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No Retreat, No Surrender: Time For Progressives to Explode Deficit/Monetary Myths

Friends, I’m concerned. I fear that too often, we on the left retreat when we should attack, surrender when we should vanquish.  What do I speak of?  Well, I am concerned that too many of us are willing to play in the frame, the box, the straighjacket of modern discourse about fiscal and monetary policy.  Obama does it.  The NDP does it.  Even some of my fellow PEF bloggers do it.

And I understand why.  Some haven’t been exposed to theoretically, empirically and institutionally-grounded alternative ways of thinking (I’m thinking Modern Monetary Theory or MMT here) about these issues and so they do a heroic job with the tools they possess. Others have been exposed but aren’t convinced. Fair enough. These things take time. Still others have been exposed, are convinced but think the whole point is moot because if you step outside of the policy box, you get ridiculed, ignored, marginalized and that can’t be good for anyone, can it? I get that.

Except except except…here’s the thing. While a great many progressive economists ignore, dismiss or downplay more radical, critical approaches to fiscal and monetary policy, people in high places are starting to come around because they are convinced by a little thing called the evidence. The unrelenting truth of the MMT propositions become increasingly obvious every day that this crisis breathes another breadth, every time inflation refuses to budge despite QE1, QE2 and stimulus, every time US treasuries rally after a credit downgrade (just like they did in Japan by the way, which last I checked is NOT the world’s reserve currency and “suffers” from a rating below that of Botswana), every time US banks reel under the weight of a seemingly endless well of outright fraudulent products, every time the economy perks up when deficit spending increases and seems to slump when austerity kicks in, every time we read about yet more fat corporate profits that stay put (or paid out as dividends, share buybacks) instead of invested, every time we hear about rising or unacceptably high levels of unemployment, and every time the Euro nations buckle under austerity.

So who are these people in high places?   Consider the Bank for International Settlements (BIS), the central banks’ bank (sort of).  In 2010, it put out a publication that challenged the belief that banks need reserves before they’ll lend, arguing (as Post Keynesians have for decades now) that banks create deposits every time they lend. Here are a few select quotations from  the document:

  • … the emphasis on policy-induced changes in deposits is misplaced. If anything, the process actually works in reverse, with loans driving deposits. In particular, it is argued that the concept of the money multiplier is flawed and uninformative in terms of analyzing the dynamics of bank lending. Under a fiat money standard and liberalized financial system, there is no exogenous constraint on the supply of credit except through regulatory capital requirements. An adequately capitalized banking system can always fulfill the demand for loans if it wishes to.
  • “Bank lending … involves the creation of bank deposits that are themselves the means of payment. A bank can issue credit up to a certain multiple of its own capital, which is dictated either by regulation or market discipline. Within this constraint, the growth of bank lending is determined by the demand for and willingness of banks to extend loans. More generally, all that is required for new loans is that banks are able to obtain extra funding in the market. There is no quantitative constraint as such. Confusion sometimes arises when the flow of credit is tied to the stock of savings (wealth) when the appropriate focus should in fact be on the flow.”

These argument have HUGE implications for how we understand banking, fiscal and monetary policy and inflation.  If you understand the above, you’re halfway to understanding why QE1, 2 and maybe 3 won’t lead to inflation.  You’re halfway towards understanding why the central bank MUST accommodate the demand for settlement balances(reserves) and is therefore a price setter, quantity taker.  You’re halfway towards understanding why fiscal policy can’t possibly crowd out private sector borrowing. You’re halfway towards discarding the whole misplaced silly debate about how we’re somehow more limited in what we can do than we were at Crisis, Mark I.

Or what about the fact — and you’ll have to take my word for it because I can’t name names — that I personally know an increasing number of economists, some quite senior, in the civil service, not one of which I would call instinctively progressive, who get these ideas and more and are quietly working to change the debate from within because they can’t abide the untruth of our current discussions.  A tough maybe impossible slog to be sure but certainly not helped when the outside community is so quiet, so willing to play the game.

Can things be different?  Absolutely, Bill Mitchell in Australia is probably the most forceful MMT advocate out there and he reaps considerable rewards — the mainstream media are always after him for interviews.  Or how about Randy Wray, Warren Mosler, Marshall Auerback, Mike Norman, Jamie Galbraith and others in the US — all in exceptionally high demand, being invited to share their radical ideas to a large public audience by the mainstream media, by politicians, by all kinds of groups.  And in Canada, nothing.  Not a peep.  Not a dissenting radical voice on these issues anywhere but the isolated, crackpot Arun Dubois post.  Otherwise, just more inside baseball.  We can do better.  No retreat, no surrender.  Time to explode those deficit/monetary policy myths.

Arun

Enjoy and share:

Comments

Comment from Roy
Time: August 11, 2011, 6:02 am

I have studied MMT enough to see it as a likely way for those in power to kick the can down the road some more. So they probably will adopt it. It will work best for them if they do it simultaneously or nearly simultaneously, so this is a definite challenge.

It does not solve the fundamental challenge of an economic system that mediates during cycles of both greed and fear; I am much more in favor of Big (Global) Labor to take on Big (Global) Capital, with not nearly so big (but still global) Government as the referee.

Comment from Paul Tulloch
Time: August 11, 2011, 7:53 am

I am with you Arun.

In many ways i do think Obama is fighting that fight, but in a very difficult setting. think about what S&P just did. In the midst of major market instabikity, they told Obama that he could not print money. Yet, he can, and in the volitility, the herd ran for safety, as you pointed out. the picked th spot, it was like they were waiting for a chance to send the message.

That was at the highest levl, some political hand slapping for printing money. But the point is, and you nail it, the USA or most other major power can print whatever they like. However the ultra powerful will try snd make an example of
One major power. I am thinking Italy, maybe Spain. The war is on, and you are right, we need more soldiers with different solutions.

Already some hand wringing can be heard with this recent volitility in markets that maybe the old ways are spent forces.

Pt

Comment from Andrew Jackson
Time: August 11, 2011, 7:55 am

Arun — I read the primer to date

I get the sectoral balances analysis and followed the work of Godley et al at Levy over the past few years. That framework is certainly key to understanding the US and global crisis, underlining that growth was dangerously dependent upon debt financed household consumption, a financial bubble, and an unsustainable rise in global imbalances. I also get the consequent need for governments to run deficits if the economy is to run at capacity despite household deleveraging and weak business investment. And I get the point that central banks can finance deficit spending.

It still strikes me that policy should focus on credit creation to support productive private and public investment. Growth beyond closing the output gap – however we define that – depends not just on credit creation, but also on the growth of productivity.

And is the obstacle to MMT technical, or the threat to the power of the financial system?

Comment from Travis Fast
Time: August 11, 2011, 9:29 am

What is more there is no necessary connection between the monetisation of government debt and inflation. It depends on what type of stimulus the government does with the proceeds. See p. 21 of:

Claudio Borio and Piti Disyatat, “Unconventional monetary policies: an appraisal, “BIS Working Papers No. 292 (2009).
http://www.bis.org/publ/work292.pdf

Comment from Ed Seedhouse
Time: August 11, 2011, 10:53 am

Thank goodness someone on the left is finally pointing this out. I’m not an economist, not even a University grad, but even I can understand the basic principals that lie behind MMT. It’s mostly just straightforward accounting principals coupled with an understanding that money is not actual wealth, applied to whole societies as opposed to individual families and corporate entities.

The NDP needs to latch on to MMT and run with it. Yet I heard one of our local NDP MP’s fall for the “Government must balance the budget” meme and thus fall into the trap of main stream macroeconomics that has us in this mess. In fact, governments sovereign in their own currencies should almost never balance their budgets. Families, Cities, Provinces, these do have to balance their budgets in the long run, but the Federal government does not and almost always should not. It is their duty, among others, to allow subsidiary governments to run worthwhile services without unbalancing their own budgets.

Yet progressives stand by and allow the “balanced budget” meme to hold them in it’s sway, for some strange reason. We can’t get out of our current mess until we get rid of irrational ideas of all sorts and progressives have a duty to combat the current irrational economic system with feasible and fact based counter arguments. MMT provides the necessary framework for this.

No, it will not solve all our problems. The real economy can only produce so much wealth under the laws of physics and we have to, eventually, learn to survive and thrive without “growth”. But that’s a problem we’ll never solve while we are throwing away and wasting the only true capital that matters, namely people, human beings, in order to “save” purely imaginary “capital” called “money”.

We aren’t going to get rid of money anytime soon, so we need to learn to use it correctly. MMT provides the framework to do this. I hope your blog joins the movement to bring sensible economics into the mainstream and pushes for it’s adoption nationally and by the NDP because unless our main progressive party understands that money is NOT the problem it won’t be able to do anything even if it gains power except slow the decay slightly, and for awhile. I expect more from progressives. Humanity needs more.

Comment from Geoff
Time: August 11, 2011, 12:18 pm

If you are searching for MMTers in Canada, look no further than the Eco dept at the University of Ottawa.

Comment from Arun DuBois
Time: August 11, 2011, 5:11 pm

Some great comments here so I don’t have a whole lot to add but let me work backwards with some off-the-cuff thoughts.

Geoff — I know the Ottawa U crew very well. Studied under them even and am in semi-regular contact. They do fantastic work — essential work — but we need more voices in the mainstream media so that we can the media’s attention, and maybe the NDPs. It can happen. In crisis situations, people go looking for answers. We can tell a coherent story around recent events and not many others can. That’s our angle — we need to be out there doing it.

Ed — couldn’t agree more although I would say that MMT is agnostic on policy choice. It defines the possible and puts the distributional battle that is politics back front and centre.

Travis — agreed, although I like most MMTers are a wary of the term “monetizing” because it implies there is something unusual or substantive about buying back one’s debt as in a QE operation. I’ll post more on this shortly but the punch line, as Marc Lavoie pointed out in a comment elsewhere on the blog, is that the BoC ALWAYS buys 15% to 20% of every new bond issue — just standard practice for settlement balance management purposes. A lot of technical details go with this like requirements for bidders to always over-subscribe to every new issue and limits on how high yields can go and hopefully I’ll get around to posting that info soon. In short, we control just about everything there is to control in the bond and remember, at the end of the day, a sovereign bond is just a promise to credit someone’s account with your unit of account. Since you make the “stuff” (a wrongheaded metaphor but am lazy tonight!) you can’t run short so there is never a default risk, just an inflation risk.

Andrew — I hear you. Lots of stuff to digest here. As I noted above, MMT is agnostic on policy, although a good many advance their pet projects on an MMT foundation. I prefer to get the debate to the point where we recognize that there’s a lot more we can do than is commonly believed. I personally quite like Mario’s work on productivity-enhancing investments (for the reasons you point to) but am also being swayed of late by ecological-based critiques of the nature of so much of our work. Still working all that out. I think a larger point however is we all (me included) have to pay some attention to the way we use language around deficits/debt and avoid the temptation to slip into phrasing that suggests that while we may not have a deficit problem not, we may in the future — that’s only true, perhaps, from a capacity perspective, not from an ability-to-pay perspective. I await that exalted day. See you at unemployment sub 2%!

Roy — as much as I’d like to believe what you say, it’s a long tough road before our policymakers give up on balanced budget rhetoric (and action). I’ve studied 60 years of debates around this issue (doctoral thesis no less) and it just ain’t going to happen overnight but that of course doesn’t mean we shouldn’t try. As for punting the issue down the road, you might be right but to Andrew’s point, really depends where we (in an ideal MMT-understanding world) put our investment energies — my choices are education, environmental action, meaningful job guarantees, infrastructure and community empowerment/investment (parcs, transit, all manner of public facilities, etc). I like to think that doesn’t punt a problem down the road so much as open up a brighter, more sane future for my children.

All the best and thanks,

Arun

Comment from Fred Williams
Time: August 12, 2011, 1:45 am

This economy is in it’s death throws. We need to replace scarce money with plentiful money. It’s a radical action, but no conventional action will save us.

Comment from Benedict@Large
Time: August 12, 2011, 6:10 am

Our overmasters have, perhaps unwittingly, already adopted MMT. They use it every time they want to bailout a bank, launch an unnecessary war, or give tax breaks to an Exxon or some other multinational corporate glutton. It is only when we the people ask for healthcare, a few extra weeks of unemployment comp, or some other help for a battered proletariat that they suddenly seem to regain their economy-crushing neoliberal paranoias over inflation or some mythical ideas that we burden our children more with future debt than with current hunger and bad schools. It is only when we the people ask that our money supply work for us instead of only for the champagne for lunch bunch that they forget their MMT, and offer up only their Calvinistic pabulums that we must suffer before we can rise and achieve our real potential.

MMT is here, just not for you.

Comment from Gofreddo Colferro
Time: August 12, 2011, 7:52 am

I follow PEF, along with another 40 blogs daily, since retirement. You are probably right that not too many conventional economists espouse MMT, but I take exception to your post this AM that in Canada, the approach has not caught on. First of all, two of your UofO bloggers-Lavoie-Seccarecca, post-keynesians I presume, dabble with it. The U of O conference recently was recognition of the merit of MMT. Secondly, I’ve been following a new (since March) Canadian blogger who and applies the theory to public policy. No small feat. I can assure you having worked with the Fed, that columnist is edging on issues that are absolutely fundamental. Here is one of the columns I have circulated to former colleagues with commendation:
http://fictionalbarking.blogspot.com/search/label/Sectoral%20Balance

Comment from Jason Mutch
Time: August 12, 2011, 9:02 am

Hi, you are not alone! I am an economist, graduate of Carleton MPA and have been converted to MMT. I reside on Mosler’s blog daily. I spend as much time as possible here in Ottawa educating friends and posting articles via social networks to further the cause. The simplicity and truth of MMT will slowly pervade the school of economic thought. Thanks for the post,
Jason Mutch

Comment from Marco Mingarelli
Time: August 12, 2011, 9:04 am

My first time on your PEF site. The MMT has been around for a while, even in Canada I surmise. Thanks for the good postings. However, I personally would appreciate more work from your A-Class blog-team exploring Northern Territories public finance and development.

Comment from Jason Mutch
Time: August 12, 2011, 9:07 am

I did once engage Jeffrey Simpson, who believes we are well-entrenched in the gold standard it seem, with several emails full of resources, articles, debates etc. I received a fairly un-polite ‘scoff’. I note his tune has not changed whatsoever.

Comment from Denise Freedman
Time: August 12, 2011, 9:54 am

OK, this is the economics part.

What about the political economic part, or just the politics part?

Many may well believe the believers in the logic of household finance actually believe it, but after all the years it has been flogged–and all the years “progressives” have capitulated to it–it is now the very way to political power.

“And then we’ll do what we really believe!” (!)

If MMT is agnostic as to policy, then there isn’t an econometric equation from MMT to policy.

All there is is the software-driven, mechanistic, mad dash to the “centre” where the power lies–and total corruption, ideological, personal, even economic.

We see this, well, I saw it in the 30 odd years before the recent “debate” in the NDP to remove “socialism” from the party constitution; Pat Martin said it would “only get in the way” of people understanding what the party actually means.

Over more than 30 years, the NDP has expelled those who sought to transform it into a movement.

Progressives, not just progressive economists, must stand up not only for MMT, or ANY progressive theory, but must also stand up for humanity.

After abandoning humanity for long in favour of mathematical models, this is a long climb back. The cliche, working outside the system comes to mind. Even for those who have long toiled within it.

I applaud you, Arun, for attempting to bring emotion back into this discussion; for far too long this discussion has focused on conceptual entities–thus reifying them–not people–hoe become cyphers in mathematical models, and cease to exist–focused on the middle-men, which always turn out to be the very reified corporate entities that corrupt and destroy our lives.

Comment from Ed Seedhouse
Time: August 12, 2011, 10:16 am

Geoff: “Ed — couldn’t agree more although I would say that MMT is agnostic on policy choice. It defines the possible and puts the distributional battle that is politics back front and centre.”

Yes, I agree with that. MMT does not prescribe a “size” to government one way or the other. That is a political choice that MMT makes possible.

I myself do not favour “big” government or “small” government. Those are just slogans. We need governments to do what needs to be done that markets cannot, or will not. They should be the right size to do that.

I am not a “socialist” in it’s original meaning, I am an advocate of an optimal mix of public and private, and think markets are a darned good idea, properly regulated. As a supposed “progressive” I feel that “progressives” need to come up with rational criteria as to what services should be supplied by the public sector and what by the market sector.

Why is it a radical thought to suggest that Governments do some things better than private markets, while markets do some things better than Government? Yet it seems that such thinking, in my experience, tends to be condemned by mainstream economics.

I think it’s they who are the radicals, myself. I hope I am and want to be a farsighted conservative. I want us to keep the best , and drop the harmful, and look more than four years into the future when making policy. Our time-frame for policy decisions should be more like the next century, always remembering that we can’t really predict much that far ahead very well, but we need to keep it in mind.

Comment from Jorge Unamuno-Ortiz
Time: August 12, 2011, 3:02 pm

Like Colferro, I am an aficionado of PEF, but I don’t read 40 blogs/day. As Colferro knows, my eyes can handle intermittently six blogs: two Canadian one of which is PEF, one UK, three US, and seven Treasury and Central Bank websites. I noticed the earlier comment by Colferro, a former yet younger counterpart, on Fictional Reserve Barking’s (FRB) contribution to the promotion of MMT in Canada and I will pleasantly concur that FRB’s postings, in particular those of April 11, 2011 highlighting conceptual nuances to a St Louis Fed article, and an addendum to that conversation on April 21, 2011, confirm MMT’s analytical presence in Canada. In this context, FRB’s virtuosity in realigning peripheral ideas from ‘other’ systems towards MMT and integrating the insights to public debates is commendable. As a recent entry in the niche, the columns are a feast: his references are comprehensive, his generosity towards colleagues and sources refreshing, and for old-timers who revel about an epoch when intellectual integrity was more significant than ‘Firsts’ and ‘I told you so’ very inviting. All the promoters and adherents to MMT you mentioned in your blog are routinely cited in Fictional Reserve Barking. Not only are you not ‘isolated’ you are not a ‘crackpot’ but rather on an interesting road with a ‘pen-pal’ I guess, called ‘circuit’. That many need pseudonyms is part of the problem; but it may be the best sunk cost to incur to protect correctness-which in most cases is part and parcel of the public service .

Moreso, the University of Ottawa, since the days of Parguez, was and is certainly a world-class center for the approach and as far as I know from friends in lovely Vancouver Island where I am now vacationing before returning south, some of the better readers in BoC and your Treasury, devour their stuff and all relevant blogs. Even some chaps at PIMCO do MMT. Therefore it is your politicians, as you correctly say Arun, that lack an appreciation of its relevance. The same is true in most countries.
Now more critical and surprising is that your NDP should be slow in catching on. MMT is the obvious (I say that with the theoretical reservations that Lavoie, Rochon and Seccareccia wish to settle with respect to policy) economic patent for a respectable monetary theory of affiliations representing the Center, Center Left and even Center Right. Although I am not ideologically left-of-center, ( sorry Mel Watkins) [I enjoyed sparring young Marx while Sidney Hook was preaching orthodoxy.] I do contend that MMT may replace existing conventions once the merits of its modus vivendi and operandi are better appreciated.

Comment from Arun DuBois
Time: August 12, 2011, 5:06 pm

Some more great comments tonight. Will just pick up on a few key items:

Fred: Scarce money — money (credit) is never scarce in a fiat currency world; effective demand almost always is however. Credit results from the demand process.

Benedict: Agreed except that the rhetoric has to follow the practice so that we can have a true debate; now it’s all smoke and mirrors.

Gofreddo: Thanks for the excellent link — wasn’t aware of that one. Very exciting. I was at the Parguez conference too. We really need to thicken the MMT network in Ottawa so we know who is doing what and think strategically about we can influence policy and debate (see below). My larger point in the original post is that MMTers are not doing a good job of getting into the mainstream media — that’s where we need to be, strategically, to start making some waves in the policy world. Outside communication influencing inside action. Absolutely key.

Jason: Thanks for the support. Simpson is a lost cause. Too far up inside the belly of the beast. See below for contact info.

Denise: Outside or inside the system — we clearly need both. I’m stuck inside for now, as are most of the people I know who get this stuff (Marc & Mario excepted). What we need is more people like Fractional Reserve Banking who can go public, with their real names, and get some mainstream attention so that people like us on the inside can draw on that outside discourse to move things. I’ve love an MMTer on The Agenda with Steve Paiken for example but Steve only goes to Globe and Mail approved sources (I exaggerate only a bit) so that’s the first step.

Ed: Bingo…singing from the same choir book.

Lastly: since there is apparently a wider community of fellow travelers than perhaps any one of us knew, might I suggest we think of developing the personal side of the network? I’ve been in discussions with a few bureaucrats about setting up a mostly informal discussion group for other bureaucrats in Ottawa that would bring in guest speakers such as Marc, Mario, myself, and anyone else who has done research in this area. Would love to build up a membership list. Interested parties should email me at : adubois@primus.ca.

Best,

Arun

Comment from collineenchantee
Time: August 12, 2011, 5:25 pm

Arun. That was a great post. My first submit as an regular. Never knew so many good MMT’ers around besides Ottawa U. Just a slight typo to correct. I think you were referring to Gofreddo’s reference to Fictional Reserve Barking

http://fictionalbarking.blogspot.com/

I checked the site, and it is very MMT; and not Fractional Reserve Banking-for all intents and purposes generic banking

Comment from Denise Freedman
Time: August 12, 2011, 6:07 pm

Probably anathema to a blog of economists, even progressive economists, I have been trying to articulate something that I found, in reading Russell Jacoby–at least it helps expiates some of the anger I feel, if not prescribing some sort of mathematical model:

“If political economy was the science of society dominated by the (capitalist) economy, when this domination ceases, so would political economy as its expression. The younger Lukacs defined liberation from capitalism as ‘liberation from the rule of the economy.’ And he added, ‘When the autonomy of the economy is ended, ‘political economy’ as an independent science also disappears.’ Similarly, Luxemburg stated, ‘The victory of the modern working class, and the realization of socialism will be the end of economics as a science.'”

I regret this is something the Conservatives never knew, the Liberals wouldn’t care if they actually knew–some of them might at one time have actually known–and the NDP is actually turning its back on, has been doing so for many, many years.

“Inside” and “outside,” Arun, I believe refers to more than just working for government and working for academia, respectively.

The dialectic has long lost one of its tails and the other, somehow, has been bifurcated and somehow made to look as if it were actually, I suppose, as some kind of contradiction, rather than a true dialectic.

Comment from circuit
Time: August 14, 2011, 7:13 pm

First, let me commend the PEF for allowing its columnists to share and discuss ideas and themes emanating from the post-Keynesian and other heterodox perspectives.

@Jorge and Goffredo: thanks for the kind endorsements. I’m very much encouraged to receive such praise from readers who clearly have a wide-range of experience and knowledge.

@Arun: Good of you to point out the work of Borio and Disyatat at the BIS. I don’t do much noise, but I do my bit on my own blog (I did a series of posts on base money and related themes, as Jorge pointed out) and also mentioned the BIS pieces at John Quiggin’s blog a while back (mine is comment number 26) http://johnquiggin.com/2011/05/09/some-propositions-for-chartalists-wonkish/#comment-149983

My comment to John summarizes the money mutliplier myth, post-Keynesian inflation theory, reverse causation and a bit more. Most of these ideas I learned from M. Lavoie, L-P Rochon, M. Seccarreccia, John Smithin, etc throughout the years. Keep up the good work.

Comment from Andrew Jackson
Time: August 15, 2011, 10:35 am

More from Krugman on MMT:
http://krugman.blogs.nytimes.com/2011/08/15/mmt-again/

Comment from Paul Tulloch
Time: August 15, 2011, 1:34 pm

It seems as though Krugman’s MMT’s pivot point is whether a currency can live through MMT at its highest saturation within the money supply and still be able to fund the currency. (isn’t he kind of saying that indeed the bond vigilantes are all powerful?) Not sure that should be the criteria on relevance, if it is his basis fro refuting, then I am not sure how he can call himself a post- keynesian kind of guy as ultimately the post keynes logic pretty much falls off the same cliff?!

Comment from Paul Tulloch
Time: August 15, 2011, 1:39 pm

http://www.nakedcapitalism.com/2011/08/video-the-bankers-as-the-enemy-of-humanity.html

as a follow up, potentially there will be no bankers left to worry about to stop the MMT money printing presses. Naked Capitalism posted a link to this video that maybe on the fringe there is a growing move towards busting the concrete that is at the foundations. Oddly enough I thought I seen the movie which this guy rants on about but reality has not totally detached itself from this guys logic.

Comment from Arun DuBois
Time: August 15, 2011, 1:53 pm

In case some of you missed it — Mosler takes on Krugman rather effectively here:

http://moslereconomics.com/2011/08/15/mmt-to-ryan-apologize-now-about-the-us-being-the-next-greece/#comments

**** NOTE – MOSLER = UPPERCASE; Krugman = LOWER CASE ****

Let’s have a more or less concrete example. Suppose that at some future date — a date at which private demand for funds has revived, so that there are lending opportunities — the US government has committed itself to spending equal to 27 percent of GDP, while the tax laws only lead to 17 percent of GDP in revenues.

And consider what happens in that case under two scenarios. In the first, investors believe that the government will eventually raise revenue and/or cut spending, and are willing to lend enough to cover the deficit. In the second, for whatever reason, investors refuse to buy US bonds.

The second case poses no problem, say the MMTers, or at least no worse problem than the first: the US government can simply issue money, crediting it to banks, to pay its bills.

WHICH, WHEN LOOKING AT GOVT. ON A CONSOLIDATED BASIS- FUNCTIONALLY COMBINING THE TSY AND FED, IS WHAT HAPPENS IN ANY CASE.

GOVT. SPENDING ADDS TO MEMBER BANK RESERVE BALANCES, AND TAXING REDUCES THOSE SAME BALANCES. BORROWING SHIFTS THOSE BALANCES FROM RESERVE ACCOUNTS TO SECURITIES ACCOUNTS, BOTH AT THE FED. AND REPAYING BORROWING IS THE SHIFTING OF DOLLARS FROM SECURITIES ACCOUNTS BACK TO RESERVE ACCOUNTS.

POINT HERE IS, THE GOVT. (FROM INCEPTION) CAN’T DO WHAT’S CALLED A RESERVE DRAIN (DEBITING RESERVE ACCOUNTS) WITHOUT FIRST DOING A RESERVE ADD (SPENDING OR LENDING).

SO UNLESS THE GOVT. ALLOWS BANK OVERDRAFTS- AND AN OVERDRAFT, IS, FUNCTIONALLY, A LOANS TO THAT BANK, AND BOOKED AS SUCH WHEN IT HAPPENS- IT CAN’T TAKE DOLLARS OUT OF MEMBER BANK RESERVE ACCOUNTS WITHOUT FIRST PUTTING THEM IN. AND IN THE CASE OF OVERDRAFTS IN RESERVE ACCOUNTS, THE OVERDRAFT LOAN IS THE GOVT DOING A RESERVE ADD FIRST, AND THEN A RESERVE DRAIN.

IT’S LIKE A BUS COMPANY CAN’T COLLECT IT’S TOKENS FOR ANY REASON UNTIL AFTER IT ISSUES THEM. THAT’S THE DIFFERENCE BETWEEN ISSUER AND USER- ISSUERS MUST ISSUE FIRST, AND THEN COLLECT, USERS MUST FIRST COLLECT AND THEN MAKE PAYMENTS.

But what happens next?

We’re assuming that there are lending opportunities out there, so the banks won’t leave their newly acquired reserves sitting idle; they’ll convert them into currency, which they lend to individuals.

IN THE BANKING SYSTEM, THE CAUSATION IS FROM LOANS TO DEPOSITS. LOANS DON’T DIMINISH THE TOTAL RESERVES IN THE BANKING SYSTEM.

So the government indeed ends up financing itself by printing money, getting the private sector to accept pieces of green paper in return for goods and services.

NOT EXACTLY. IF GOVT SPENDS AND DOESN’T ISSUE SECURITIES, WHICH ARE TIME DEPOSITS IN FED SECURITIES ACCOUNTS, THE DOLLARS INSTEAD SIT IN RESERVE ACCOUNTS. IN ORDER TO SUPPORT THE FED’S TARGET RATE OF INTEREST, THE FED THEN PAYS INTEREST ON THOSE RESERVE BALANCES, OFTEN CALLED THE ‘SUPPORT RATE’, OR THE MARGINAL COST OF FUNDS- THE FED FUNDS RATE- FALLS TO 0%.

THE WAY THE GOVT SUPPORTS A NON ZERO RATE TARGET IS TO PAY INTEREST ON THE RESERVE BALANCES CREATED BY DEFICIT SPENDING. IT CAN USE EITHER TSY SECS, WHICH ARE FUNCTIONALLY TIME DEPOSITS AT THE FED, OR INTEREST BEARING RESERVE BALANCES HELD BY MEMBER BANKS AT THE FED.

And I think the MMTers agree that this would lead to inflation; I’m not clear on whether they realize that a deficit financed by money issue is more inflationary than a deficit financed by bond issue.

WITH TODAY’S FLOATING EXCHANGE RATE POLICY, IT’S PRIMARILY THE ACTUAL SPENDING THAT’S INFLATIONARY, AND NOT SO MUCH THE WAY THE SUPPORT RATE IS PAID- EITHER ON OVERNIGHT BALANCES OR ON TERM DEPOSITS (TREASURY SECURITIES).

For it is. And in my hypothetical example, it would be quite likely that the money-financed deficit would lead to hyperinflation.

AS ABOVE. YOUR CONCERN IS FOR FIXED EXCHANGE RATE REGIMES, SUCH AS A GOLD STANDARD, WHERE TREASURY SECURITIES MUST COMPETE WITH THE OPTION TO CONVERT AT THE GOVT. OF ISSUE. AND BY NOT OFFERING TREASURY SECURITIES OR OTHERWISE COMPETING WITH A COMPETITIVE INTEREST RATE, THE HOLDERS OF THE DOLLARS WOULD BE PRONE TO CONVERT THEM AND DRAIN THAT NATION’S RESERVES, WHICH CAN QUICKLY LEAD TO DEVALUATION AND AT LEAST A ONE TIME JUMP IN THE PRICE LEVEL.

The point is that there are limits to the amount of real resources that you can extract through seigniorage. When people expect inflation, they become reluctant to hold cash, which drive prices up and means that the government has to print more money to extract a given amount of real resources, which means higher inflation, etc..

I CALL THAT A DROP IN SAVINGS DESIRES. WITH FLOATING EXCHANGE RATES, INFLATION FROM THAT SOURCE IS TAKEN OUT IN THE LEVEL OF THE CURRENCY. AND YES, WITH INFLATION GOVT SPENDING TENDS TO GO UP, HOWEVER SO DO TAX RECEIPTS, AS PER THE SMALL CARTER SURPLUS IN 1979?
Do the math, and it becomes clear that any attempt to extract too much from seigniorage — more than a few percent of GDP, probably — leads to an infinite upward spiral in inflation.

ALSO, INFLATION IS ALREADY DEFINED AS A CONTINUOUS INCREASE IN THE PRICE LEVEL. MORE OFTEN THAN NOT, I’VE SEEN RATES OF INFLATION STABILIZE AT ELEVATED LEVELS, RATHER THAN ACCELERATE, THOUGH IT’S CERTAINLY POSSIBLE IF PUSHED ENOUGH.

I SAY IT THIS WAY- THE RISK OF OVERSPENDING IS INFLATION, NOT SOLVENCY.

AND EVEN IN RUSSIA IN 1998, A CLASSIC FIXED EXCHANGE RATE BLOW UP, THE RUBLE WENT FROM 6.45 TO THE DOLLAR TO ABOUT 28 TO THE DOLLAR, WHERE IT’S PRETTY MUCH BEEN EVER SINCE. SAME WITH THE MEXICAN PESO A FEW YEARS BEFORE THAT. IT WENT FROM 3.5 TO ABOUT 10 TO THE DOLLAR AND PRETTY MUCH STABILIZED THERE. BUT ALL I’M SAYING HERE IS THAT CONTINUOUSLY ACCELERATING INFLATION ISN’T NECESSARILY AUTOMATIC, EVEN IN SITUATIONS FAR WORSE THEN ANYONE’S IMAGINING FOR THE US.

In effect, the currency is destroyed. This would not happen, even with the same deficit, if the government can still sell bonds.

AS ABOVE, IT’S NOT ABOUT BOND SALES PER SE WITH OUR CURRENT INSTITUTIONAL ARRANGEMENTS.

The point is that under normal, non-liquidity-trap conditions, the direct effects of the deficit on aggregate demand are by no means the whole story; it matters whether the government can issue bonds or has to rely on the printing press. And while it may literally be true that a government with its own currency can’t go bankrupt, it can destroy that currency if it loses fiscal credibility.

RESPECTFULLY DON’T AGREE, AS ABOVE. WITH TODAY’S INSTITUTIONAL STRUCTURE IT’S ENTIRELY A MATTER OF AGGREGATE DEMAND.

Now, I am not predicting hyperinflation for the US — I am not Peter Schiff! Most of our current deficit is cyclical, and even in the long run a modest return of political rationality would make the budget issue eminently solvable. But the MMT people are just wrong in believing that the only question you need to ask about the budget deficit is whether it supplies the right amount of aggregate demand; financeability matters too, even with fiat money.

AGAIN, NOT THE CASE WITH TODAY’S INSTITUTIONAL STRUCTURE. I’VE BEEN AN ‘INSIDER’ IN MONETARY OPERATIONS FOR ALMOST 40 YEARS. I KNOW HOW THE DEBITS AND CREDITS WORK. AND EVERYONE IN FED OPERATIONS WOULD AGREE WITH ME.

OK, I have no illusions that this will convince anyone in this area. (Can you imagine John Galt admitting that he was wrong?) But I thought I should put it down.

Comment from Coleen E.
Time: August 16, 2011, 9:29 am

Ce débat s’est propagé comme vous vouliez. Ne doit-on pas remercier le prof. Krugman plutot.

Comment from Jeff Dean
Time: August 16, 2011, 11:07 am

Ed Steelhouse: “I am not a “socialist” in it’s original meaning, I am an advocate of an optimal mix of public and private, and think markets are a darned good idea, properly regulated. As a supposed “progressive” I feel that “progressives” need to come up with rational criteria as to what services should be supplied by the public sector and what by the market sector.”

Ed, to come up with a rational criteria as you suggest, I think a good starting point would be to go back to the economic theory that powered the progressive era reforms. I learned about them in Michael Hudson’s recently reprinted book, American’s Protectionist Takeoff. Hudson says that the American school of political economy (the history of which has been severely neglected) focused on reducing prices to the technologically necessary cost of production. He summarizes the rationale something like this:

The role of the economy is to provide increasing living standards and capital formation. The role of the government in the economy is to manage (regulate) it so as to minimize the cost of living and the cost of doing business to the economy as a whole. And to do this, the government should reduce and eliminate inefficient taxes on labour and business enterprise and to instead tax economic rent in the form of nature (including land) and licensed monopolies.

Basically, peoples’ lives should be improving and we should be making tangible, productive investments in physical and human capital. If this isn’t happening then something is wrong. The cost of living should be minimized so people can live well and maybe not have to work so much. The cost of doing business should be minimized so people can start new businesses and engage in productive activity without being penalized by predatory monopolies or unfair taxes (as is the case in our present “toll booth” economy). These costs should be minimized for the economy as a whole and not for special interests. Taxes on labour and business penalize productive activity, while taxes on nature rationalize its use. Taxes on nature and licensed monopolies (anything where a government imposes a barrier to entry, notably banks but also limited liability corporations), in addition to being more economically efficient, are also just and equitable because the value of these are given by the community at large – ie. a parcel of land will appreciate when demand (for example population) increases, without any effort by the landowner.

Comment from Andrew Jackson
Time: August 24, 2011, 9:33 am

Thanks for Mosler vs Krugman.

Comment from Matt
Time: July 12, 2012, 3:10 am

If you are searching for MMTers in Canada, look no further than the Eco dept at the University of Ottawa.
Matt

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