dynamics are very different than if we are allowing a demand deficiency.
With that kind of demand there will be at least as many and most likely a whole lot more good paying jobs.
And if at the macro level we are consuming all we can produce at full employment domestically plus all the net imports the rest of world wants to send us,
we have to be better off overall by the net imports, as a point of logic.
yes, some people may lose, but the gains of others have to be greater. And those hurt probably would have lost anyway in the demand deficient economy.
(Not related to the above)
Thanks for comments. If you think that interest paid to foreigners keeps accumulating and accelerates and that the public debt/gdp keeps growing over time with no problems whatsover, then thats some view. In that case, the argument is over then and there 😉
f you think that interest paid to foreigners keeps accumulating and accelerates and that the public debt/gdp keeps growing over time with no problems whatsover
What do you see that makes this problematic or unsustainable? As far as I can tell, most people asserting it just take as obvious. But it’s not obvious unless it goes exponential, it would seem.
Japan has been doing just that. Maybe 2T in reserves over the last 60 years, including interest, and they haven’t spent a dime. And no interest in doing otherwise.
Not that it has to happen that way, but it seems to happen more often than not.
Now don’t you go telling them and ruin it for us, thanks!!!
as the jg pool grows that’s the signal to cut taxes until it gets down to desired levels for price stability. probably 3% of the work force or less.
Warren, I would suggest lashing JG to the mast of Social Security and provide for automatic FICA rate adjustments based on unemployment rate. Any “signal to cut taxes” is worthless without an automatic and immediate trigger, President Kennedy proposed tax cuts to stimulate demand in 1962, they were finally passed by Congress and signed by President Johnson in 1964.
A Job Guarantee was actually part of the original 1935 Social Security Report, in fact, it was the report’s first recommendation. I’d suggest that Social Security’s term is better, “Employment Assurance”.
Since most people must live by work, the first objective in a program of economic security must be maximum employment. As the major contribution of the Federal Government in providing a safeguard against unemployment we suggest employment assurance– the stimulation of private employment and the provision of public employment for those able-bodied workers whom industry cannot employ at a given time… it is a sound principle that public employment should be expended when private employment slackens, and it is likewise sound that work in preference to relief in cash or in kind should be provided for those of the unemployed who are willing and able to work.
http://www.ssa.gov/history/reports/ces/ces5.html
As for the automatic FICA tax adjustment, tie it the U3 unemployment rate. The simplest formula would be U3 rate x 10 — reducing FICA taxes payable by that percentage. At its baseline rate, FICA raises $75 billion a month for Social Securit and Medicare. A 95% (9.5 x 10) reduction would collect $3.75 billion instead, leaving $71.25 billion of waived FICA payments would stay in taxpayers’ pockets, ($855 billion annualized). Then, every month as soon as DOL updates the unemployment rate, Tsy could adjust the FICA tax waiver. A 7.5% U3 rate would reduce baseline FICA collections by 75%,a 5% U3 rate means a 50% FICA tax waiver and so on.
Tsy could fund the SS and Medicare trust funds, and the Employment Assurance JG program, directly. What’s interesting is that the cost of the Employment Assurance program only matters (in terms of necessary tax revenue to pay for it) at the level of full employment. But at full employment, JG costs are at their lowest anyway and the adjustable FICA rates are at their highest. If more revenue is required at the full employment level, $200 billion a year could be raised by simply by uncapping Social Security above 106K, another $100 billion by expanding the unearned income Medicare tax (for income above $200/250k) to cover the Social Security of FICA as well.
Just to clarify, if the potential $300 billion in additional FICA revenue is necessary to fund a JG, these too would be reduced by the U3 x 10 formula.
I imagine the lower real tax rates even at full employment (since a 3% U3 rate would still means a 30% reduction from the baseline FICA rate) would be canceled out by the larger GDP and tax base generated via Okun’s law, each one point drop in unemployment rate increases GDP by 2 to 3 points.
point taken, but fica is a bit too regressive for me.
also, without fica the full employment deficit is probably just about right so that when we do get to full employment the budget won’t be in surplus and shut it all down as in the late 90’s
Warren, can’t disagree with you about FICA’s regressivity and there’s never a good reason to run a budget surplus (especially when we’re also running a trade deficit).
I’d just suggest that there’s no way for Congress to fine tune the economy by fiscal adjustment on an ad hoc basis; and politically, Congress would be far more willing to go to an automatic fiscal adjustment system than to delegate discretionary authority to the President.
Just as the the Fed learned to stop targeting quantity of money instead of price, Congress should top targeting fiscal adjustments by quantity of revenue and instead target unemployment rate. Seems to me the easiest way to do that is to adjust tax rates inversely to the monthly change in the U3 rate. Think of it as the Ultra ProFund version of automatic stabilizers. :o)
http://www.profunds.com/funds/ultra_profunds.html