Summary: Next in a series about economics and the global government debt crisis, Ed Dolan talks to us about modern monetary theory. How does it differ from mainstream economics? And he has a few words to say about the Austrian school. This was lifted from the comments of yesterday’s post.
Other posts in this series:
(1) America’s strength is an illusion created by foolish borrowing, 10 October 2012
(2) Prof Black blasts back at yesterday’s post about the US debt, 11 October 2012
(4) Ed Dolan Asks What Does it Mean for Fiscal Policy to be “Sustainable”? MMT and Other Perspectives, 30 November 2012
Contents
- Ed Dolan’s comment
- About the Author
- About Modern Monetary Theory
- About Keynes
- For More Information about Economics
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(1) Ed Dolan’s comment
I have been reading this lively thread with great interest. I do not think of myself as an MMT advocate, and I gather that most of the commenters agree, yet I keep seeing them passionately claim as uniquely “MMT” views that are completely commonplace and that I, as a “mainstream” economist, have always taught as obvious truths. For example, Ikonoclast writes:
“A key MMT view is that taxes do not pay for expenditure. In one sense this is right. In another sense it is wrong but more of that later. MMT takes the view that the national budget creates all the dollars of expenditure for that year at the time the budget is brought down. MMT further states that taxes when collected extinguish the dollars thus collected”
Well, it happens that I am in the middle of teaching a monetary economics course right now, and tomorrow’s lecture addresses just this subject. One slide in my lecture (a slide that has been there for years) contains a set of T-accounts that demonstrates precisely this point: Collection of taxes extinguishes money, spending by the Treasury creates money, and when you consolidate the two T-accounts, the two transactions net out to no change in money. In exactly that sense, as Ikonoclast points out, the “MMT” proposition is both right an wrong.
Surprise, surprise! I’ve been teaching MMT for years and didn’t even know it.
Ikonoclast is right on the mark in saying that we have to distinguish between mainstream economics – here I mean truisms like “assets = liabilities + net worth” – and “man on the street” (MoS) economics. The trouble is exactly that MoS does not understand economics of any kind very well, including the truisms.
Here is a perfect example: Sometimes I take my students to a “money museum” set up by the central bank of the country where I am teaching. Among other displays there is a cube, about 18″ on a side, that contains paper bills in the local currency amounting to 1 million currency units. When I get back to the classroom, I ask my students the following question: WHERE DO THE BANKNOTES IN THAT STACK IN THE MUSEUM APPEAR ON THE CENTRAL BANK’S BALANCE SHEET?
Now, these are undergraduate students, still teenagers, and most of their preexisting knowledge is of the MoS school. 90% of them answer that the banknotes in the museum should be entered on the Central Bank’s balance sheet as a 1 million unit asset. The other 10% – the ones who know a little bit about how central banks work – answer that the banknotes should be entered as a 1 million unit liability. Of course, both are wrong! The correct answer is the the banknotes in the museum are just a stack of paper and do not appear on the CB balance sheet at all until they are issued to the public in some way, for example, through an open market operation, or transferred to the Treasury which subsequently spends them on goods and services.
I can see from the “taxes extinguish money” thread here that members of the “serious” subset of MMTers agree with me that banknotes stored by the Treasury or CB are neither assets nor liabilities of the government, they are “nonmoney”, just paper. What many contributors to this discussion thread fail to realize that us “mainstream” economists know that and have always known it, along with many other “uniquely MMT” propositions.
At the same time, I would be willing to bet a large stack of colorfully printed paper that many participants in this discussion would have given the wrong answer right to my trick question about the banknotes in the museum. Clearly, there is an MoS version of MMT as well as the serious version.
The same goes for the view of whether sovereign governments can “go broke.” I think all mainstream economists recognize that there is a sense in which the answer is yes and a sense in which it is no. In the sense that they can always create new money to settle any financial obligation that has a fixed nominal value in their own currency, the answer is, almost trivially, that no, they cannot go broke. On the other hand, they face the inflation constraint, and under conditions of hyperinflation, governments can “go broke” in the sense that the cease to be able to buy real goods and services with any finite nominal amount of currency.
Zimbabwe is a perfect case in point. It had a sovereign currency and did not blush to print octillion dollar banknotes, but eventually the people they tried to buy goods and services from just said “no thanks, I’d rather keep this loaf of bread than sell it to you for 1 octillion dollars.” Instead, they just turned their back on the government and used substitute currencies, mostly euros and rand, for day to day transactions.
The government ranted “no, you can’t do that! This is our sovereign fiat currency! You have to use it!” No one paid any attention. The government ranted “you have to pay your taxes and you have to pay them in Zimbabwe dollars!” People just said, “why should we pay taxes to you bunch of clowns?” and turned their back again. So the Zimbabwe government went broke despite its mighty printing presses. Seriously, I’d be very interested to read a good MMT analysis of the Zimbabwe hyperinflation. Know of any?
Ikonoclast is again right on the mark when he writes “It leads one to wonder why MMT advocates are so keen to make odd-seeming claims to emphasise their difference from Keynesianism in general. Perhaps one can put it down to what Freud called the “narcissism of minor differences” {see Wikipedia}.
MMTers seem to share this narcissism of minor differences with some other small schools of economics. For example, I have hung out a lot with members of the Austrian school, and even edited a book once called Foundations of Modern Austrian Economics (see it here and here). I like these Austrian guys, they are smart and have good ideas, but wow, are they ever heavy into the narcissism of minor differences. The sad thing is, although it gives them some kind of boost to their self-esteem, it hurts their ability to convince the world at large of the validity of that subset of their ideas that are both sound and original.
In the above mentioned book, I cited Milton Friedman as saying “There is no such thing as Austrian Economics – only good economics and bad economics.” (Friedman did recognize that Austrians, for example his Chicago colleague Hayek, had many good ideas.) I would say very much the same thing about MMT.
(2) About the author
Edwin G. Dolan is an economist and educator with a Ph.D. from Yale University. He was a Asst Prof of Economics at Dartmouth College, and later on the faculties of U of Chicago, and George Mason U. From 1990 to 2001, he taught in Moscow, Russia, where he and his wife founded the American Institute of Business and Economics (AIBEc), an independent, not-for-profit MBA program. Since 2001, he has taught at several universities in Europe, including Central European University in Budapest, the University of Economics in Prague, and the Stockholm School of Economics in Riga, where he has an ongoing annual visiting appointment.
During breaks in his teaching career, he worked in Washington, D.C. as an economist for the Antitrust Division of the Department of Justice and as a regulatory analyst for the Interstate Commerce Commission, and later served a stint in Almaty as an adviser to the National Bank of Kazakhstan. When not lecturing abroad, he makes his home in Washington’s San Juan Islands.
His publications include Introduction to Economics (2011), and TANSTAAFL: An Economic Strategy for the Environmental Crisis , v40 (2011). See his posts at Roubini’s Economonitor.
(3) About Modern Monetary Theory (MMT)
MMT is best known for stating that governments can print far great amounts of currency without ill consequences than conventional theory suggests. It is in one sense the mirror image of the austerian (not Austrian) obsession with gold and inflation. They are bookends, in a sense.
Many well-respected economists advocate this theory. Such as my fellow author at Roubini’s Economonitor L. Randall Wray (Prof Economics at U of Missouri-Kansas City); see his articles here.
About MMT and the limits of monetizing the debt:
- “Deficits Do Matter, But Not the Way You Think“, L Randall Wray, 20 July 2010
- “Deficit Doves Meet the Deficit Owls“, Stephanie Kelton, New Economic Perspectives, 21 July 2010
Here are two clear explanations of MMT by Paul Krugman (also not a fan of MMT):
If you would like to really learn about MMT, here are two ebooks by Warren Mosler (hedge fund manager and banker), a founder of MMT:
- “Soft Currency Economics” — 32 pages
- Seven Deadly Frauds of Economic Policy (2010) — 63 pages
(4) For More Information about the work of John Maynard Keynes
- The greatness of John Maynard Keynes, our only guide in this crisis, 4 December 2008
- About the state of economic science, and advice from a famous economist, 8 December 2008
- Words of wisdom about the global recession, from the greatest economist of our era, 29 December 2008
- Some thoughts about the economy of mid-21st century America, 12 January 2009
- Economics is not a morality tale, 14 January 2009
- Keynes comments on our new-found love of austerity, 21 June 2010
- Keynes looks 80 years into the future and across the Atlantic, to explain our broken values, 25 July 2012
(5) For More Information about Economics
(a) These FM Reference pages list all posts about two of the great economic stories of our age:
- about the Financial crisis – what’s happening? how will this end? – esp section 8, about solutions
- about the End of the post-WWII geopolitical regime
(b) Where to find good commentary about economics:
- Economics can help understand events in America and the world. Here’s where to find those answers., 16 February 2010
(c) Posts on the FM site about economics — theory and practice:
- “A depression is for capitalism like a good, cold douche.”, 17 December 2008
- A very important article by an expert, discussing the necessary next step to solve the financial crisis, 17 February 2009
- Economic theory as a guiding light for government action in this crisis, 10 March 2009
- Why have mainstream economists lost the argument about the need for more economic stimulus?, 27 June 2010
- Looking at one of the most popular books in the conservative canon: The Road to Serfdom, 7 July 2010
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Uh oh… MMT analysis of Zimbabwe is common place. One small part is “if you ain’t got nutin to sell ain’t no body want your cash”
Amd now it begins :-)
FYI:
Ya know I think I must be doing something right because I keep running into some incredible communities on this web thing.
Wonderful article Mr. Maximus. Looking forward to having a lot more to weigh.
Is it too soon to broach the subject of endogenous vs exogenous money creation?
A comment yesterday noted that Krugman had backed away from the loanable funds model. Not really. He says there can be patient savers who lend to impatient borrowers. This is no retreat from loanable funds. This is a core issue separating neo-classicals from MMT as well as post Keynesians like Keen.
We can include Austrians in the discussion by noting they appear to have no theory of money creation at all other than saying it started as an improvement over barter and if only govt would stop meddling, the total amount in existence would not matter. IMO no established theory of money creation and destruction by credit, means no framework for discussion. That’s how seminal the debate over Exo/Endo-genous view of money creation is.
I think the article Peterblogdanovich refers to is “Debt, Deleveraging, and the Liquidity Trap: A Fisher-Minsky-Koo Approach“, Gauti B. Eggertsson and Paul Krugman, The Quarterly Journal of Economics, August 2012. Free copy available at Scribd.
Abstract
In this article we present a simple new Keynesian–style model of debt-driven slumps—that is, situations in which an overhang of debt on the part of some agents, who are forced into rapid deleveraging, is depressing aggregate demand. Making some agents debt-constrained is a surprisingly powerful assumption. Fisherian debt deflation, the possibility of a liquidity trap, the paradox of thrift and toil, a Keynesian-type multiplier, and a rationale for expansionary fiscal policy all emerge naturally from the model. We argue that this approach sheds considerable light both on current economic difficulties and on historical episodes, including Japan’s lost decade (now in its 18th year) and the Great Depression itself.
The paper by Eggleston and Krugman highlights the policy issue which, to me, should be the practical application of the insight gained from looking at these different models:
“This in turn explains why more (public) debt can be a solution to a problem caused by too much (private) debt. The purpose of fiscal expansion isto sustain output and employment while private balance sheets are repaired, and the government can pay down its own debt after the deleveraging period has come to an end.” p. 20, Eggleston & Krugman, op cit
sorry, Eggertsson, not Eggleston
Yes, this is Krugman’s contribution to considering how debt can matter while still hewing to the notion of loan-able funds, i.e. for every lender who agrees to surrender (loan) an asset (this agreement hits the lender’s balance sheet as a liability) there is symmetrically a borrower who receives same (appearing as an asset on his balance sheet), but the borrower generates a note (a liability on his balance sheet) which the lender takes as a replacement asset onto his balance sheet. For both parties the transaction nets to zero. By this apparently unassailable logic, debt cannot matter to a macro economy because in aggregate debt nets to zero. Then, in response to Mos entering the policy discussion and debt coming up repeatedly, Krugman says,”Well, I suppose the problem could arise due to a duration mismatch between the note, which might be callable, and the expected time of possession of the loaned asset in the mind of the borrower.” That is, the bank could call the loan and wreak havoc on the borrower as the rug gets pulled out from under him. Krugman suggests the problem is banks can change their minds about duration.
There is a problem with loan-able funds at a deeper level than this. Steve Keen has demonstrated that it is possible to build a dynamic model of a simplified (he says “Toy”) economy containing banks, firms, and workers. The model is so simple there might as well be one bank, one firm, and one entity called “workers”. The defining relationships are nothing more than the rules of double entry book keeping combined with simple rules setting flows between the three sectors. These rules can be adjusted to reflect behavior consistent with simple loan-able funds without duration mismatch, loan-able funds with duration mismatch, and no loan-able funds constraint. These rules combined with double accounting book keeping manifest as a system of coupled non linear ordinary differential equations stated as an initial value problem. The initial values are the state of capitalization of the three actors at time zero.
Here’s the problem. If you put in a loan-able funds constraint on banks, i.e. bank loans must “come from” either worker’s savings or firm’s retained earnings, the Toy economy will grow initially as the start up capital works its way through the three sectors, but eventually all internal capital flows will flat line. Growth in both capital stocks and flows is eventually zero for all values of time forward. We have a paradox. How can a loan-able funds economy disallow growth? It turns out Schumpeter pondered the same question, as did Marx (sort of) and Minsky too. The answer is that you can posit a “no loan-able funds constraint” economy. It’s frighteningly easy to do this in the model and in our real world. You simply allow banks to lend money they don’t have. Banks do this every day. They “fund” your loan by simply crediting your account with dollars. They add a book entry showing your note to them as an asset. To paraphrase the banker in that famous Southpark episode, “…And it’s created!”. (In the original he tells Kyle, “…And it’s gone!”. Very funny, but not to Kyle.
Banks don’t save in any ordinary sense. They intermediate between agents who can and do create wealth by their activities. These agents can save in the ordinary sense. They can lend as well. Banks don’t need these actor’s savings in order to lend. Very often, in real economies, they simply lend anyway, and it’s a damn good thing they do because an economy like ours can’t grow if they don’t. If you do the case where loan-able funds is constraining banks but add duration mismatch -same result;no growth.
But what if they lend stupidly? Good question.
Actually, the Austrian theory of the origins of money has already been absorbed into mainstream economics.
The theory is this: “If people barter…, then they can rarely get what they want in one or two transactions. If they have lamps and want chairs, for example, they will not necessarily be able to trade lamps for chairs but may instead have to make a few intermediate trades. This is a hassle. But people notice that the hassle is much less when they trade what they have for some good that is widely accepted, and then use this good to buy what they want. The good that is widely accepted eventually becomes money.” – Library of Economics and Liberty (the section on Carl Menger)
It’s quite simple actually.
George,
That insight is centuries older than any of the existing schools of economics, and indeed older than economics as a science.
As evidence, can you find someone who disagrees — now or in the past — who is any sort of mainstream economist?
Insights are “absorbed” when disagreements cease.
“So the Zimbabwe government went broke despite its mighty printing presses. Seriously, I’d be very interested to read a good MMT analysis of the Zimbabwe hyperinflation. Know of any?”
“boscoe degama” referenced Bill Mitchell’s analysis in the last thread, but he didn’t manage to include the link.
Whether it’s a “good” analysis is beyond my competence to judge. It seems to make sense, but I am, alas, a MoS. (I don’t mean that sarcastically. It is a real problem for democracy. Most voters will be MoS about most issues. So either democracy has to work around the “common people”—at which point it’s really just a dictatorship by the elite with ceremonial ratification by the unwashed masses—or the various disciplines relevant to geopolitics have to make themselves comprehensible to the MoS.)
Thanks for the link.
Zimbabwe’s hyper-inflation began with Robert Mugabe, who stole farmland from farmers and gave it to people who didn’t know how to farm. The resultant food shortages caused inflation, which Mugabe attempted to address, not by increasing the value of the Zimbabwe dollar (by raising interest rates), but rather by printing banknotes.
Value still = Demand/Supply and if the value is to be maintained, the demand must be stimulated. That is the way the U.S. Fed controls inflation to its target levels.
For Zimbabwe, the inflation caused the printing, rather than the other way around.
Debt hawks love to worry about U.S. hyper-inflation (which we never have had in our history, even during world wars and depressions), when in fact, since the U.S. became Monetarily Sovereign in 1971, there has been zero correlation between federal deficit spending and Inflation. See: http://rodgermmitchell.wordpress.com/2010/04/06/more-thoughts-on-inflation/ Thank you, U.S. Fed.
I also noticed a concern about the U.S. becoming like Argentina, and that concern is valid, not because the U.S. is Monetarily Sovereign, but because, like Argentina did, the U.S. is determined to act as though it isn’t Monetarily Sovereign.
Thus you have the foolish debt limit and the misleading debt clocks, and the truly terrible drive to reduce the federal deficit. There are only two ways to reduce the deficit and both cut GDP growth: Increase federal tax collections and/or reduce federal spending.
You can see this problem in the calculation of GDP:
GDP=Government Consumption & Investment + Personal Consumption Expenditures + Private Domestic Investment – Net Imports
Even the most cursory examination of this formula shows that the efforts to reduce federal deficits, are misguided. Cut federal spending and you cut Government Consumption and Investment. Increase taxes and you cut Personal Consumption Expenditures and Private Domestic Investment.
There is in fact no way to reduce the deficit without negatively affecting GDP (unless one thinks reducing Net Imports is a realistic option). And that is the whole point of MMT (or Monetary Sovereignty).
The criticisms of MMT and Monetary Sovereignty seem to miss that fundamental point — a point mainstream economics has not made clear to the public, the media and the politicians, all of whom mistakenly believe the federal deficit should be reduced.
Since the mainstream is the “uber” majority in economics, I am surprised it has not done more to save America from the debt hawks, whose beliefs threaten to take us over the “fiscal cliff.”
Finally, some take exception to my oft-stated comment, that if you don’t understand the difference between Monetary Sovereignty and monetary non-sovereignty, you don’t understand economics, and I stand by that statement. The monetarily non-sovereign euro nations are Exhibit I.
Rodger Malcolm Mitchell
That’s a clear explanation from an MMT perspective. Thank you for posting it.
Mr. Dolan and Fabius,
I’d like to try, if you would bear with me, again to ask the question I seem to have bungled in the previous thread.
A household, or a business, can lose access to credit due to the amount of outstanding debt it has, even if it is *currently* prudent.
Can this ever happen to a nation like the United States, Australia, Japan or Great Britain?
One of those countries could become a bad risk—meaning no one wants to buy their bonds at a reasonable price—if its political or financial institutions became unreliable, or if its real economy collapsed or inflated due to mismanagement or external shock (either it becomes doubtful that the country will honor its honest debts, or it becomes doubtful that the currency in which the debt is denominated will retain value).
But would a currency issuer ever lose access to the bond markets *just* because of the amount of debt from past years (as a currency user might)?
My understanding is that this is a significant claim MMT makes¹, and others either ignore or dispute: that the current state of public finances—e.g., the *deficit*—affects the current economy, but the accumulated *debt* is irrelevant. If true, that means we should properly think about the effects of current deficit or surplus on today’s economy (inflation, unemployment, etc.); but the future effects of concern are those on investment (public and private, including education, infrastructure, etc.)—*not* the debt.
That makes a big difference, because whenever there is insufficient aggregate demand to generate full employment and utilization of productive capacity in the private sector, there is an obvious value *now* to taking up the slack with any reasonably useful public investment. The argument against this always takes the form of worry about “the burden of (public) debt we are leaving to future generations.” If, as I suspect, and I think MMT says, that notion is nonsense, then most of the anti-deficit arguments we hear are bogus.
(We should worry about deficits when we see full employment and capacity utilization coupled with inflation: at that point, government is competing with the private sector, and should either reduce spending or raise taxes. When there is unemployment, capacity is underutilized, and there is no inflation, government should be increasing its deficit so that idle resources are sensibly utilized. If some other combination occurs—like the 1970s stagflation—damned if I know what the theory says then.)
¹Actually, I believe MMT doubles down on this by saying that even if the access to bond markets were lost it wouldn’t matter, because it makes no difference whether a currency issuer borrows or monetizes to cover deficits. This seems to be a point strongly contested by non-MMT folks (such as Paul Krugman). It’s not clear to me whether there have been any natural experiments that shed light on which belief is accurate.
“Can this ever happen to a nation like the United States, Australia, Japan or Great Britain?”
Easily, in practical terms (ie, at an acceeptable price; almost everything is available at some price). Japan might become a test case in the future. The UK was on their way to that point before the IMF loan in 1976 (largest ever at that time); see the UK Cabinet Papers for details. Australia too had a severe debt crisis, after which they got religion and reduced it significantly (now 23% – 30% of GDP, depending on the source).
The point at that is reached depends on many factors, some structural and some circumstantial.
from UK Cabinet Papers cited:
I could be missing the point, but I don’t see anything there that supports the idea that it was the existing debt—not current conditions (excluding the debt, and perhaps including investors’ whims)—that spooked the currency speculators. I have to emphasize (as always, subject to the caveat that I am far from expert) that precisely that distinction is what leads to differing conclusions in the MMT-type analysis and the standard one. MMT doesn’t dispute that budget deficits matter *now*, and I don’t get the impression that they differ greatly from the (center-to-left, at least) mainstream in how to think about current effects. What they insist is that there is no *future* effect of concern from the accumulation of today’s deficit into tomorrow’s debt. (There can, of course, be future effects from the impact of taxes and spending on *real* things in the present, like investment and education.)
Unless I misunderstand, the MMT contention is that the amount of debt (not deficit, debt) on the books of a nation that controls its own fiat currency is completely irrelevant to anything; other things being equal, the debt could be any number you like, and the economic situation would be exactly the same.
Perhaps it is vital to MMT logic on this point to hold, as they do, that monetizing the deficit and borrowing to cover it are equivalent. That discussion is going on in another sub-thread, and it seems to be a significant point of division (not a narcissism of small differences).
The next post going up addresses this point, and gives links to some of the major points.
As for the UK, their debt/GDP was one element in the loss of creditor’s confidence. Inflation and financial repression had recorded the war debt down to under 50% of GDP, but with a 9% fiscal deficit, falling currency, and creditor rebellion they were faced with the prospect of rates rising to unsustainable levels.
In other words, the solvency equation for sovereigns has many dimensions — debt being one of the key ones (as this is transmission belt by which higher rates increase the deficit, setting up positive feedback to insolvency).
There is an MMT take that reconciles the apparent exception for Britain in 1976. This from Bill Mitchell (Bill Mitchell is a Director of the Centre of Full Employment and Equity (CofFEE) at the Charles Darwin University, Northern Territory, Australia): “Bailouts will not save the Eurozone“, 5 May 2010. In the section talking about the 1976 IMF loan…
FM,
You’ll soon discover that MMT’s treatment of the foreign sector is one of their weakest points. They actually think trade surpluses are inferior to trade deficits and that a nation that can produce nothing domestically and import everything is better off than a nation that produces domestically. See this article by Bill Mitchell: “What you consume or what you produce?“, Bill Mitchel, billy blog, 6 September 2010.
In Mosler’s book 7 Deadly Innocent Frauds, he actually says “the bigger the trade deficit, the better”. This ignores the obvious exorbitant privilege that some developed nations experience. MMTers know that sectors must balance and that one countries trade surplus is another’s deficit. So their position on trade deficits is internally inconsistent since bigger trade deficits obviously also mean bigger trade surpluses. For instance, while America is experiencing an ever increasing trade deficit someone is forced to take the other side of this trade. So, let’s say MMT is right and trade deficits are great. Then MMT obviously promotes large trade surpluses as well. And you end up with nations like Germany and China and other export driven nations who must take the other side of this trade.
If you study the recent Iranian hyperinflation you’ll see that many of MMT’s core arguments are wrong. They think currency demand is an extension of taxes and the government’s ability to enforce taxes. Mosler says the government just needs to hold a gun to people’s heads. See here: “taxes and money“, Warren Mosler, The Center of the Universe, 23 October 2009
This is obviously wrong in the case of Iran where a collapse in oil exports is driving the currency lower. It has nothing to do with taxes or enforcement. MMT is very weak on hyperinflation and even managed to write several confused stories about the Zimbabwe hyperinflation. What really happened in Zimbabwe? A socialist came in and took the means of production from capitalists and redistributed the wealth to his friends. And when this export driven nation’s one export collapsed the country collapsed. LIke the Iranian hyperinflation, this proves core pieces of MMT wrong.
MMT loves to take this position of exorbitant privilege or misconstruing developed nations to claim that any country can be applied to the MMT principles. It’s obviously wrong. It’s not a mistake that you’ve seen no one in the MMT camp respond to the currency collapse in Iran. It disproves core pieces of their work.
This barely scratches the surface though. You’ll find that MMT has a weak excuse for all sovereign bankruptcies because they don’t understand how currency demand works. They think it’s all one sided starting and ending with how well the government can establish and maintain the currency.
One more thing on trade. MMT says imports are “real benefits” and exports are “real costs”. I’ve previously mentioned that MMT downplays the importance of Investment in their work because they change the OECD definition of “net saving” to subtract domestic investment (S – I) = (G -T).
So from the MMT perspective, they say America is better off than China in foreign trade because America gets “real” things (like plastic pieces of crap) and China gets pieces of paper. Of course, what MMT ignores is that along with all those pieces of paper comes millions of real jobs and tons of real domestic investment.
This is a huge flaw in MMT’s thinking on the foreign sector. But they hate domestic investment because to include investment in their definition of saving would mean you change the focus from government spending to domestic private investment (which is what most economies are built on anyhow). But MMT has to build this government based view of the world in order to remain consistent. It doesn’t work and it’s not an accurate representation of reality.
“a nation that can produce nothing domestically and import everything is better off than a nation that produces domestically”
Mitchell doesn’t actually say that.
“Mosler says the government just needs to hold a gun to people’s heads.”
He doesn’t actually say that.
“This is obviously wrong in the case of Iran where a collapse in oil exports is driving the currency lower.”
US-led international sanctions are a major cause.
“It has nothing to do with taxes or enforcement.”
How clever you are.
“MMT is very weak on hyperinflation and even managed to write several confused stories about the Zimbabwe hyperinflation.”
Who is MMT?
“What really happened in Zimbabwe? A socialist came in and took the means of production from capitalists and redistributed the wealth to his friends.”
Yeah, I think that qualifies as quite a confused story.
“Like the Iranian hyperinflation, this proves core pieces of MMT wrong.”
Only to people who clearly don’t know what they are talking about.
“MMT loves to take this position of exorbitant privilege or misconstruing developed nations to claim that any country can be applied to the MMT principles.”
What does “misconstruing developed nations” mean? And no, MMT economists don’t claim that MMT is currently applicable to all countries.
“You’ll find that MMT has a weak excuse for all sovereign bankruptcies because they don’t understand how currency demand works.”
More gibberish.
“This is a huge flaw in MMT’s thinking on the foreign sector. But they hate domestic investment because to include investment in their definition of saving would mean you change the focus from government spending to domestic private investment”
Well it’s pretty obvious that you hate MMT. But no, MMT economists do not hate domestic investment, so what you are saying is once again completely false.
The MMT claims are so utterly bizarre and fascinating that I went out and spent good money on a book by Abba Lerner entitled“The Economics of Control”. It is a truly strange attempt to somehow merge totalitarian socialism with a controlled market that allows for some limited “pricing”. I have scanned a portion of the table of contents and a few other pages.
http://www.flickr.com/photos/bob_roddis/5560086644/in/set-72157626353319778
I still maintain that the MMTers know nothing of the socialist calculation debate and do not understand that that the socialists lost the debate. They seem completely unaware of the problems of economic calculation in society and assume that the government can and will be able to centrally “manage” society and the economy with benevolent injections of fiat money here and there.
The monetary theory part of their narrative is secondary to their unshakable belief in dirigisme. As John Carney of CNBC has written:
“MMTers do not seem to fully appreciate the problems of ignorance and calculation that inform Austrian economics. They seem to recoil at even thinking about them because of the implications for the limits of political action.”
http://tinyurl.com/7sycbey
For us non-tv watchers, his bio at CNBC:
“John Carney is a senior editor at CNBC.com, covering Wall Street, hedge funds, financial regulation and other business news. Prior to joining CNBC.com, John was the editor of Clusterstock.com and DealBreaker.com.”
It’s not clear from his bio that he’s an economist.
What has Lerner to do with MMT or anything else in this discussion?
As for the “socialist calculation debate” (I presume this: Wikipedia entry on the Economic Calculation Problem is the same thing?), it sounds as if you would say all those who don’t adhere to the Austrian school “do not understand that that the socialists lost the debate.” There’s nothing wrong with asserting that, but it’s not a complaint against MMT in particular.
Aside from the peculiar insistence on the Job Guarantee (and there is disagreement about whether that is detachable from the rest of MMT), it doesn’t appear to me that MMT is out of line with the center-to-left mainstream in their assessment of government involvement in the economy:
On that last point, MMT limits itself to sovereign fiat currency regimes. While individual MMT advocates surely might argue against “hard money” proposals, MMT itself has no comment, as that’s not within its field of study.
Or asks (see previous discussion thread): “I’m curious why you think monetization creates potential for inflation – aren’t govt debts already held as assets on private balance sheets? What would be the huge inflationary impact of changing the word next to that number from “bond” to “reserves” ?
I’m not sure whether the “you” means “me,” as in “Ed Dolan,” but I’ll put my oar in anyway.
A mainstream economist would give two reasons why financing a deficit by issuing monetary liabilities (adding to reserves or currency) would be more inflationary than financing the same deficit by selling bonds. Note that both of the mainstream reasons pertain to “normal times,” not a near-deflationary slump, as at present. I think it would be widely accepted that bonds and money are much closer substitutes at present than in “normal times,” by which I mean, roughly, 90 out of the last 100 years.
The first mainstream reason has to do with the fact that commercial banks are, in “normal times,” liquidity-constrained in their lending operations. The textbook version of the liquidity constraint is the “required reserve ratio.” Obviously, that is a gross oversimplification. Modern banks manage their liquidity position by looking both at the assets side (not just formal reserves, but also considerations like market depth and market resilience for less liquid assets like securities and loans) and the liabilities side (access to liquid liabilities like repos, rollover risks, redemption risks, etc.) Whether one uses the textbook model or the more realistic approach to liquidity management, placing the world “reserves” next to a bank’s asset rather than “bonds” relaxes the liquidity constraint and therefor makes the bank a more aggressive participant in the lending market. More aggressive lending means lower loan rates, more deposit creation, more spending on goods and services by borrowers, etc. all of which have potentially inflationary consequences as the economy approaches and then surpasses its natural level of real output. (MMTers seem still to like the quaint term “full employment.”)
The second reason has to do with portfolio choice, asset substitution, and velocity. In normal times, in which inflation is positive an real interest rates are also positive, bonds and money are not close substitutes. The reason is that the former carry a positive real rate of interest and the latter a negative real rate of interest. If we put “bond” next to an asset rather than “money,” that means both firms and households are more willing to hold it as a store of value instead of exchanging it for alternative stores of value like interest-bearing financial assets like, say, real estate or cases of canned soup. Less demand for real estate or canned soup means lower prices for those goods, hence less inflation. Instead, if you prefer to look at it that way, we could say, equivalently, that loading firms and households with liquid monetary assets beyond their level to willingly hold them for transaction purposes simply drives up velocity, and hence, the rate of inflation associated with any given money stock
So, Or, those are the conventional reasons for thinking that changing the word next to that number from “bond” to “reserves” would have an inflationary impact. Now, let me turn the question around. What are your reasons for thinking that neither of these conventional arguments is valid?
Thank you for that detailed answer!
So you’re saying that banks have in the past made loans based on their capital constraints, and have at times the next Wednesday when seeking to purchase the necessary reserves to cover the reserve requirements of the loan, found that they were not available or the fed relinquished control of their target interest rate?
I’m MoS so I may be misstating the opposing argument.
Hi Ed,
Appreciate the response.
I’m with DAB on this one – where is the liquidity constraint when a bank can access the Fed’s discount window? Surely in terms of relative stock of reserves and bonds (which are both high capital quality assets), the only constraint is the interest rate, which means that with respect to reserve requirements, bank lending is interest rate constrained not reserve constrained?
With regards to your second point, how does that fit with the current practice of Interest-on-Excess-Reserves? I understand that there is a spread between that interest rate and the rate currently paid on T-bonds of different maturities, but couldn’t the Fed just as easily pay IOER directly on bank reserve holdings to reach a positive interest rate and avoid the problems you mention?
Also, i’m not sure about this:
“If we put “bond” next to an asset rather than “money,” that means both firms and households are more willing to hold it as a store of value instead of exchanging it for alternative stores of value like interest-bearing financial assets like, say, real estate or cases of canned soup”
there are capital requirement regulations that make T-bonds a more attractive asset for large banking institutions compared to many other forms of financial assets. But secondly, government-backed bonds are risk-free in a way that other financial assets are not. I think that explains why, for example, the long-term real interest rate on T-bonds has been slightly negative – people pay a premium for holding some fraction of their assets in risk-free dollar holdings.
Am i making sense here?
Humbly,
#anotherMoS
(1). Note that treasury securities are often exempt from State/local taxes, which accounts for some of the yield difference.
(2). These discussions tend to, as Krugman and others have often noted, grossly exaggerate the role of banks in the private sector of economy, let alone the full economy. In most respects they are just not large a factor. Especially since the rise during the past 4 decades of non-bank actors doing traditional banking functions.
This seems to be a major point of division between MMT and its relatives and everybody else.
Krugman notes it here: MMT, Again NY Times, 15 August 2011) and Randall Wray responds: Paul Krugman Still Gets it Wrong: Modern Money Theory (Roubini’s Economonitor, 16 August 2011).
So, the professionals disagree in a way that appears to lead to significantly different policy conclusions (though not, as it happens, for short-term policy under present conditions). Unsurprisingly, this non-pro can’t hope to sort out a priori what they cannot, no matter how many of their arguments I read.
So… have there been any natural experiments that lend credence to one view over the other?
Colses,
This is where reading the history of science literature, esp Thomas Kuhn and afterwards. There are multiple paths by which these paradigm crises get resolved, some are not obvious.
The other form of scientific revolution — from new instruments (eg, telescope, microscope, X-ray diffraction) — create more easily resolved revolutions.
Interesting piece from Bill Mitchell: Building bank reserves will not expand credit, billy blog, 13 December 2009.
Thanks very much to Ed Dolan for his nuanced and sensible discussion of modern monetary theory. It sounds as though MMT is just warmed-over classic IS / LM Keynes-Wicksell-Fisher macro with minor gingerbread add-ons by Milton Friedman — but the proponents of MMT seem to think that the minor add-ons make a huge difference, whereas they appear to serve mostly an ornamental function.
The reverence for Friedrich Hayek continues to mystify me. Did Hayek ever provide any rational rebuttal to Keynes? AFAIK, Hayek merely reiterated variations on “in the end, government intervention doesn’t fix anything,” whereas the entire experience of the 1930s disproved that claim comprehensively. It requires little knowledge and less intelligence to debunk Hayek’s absurd claims that socialism represent a short path to fascism: looking around the world today, the most socialist European countries (Sweden, Norway, Finland, et al.) show the least evidence of fascism, while the most laissez faire capitalist country, America, is galloping toward fascism at an astounding rate. As FM notes, America appears to be in a pre-fascist state, just inches from a truly Mussolini-style strongman.
To the best of my knowledge, Hayek’s “great insight” in economics was supposed to be the market as a mechanism for accurately setting prices. How that squares with the gigantic bubble economies of 1999-2000 and 2007-2009 in which the markets systematically misallocated trillions of dollars worth of funds (dumped into junk dot-com stocks and worthless subprime mortgages destined never to be paid back) and incorrectly set prices on a Brobdingnagian scale, isn’t clear to me.
I think you are mixing up MMT with Austrians. Also, MMT holds that IS-LM is a faulty model that doesn’t consider the action of banks.
“Whichever mainstream approach you like to choose (simple Mankiw type models of the loanable funds market or standard IS-LM models where the money supply is assumed to be exogenous and money demand driven by liquidity preference) you fall into the same errors of reasoning.” – Bill Mitchell
http://bilbo.economicoutlook.net/blog/?p=20011
They appear to be the opposite of all of that but I’m out of my league here…
if IS-LM is such a faulty model, then why were the predictions made on the basis of the IS-LM model (viz., continuing low interest rates, no hyperinflation, and increased economic growth) so accurate in the aftermath of the 2009 global financial meltdown, while the prediction made on the basis of other models were so flagrantly wrong (viz., claims that hyperinflation would result from ongoing large deficits, claims that austerity was necessary to generate economic growth by enhancing “market confidence”, etc.)?
That link explains why they feel the IS-LM model says what is says and also why the other models are flawed as well.
I guess technically the IS-LM model says we should have soaring rates right now but proponents of it say this is a “special case” that they now call a liquidity trap.
again…if I understand what both sides are saying.
I’m in a different time zone right now so I haven’t been able to keep up with these comments one at a time as they have come in. Let me catch up with a few.
(1) Or asks: “I’m with DAB on this one – where is the liquidity constraint when a bank can access the Fed’s discount window?”
Yes, theoretically a bank could meet all of its liquidity needs by borrowing from the central bank, but that would raise several practical issues.
First, it would require that the central bank be willing to loan unlimited funds to the bank regardless of the quality of the collateral offered. Doing so would be contrary to the long-established Bagehot principles for the lender-of-last-resort functions of central banks. True, these are not carved in stone. Both the Fed an the ECB have recently become much more lax in their standards for collateral, and the Fed no longer applies “administrative pressure” to banks that repeatedly borrow large sums. Still, openly moving to unrestricted CB lending would be a radical change in the way both commercial and central banks have done business in the past.
Second, as a practical matter, such heavy reliance on the central bank as a source of liquidity by any given commercial bank very likely cause other financial institutions to regard it as a questionable counterparty for other kinds of financial transactions, for example, interbank lending, repurchase agreements, letters of credit, credit derivatives, etc. All the more so since credit rating agencies would likely downgrade it. If so, a bank that relied excessively on the central bank as a source of liquidity could reach a tipping point where private sources of liquidity were cut off.
The end result of giving commercial banks unlimited access to central bank funds could very well end up making them little but agents for the central bank in their lending operations. You would end up with something very close to the “monobank” model used in the Soviet Union. Perhaps MMT sees that model as a good one to move toward.
(2) Or asks: “Surely in terms of relative stock of reserves and bonds (which are both high capital quality assets), the only constraint is the interest rate, which means that with respect to reserve requirements, bank lending is interest rate constrained not reserve constrained?”
I’m not sure I exactly understand this question, especially the part that both reserves and bonds are “high quality capital assets.” There is no such thing as a “capital asset.” Assets are found on the left hand side of the balance sheet, capital on the right. Perhaps Or is referring to the fact that under Basel risk-weighting procedures, both reserves and sovereign bonds, unlike corporate bonds, receive a 100% risk weighting. That fact affects so-called “risk-weighted regulatory capital,” although that has no effect on economic capital, or so-called “tangible common equity.”
Perhaps, instead, Or is suggesting that the initial mix of a bank’s assets between reserves and capital makes no difference to its ability to lend. I dispute that. When a bank makes a loan, it credits the proceeds to the borrower’s account, so it must have adequate liquidity in the form of reserves at the CB or some private clearinghouse to clear the transactions. If it has reserves equal to the loan to start with, there is no problem. However, a portfolio of government bonds gives it less reliable access to liquid funds. The reason is that gov bonds, although free of credit risk, are subject to market risk, that is, to a fall in their market value due to rising interest rates. Perhaps that is what Or means by saying that lending is “interest constrained.” If so, we are just dealing with semantics. The fact remains that a bank that starts with an all-bond portfolio cannot lend as freely as one that starts with reserves.
(3) Or further says, “government-backed bonds are risk-free in a way that other financial assets are not. I think that explains why, for example, the long-term real interest rate on T-bonds has been slightly negative – people pay a premium for holding some fraction of their assets in risk-free dollar holdings.”
Yes, government bonds are “risk-free in a way that other financial assets are not,” but it is important to understand in exactly what way. Government bonds are free of credit risk, but they are not free of market risk. What that means is that a government bondholder has absolute assurance that the government will, when the bond matures, make a payment in nominal currency units equal to the nominal principle value of the bond plus accrued nominal interest. That is, indeed, the reason that people are sometimes willing to hold government bonds at negative real interest rates. However, the bondholder has no guarantee that market prices of financial instruments and real goods will move in such a way that the proceeds from the bond, either at maturity or by prior sale on a secondary market, will exchange for any given quantity of real goods. That is why it is commonplace in high-inflation countries to see people fleeing both domestic currency and domestic bonds in favor of assets that have less market risk, for example, real estate, commodities, currencies issued by more stable foreign governments, or, at the household level, practical items like cases of canned soup.
(4) Thomas Moore writes “The reverence for Friedrich Hayek continues to mystify me.” well, I am sorry if I exhibited “reverence” toward Hayek. I think he wrote a lot of interesting things, but I don’t want to put him up there with Jesus. The trouble is, he wrote so much, over such a long period, that different people grab different bits of his writing and run with them.
With regard to the Keynes v Hayek debate, I don’t want to get into that, it is a footnote to the history of economic thought as far as I am concerned, although many of my Austrian friends have written about it at great length. I don’t want to commit to who “won” the debate, but from a history-of-though perspective, I think Hayek’s contribution was regarded at the time, and is now, as sufficiently substantive to meet the standard of a “rational rebuttal.” Of course, the Keynesians would say they have an an effective “rejoinder” to Hayek’s “rebuttal,” so the debate goes on.
I would say much the same about the socialist debate. Leave it to the historians of thought. Even the Swedes have now abandoned socialism, although most Americans seem unaware that they have be governed from the center-right for years now.
The two things I find myself citing Hayek on most often are
IMHO both (i) and (ii) are important concepts with which the MoS is, sadly, not always conversant. Even the esteemed Prof. Black could gain from becoming conversant with that part of Hayek’s thought.
BTW, with regard to “galloping toward fascism,” right wing fringe parties have made some pretty strong gains in countries like Finland, Netherlands, Greece, even France. Thank goodness we have nothing like “Golden Dawn” in the US.
If this is the case, that banks actually are or can be reserved constrained, then there should be examples of banks with available capital that are unable to make loans despite having credit worthy customers. No?
Also, if the window is closed than the interest rate would be bid up beyond the target rate in the interbank market as banks bid for reserves. Is there an example of the fed deciding not to set a target rate?
I think this is a fundamental question for me. MMT only makes sense to me if banks are not reserved constrained. And, I would normally find that a hard thing to believe. But, when actual bankers as well as Warren Mosler, someone who has owed a bank, tells me they are not, their arguments become very convincing.
Hi Ed,
Thanks very much for this reply and your ongoing engagement.
1) “Yes, theoretically a bank .. Doing so would be contrary to the long-established Bagehot principles for the lender-of-last-resort functions of central banks.”
If – as you say below – liquidity is widely available in good times, how can you be sure that “moving to unrestricted CB lending would be a radical change in the way both commercial and central banks have done business in the past”? Isn’t a large-scale financial crisis, i.e. 2008, exactly when this proposition actually gets tested? The soft pressures you are talking about sound like industry practice/gentlemen’s agreements rather than hard constraints, and moreover they appear to have been abandoned at the first sign of serious stress to the system. Kind of like saying “we have a policy not to provide medical care to uninsured people” but then not turning away people when they show up at the emergency ward – what’s the actual real practice in that situation? Should we really describe moving from that model to a single payer option “an unprecedented move to unrestricted healthcare provision’?
Moreover, (and please correct me if i’m wrong on this), isn’t the lesson from Bagehot that LOLR always provides liquidity in a liquidity crisis, but does so at a premium interest rate? If so, doesn’t that mean bank lending is still interest rate constrained not liquidity constrained?
“Second, as a practical matter.. If so, a bank that relied excessively on the central bank as a source of liquidity could reach a tipping point where private sources of liquidity were cut off.”
Assuming that actually happened, couldn’t the bank just continue to borrow 100% from the discount window at whatever rate is set by the Fed? Where is the liquidity constraint in your scenario? It appears to me you’ve merely provided reasons why tapping the discount window might not be a smart move when other options are available at an equivalent interest rate – makes sense, but doesn’t really support your point does it?
“The end result of giving commercial banks unlimited access to central bank funds could very well end up making them little but agents for the central bank in their lending operations”
Well, from my (amateurish) understanding, many “reputable” financial institutions have been tapping the Fed like crazy since 2007, and people still seem to willing to accept them as counterparties. So i’m not sure it makes sense to make empirical claims that treat post-2008 behavior as anomalous, since for many of the ideas we are talking about (systemic liquidity constraints) post-2008 is the most directly relevant period in recent memory. I don’t know much about the USSR’s monobanking, but if your point was intended to be more than a low-value communist jibe (uncharacteristic in light of other response, so i’ll give benefit of the doubt), i suppose my question is whether that’s actually much different to the status quo today?
2) “Perhaps Or is referring to the fact that under Basel risk-weighting procedures, both reserves and sovereign bonds, unlike corporate bonds, receive a 100% risk weighting”
Yes, i was – sorry for my terminology fail, and thanks for interpreting.
“Perhaps that is what Or means by saying that lending is “interest constrained.” If so, we are just dealing with semantics. The fact remains that a bank that starts with an all-bond portfolio cannot lend as freely as one that starts with reserves.”
Yes, that was what I meant – i’m not entirely sure our disagreement is semantic though. Given the choice between holding $100 in reserves and a bond that pays back interest+principal totally $100, i absolutely agree that the relative stock matters. But i’m starting earlier in the process, when the bond is created – if the distinction is between holding $97 in reserves and using those reserves to purchase a $100 T-Bill being offered at a 3% discount, surely no matter the interest rate variation (unless it goes negative nominal), you are not going to end up with less reserves to lend from than if you hadn’t bought the bond in the first place? The interest payments are pure welfare, so while you may *risk* losing that welfare if interest rates change, you’re never going to be in a worse position than not having had the opportunity to buy the bond – the interest is pure bank welfare.
(Another way of saying this would be that a firm commitment of maintenance of a particular interest rate – i.e. zero – by the Fed could reduce any liquidity risk of holding bonds to zero, meaning the existence of this risk is in itself a policy variable).
3) “Government bonds are free of credit risk, but they are not free of market risk…the bondholder has no guarantee that market prices of financial instruments and real goods will move in such a way that the proceeds from the bond, either at maturity or by prior sale on a secondary market, will exchange for any given quantity of real goods.”
Of course, but that’s just general inflation risk, which would be the same if you held dollar bills. So what’s the difference in risk between holding a bond and a dollar bill? If nothing, why do we talk about treasury securities as a “debt” of the government rather than a “dollar bill with an added bonus of duration-limited interest-welfare”? Presented in the latter framing, it’s very clear how ludicrous it is to keep paying banks interest on national “debt” for the privilege of “lending” dollars we can create.
Or– Let me comment on a couple of your specifics here, but before doing so, I should say I am beginning to loose sight of where this conversation is going. I’m not quite sure of the larger issue at stake behind the discussion of the microtechnicalities of banking. Is the point that it makes no macroeconomic difference whether the government finances its deficit entirely by issuing money (i.e., “high powered” or “base” money) rather than largely or entirely by selling bonds? Is it that the central bank can offer to provide limitless uncollateralized loans to banks without disrupting either the business or banking or macro price stability? In other words, what is the bottom line? Why is it important to establish whether or how banks are constrained in their lending?
(1) “Kind of like saying “we have a policy not to provide medical care to uninsured people” but then not turning away people when they show up at the emergency ward – what’s the actual real practice in that situation? ” Very apt analogy. I agree this could well describe what the Fed and the ECB have been doing. I would say that just as using emergency rooms to provide primary health care increases the cost of health care and degrades the quality, so using the central bank to provide primary financing for the government’s budget has greater costs and more disruptive consequences than other, more conventional rules. There is more than one set of possible rules for financing the budget, but they should emphasize financing the budget through a balanced mix of taxation, borrowing (bond issue) and seigniorage (issuing money). I think I have a basic disagreement with MT regarding that balance and the rules for establishing it at any point in time.
(2) “If so, doesn’t that mean bank lending is still interest rate constrained not liquidity constrained?” I fail to see why it is a matter of one or the other. It is like asking, what constraints how far I decided to drive for vacation? Am I constrained by the quantity of gasoline available or by the price of gasoline? In fact, although it appears to me as an individual that I am constrained only by the price, what is really going on is that motorists in general are constrained by a supply curve for gasoline, which is a function with both a quantity and a price variable in it. Similarly, banks are constrained in their lending by the availability of liquidity, which has both a price dimension (interest) and a quantity dimension.
To ask the central bank to provide banks with limitless liquidity for free or at a fixed, below-market interest rate is to behave like those third-world countries that insist (at great expense and waste of resources) on making gasoline available to their citizens at a fixed, low price even when global oil prices rise.
(3) ” I don’t know much about the USSR’s monobanking, but if your point was intended to be more than a low-value communist jibe, i suppose my question is whether that’s actually much different to the status quo today?”
It was meant as more than a jibe. The monobank system in which the central bank both controls the money stock and makes commercial loans has two problems. One is that it is vulnerable to politicization, what economists call “directed lending” where scarce capital flows according to political priorities, not to where it can be used most productively. The other is that it leads to inflationary growth of the money stock, which in Soviet practice, was constrained by administrative price controls, leading to misallocation of phyisical as well as financial resources and to the long lines associated with repressed inflation. It is true that one can see hints of a move toward such a system in the recent conduct of monetary policy. I find that as alarming. I can’t quite figure out whether it is something MMT would find acceptable or even beneficial.
(4) “Of course, but that’s just general inflation risk, which would be the same if you held dollar bills. So what’s the difference in risk between holding a bond and a dollar bill?” Both the bond (unless it is an indexed bond like TIPS) and the dollar bill are subject to inflation risk, but even if there is no inflation, the bond is, in addition, subject to risk due to interest rate changes, because the market price of the bond moves inversely to interest rates.
“It is like asking, what constraints how far I decided to drive for vacation? Am I constrained by the quantity of gasoline available or by the price of gasoline? In fact, although it appears to me as an individual that I am constrained only by the price, what is really going on is that motorists in general are constrained by a supply curve for gasoline, which is a function with both a quantity and a price variable in it. Similarly, banks are constrained in their lending by the availability of liquidity, which has both a price dimension (interest) and a quantity dimension.”
2 fiat cents worth of rambling MoS analogy…
Imagine a bank as gas station and the Fed as monopoly supplier of gasoline reserves. Instead of selling loans they fill gas tanks. Liquidity, in the form of gasoline, is a pass-through cost. Everyday operations require reserve balances of gasoline in their underground tanks. If they need more, they can schedule more deliveries (the federal gasoline reserve can’t run out). More gasoline is always available from the Fed, at some cost. The station puts a price up on the sign based on their liquidity costs, some desired profit, what the market will bear, etc. If the Fed refuses to supply liquidity, the entire system of transportation which relies on it will come to a screeching, catastrophic halt. Price, not quantity is the controlling factor.
Does this mean that a given gas station can sell an arbitrary, unlimited amount of gas without constraint? No, there are other constraints. The size of the station, how many pumps it has, location and a host of other things. If they want to become a “bigger” gas station they need a capital investment to expand by installing new pumps or buying the lot next door or even relocating to a higher traffic spot. These capital constraints on the size of the gas station are of a completely different nature and more or less unrelated to liquidity provision. To obtain more capital they have to raise it out of their own profits or from outside investors.
In today’s environment your problem is that few customers are showing up to get their tanks filled. No matter how far you mark down the price of gas or how many tempting options you offer in your snack shop. Maybe an examination of the broader economy might identify factors like unemployment and weak aggregate demand are suppressing car miles traveled in a way that’s fairly insensitive to the price of gas.
Along comes the federal gas reserve with quantitative easing. They park a couple full tankers of gasoline at your station at all times. This excess reserve of liquidity is nice, you suppose, but it doesn’t put customers at your pumps. Then they tell you instead of charging you a quarter of a cent for gas (fed gas is really cheap) they are going to pay you a quarter of a cent for every gallon in your underground tanks plus a quarter of a cent for every excess gallon in the tankers parked in your lot.
Now, instead of your profit being the margin between your liquidity cost and the price on your sign your profit is the opportunity cost between interest on gas reserves and the price on your sign. Even though many observers complain that it’s bad policy to “pay you to hoard gas” not much has changed in your business model. You still need customers to show up demanding full tanks and you still charge a rate based on the (opportunity) cost of your liquidity.
The gas station remains under criticism for “not filling tanks” and the federal gas reserve is under intense pressure to do something. So instead of parking two extra tankers of fuel at your station they park three. Still nothing happens. Next they make an open ended commitment to deliver an extra tanker a month until business improves.
Some insist that the excess tankers are a time bomb which will eventually leak out (by some unspecified channel) and burn down the city in a firestorm (of inflation) unless the Fed can somehow unwind this policy and take away the extra tankers. Others argue that since the constraint was never liquidity to start with, it’s a non-issue. Proponents of the policy believe that the mere presence of excess gas reserves is enough to make people expect a firestorm and fill their tanks to get ahead of it.
I’ll stop here, having already walked way too far out on a thin branch of analogy but the moral of the story is capital, not liquidity, constrains lending.
Ed,
Appreciate the time and response. I think there are two points here, both of which you’ve identified (printing money/reserve constraint). The link between the two of them is your earlier claim that reserve ratios conventionally limit bank lending and that consequently, “printed money”-financed deficits will be more inflationary than bond-financed deficits. My attempt is to point out that since banks are already not reserve-constrained, the shift from bonds to reserves is not going to have the effect you mention provided.
(1) “I would say that just as using emergency rooms to provide primary health care increases the cost of health care and degrades the quality, so using the central bank to provide primary financing for the government’s budget has greater costs and more disruptive consequences than other, more conventional rules.”
It appears you’ve jumped the analogy here – my analogy concerned the CB providing reserves to banks without limit. Later, you suggest “banks are constrained in their lending by the availability of liquidity, which has both a price dimension (interest) and a quantity dimension.” But isn’t the truth that a CB has two options – one is to have a fixed quantity of reserves and to let the interest rate float (i.e. Volcker’s failed monetarism), and the other is to set a fixed interest rate and let the quantity of reserves float (i.e. interest-rate targeting)? I fail to see how reserve-liquidity can have a quantity dimension unless the Fed is willing to shut down the discount window and abandon its interest rate target. Is that what you are suggesting?
(2) Perhaps you are suggesting that there is a “natural” rate of interest, i.e. in this comment: “To ask the central bank to provide banks with limitless liquidity for free or at a fixed, below-market interest rate.” What is the “market” interest rate? Doesn’t the Fed set this rate? What would be the harm in setting a permanent zero-interest rate policy, and then managing bank lending through capital quality/leverage regulation?
There is more than one set of possible rules for financing the budget, but they should emphasize financing the budget through a balanced mix of taxation, borrowing (bond issue) and seigniorage (issuing money)
(3) “The monobank system in which the central bank both controls the money stock and makes commercial loans has two problems.”
I don’t think MMT’s observations about central banking operations lead to the conclusion that the CB is directing commercial loans. Setting the interest rate and regulating the capital of banks does not require any direction as to how and when individual loans must be made. That said, there are some advocates of MMT (myself included) that would prefer a move towards public banking, or at least a public option in banking. Perhaps this is what you are referring to, although that is a distinct question from whether the CB/Treasury collectively control the monetary base. I would assume that’s obvious, in which case i’m not sure from what direction the whiff of monobanking is coming from when you view MMT.
(4) “Both the bond (unless it is an indexed bond like TIPS) and the dollar bill are subject to inflation risk, but even if there is no inflation, the bond is, in addition, subject to risk due to interest rate changes, because the market price of the bond moves inversely to interest rates.”
Yes, but we were discussing this in the context of the govt making a firm commitment to defend a particular interest rate, and moreover, as i mentioned earlier, the interest rate cost is only on the extra-interest above the original cost of purchasing. So what is the difference in inflationary terms of deficit spending by printing $97 of reserves and printing a $100 t-bill at a 3% discount? If anything, isn’t the bond-finance spending going to be more inflationary, because the $97 worth of purchasing power for the govt comes with unnecessary interest?
I’m sorry, i missed one bit:
“There is more than one set of possible rules for financing the budget, but they should emphasize financing the budget through a balanced mix of taxation, borrowing (bond issue) and seigniorage (issuing money)”
– Here would be MMT’s proposal for a balanced mix:
1) create all dollars by issuing money
2) vary the interest rate directly through IOER as needed
3) use taxation to regulate aggregate demand and achieve other public policy goals (i.e. pigovian taxes), not to raise revenue
Also, as i mentioned before, bond-issue is not “borrowing,” it is merely issuing a different form of money – one with a fixed principal and a variable, time-limited interest component. So excluding taxation, the real choice is between zero-interest seignorage and variable-interest seignorage, not between issuing money and borrowing.
Sounds like many here don’t really understand what MMT is. Let me explain since I’ve had all these debates with them over the years.
First, MMT is nothing new. It’s really just Knapps State Theory of money, Minsky’s Employer of Last Resort. And Godley’s Sector Financial Balances. They mess up all three in an attempt to promote a left wing agenda.
First, Knapp’s state theory says that money is a creature of law. MMT changes this to say that “taxes drive money”. As if we all wake up in the morning and use money just because we can’t wait to pay the taxman! Ha. They create this distorted government centric view of the world in which they claim the government is the center of the monetary universe.
The MMT Job Guarantee is just Minsky’s ELR stolen and rebranded. They claim it can create price stability and full employment, but there’s zero real world evidence of this. Again, nothing new here though.
Lastly, MMT distorts Godley’s SFB by changing the definition of net saving to minimise the importance of private investment in order to create a view of the world where no one can save unless the government is spending money. It’s not good accounting, it’s misleading and it’s wrong. Godley would be rolling in his grave if he knew what they were doing.
All in all, there’s nothing knew here, but to amateur economists (and even some experienced economists) this all sounds like a brand new theory when the reality is that it’s just a bunch of old stuff rebranded and repackaged. The MMT economists are thieves who contribute nothing new to anything except for their constant attacks on the mainstream for “not understanding” things that are in fact very old and well known by many.
That may be but doesn’t really address the fundamental operational claims of how the system works that ARE quite different than what most people including economists believe. As a man on the street I am willing to listen to various policy ideas from MMT (liberal?) to MR (conservative?) to MS (independent?) but for even those who would like to create a fascist utopia I think understanding the operational truths of the system, if they are different than common knowledge, would be helpful.
The MRists created MR because they disliked MMT’s political agenda, not because they’re conservatives. I think their view of the world is as close to apolitical as one can get. These two papers are about as good as it gets when it comes to understanding the operational realities and eliminating the politics from economics.
FDO – i’ve watched you flog your anti-MMT rant for a long time to anyone that would listen. It’s impressive to see someone so committed to hate that they devote this much time to it.
I won’t bother trying to explain why your interpretation of their position is wrong, or why your notion of apolitical theory is hopelessly naive. I will say, however, that calling someone a “thief” here is completely wrong. Minsky and Godley were both alive until very recently, and worked very closely with MMT developers. They were clearly aware of their writing and alleged “misrepresentations”, and did not seek any redress through any official academic processes or legal action. To suggest that they “stole” their ideas is to imply a lack of permission, a claim for which you have absolutely no warrant.
Now, you *might* be able to say with a straight face that you don’t think they have added anything new because all they have done is synthesize other ingredients to produce a single banner called MMT. You’re welcome to that opinion, although I (and probably every cook, DJ, clothing designer/ musician who’s integrated existing ideas to create a new product) strongly disagree with your theory of value and think you end up revealing more about your own agenda than theirs.
I should also point out for the record that this commenter regularly posts on MMT blogs under various pseudonyms and makes horrible ad hominem attacks and slurs despite being asked numerous times to desist and move on.
“makes horrible ad hominem attacks and slurs ”
Not going to happen here. We have a zero tolerance policy.
Who made any ad hominems? Not me. That’s what MMT is known for doing. Everyone who interacts with you people knows your reputation is horrible. You all can’t have a respectable conversation with anyone. No one takes MMT seriously because the MMT economists don’t even take it seriously. Your most well known proponents run around internet forums calling people names and acting like children. Have you ever seen Fullwiler? He’s an embarrassment who acts like a teenager. Or Wray calling other “retards” in his articles? It’s a ridiculous joke for any MMTer to accuse anyone else of behaving poorly. Everyone in economics knows MMTers are an embarrassment and a joke.
Attention everybody: Enough of this back and forth about who is more nasty. That’s not how we work here. Please stick to the subject.
“Let me explain since I’ve had all these debates with them over the years.”
Well, no, you’ve just repeated the same hate-filled, garbled, fact-free rants over and over again. There is no “debate” with you.
“The MRists created MR because they disliked MMT’s political agenda, not because they’re conservatives. I think their view of the world is as close to apolitical as one can get.”
Is that meant to be a joke?
Cullen’s “Understanding the Modern Monetary System“ has been changed and re-cobbled together so many times it’s barely legible. It’s full of internal contradictions, errors, non-sequiturs, empty rhetoric, political bias and unfounded assumptions.
JKH’s “Contingent Institutional Approach” paper is just wrong on key points. It is flatly contradicted by what Ed Dolan says above:
“Collection of taxes extinguishes money, spending by the Treasury creates money, and when you consolidate the two T-accounts, the two transactions net out to no change in money.”
“members of the “serious” subset of MMTers agree with me that banknotes stored by the Treasury or CB are neither assets nor liabilities of the government, they are “nonmoney”, just paper. What many contributors to this discussion thread fail to realize that us “mainstream” economists know that and have always known it”
Mr,
You sound like the same spiteful person you accuse others of being. But that’s not what matters. What matters here is that no one in MMT actually understands how the banking works here. You see, I actually work for a bank and run a larger unit than Mosler or any MMTers has even come close to running. I know all the operations because I have to check the records daily. And the MMT description is wrong. Completely wrong.
I don’t know who this Ed Dolan is, but from his bio page I don’t see “commercial banking” anywhere on it. JKH is far from perfect, but one thing he gets right is the accounting behind the banking and that’s what matters here. MMT just makes things up to pass their myths on as fact. It’s a joke. Every MMT economist is an ivory tower joker with no real world experience.
Taxes do not extinguish money. That idea is an accounting myth. When the US Treasury taxes you they do not destroy money in any sense. They are taking bank deposits and redistributing them to other people. They do not credit their own accounts until they have debited private accounts. The government in the USA is a user of bank money by choice. That’s how the system is designed. It’s the same here in the UK. The government chooses to use bank money and they must obtain bank money before they can redistribute it. This idea that taxes destroy money is ridiculous. Mosler likes to use the “money shredding” idea to lure amateurs (like you) into believing his myths. It’s absurd.
You’ve obviously been suckered into believing MMT is right and you’re all pissed off that people are now starting to debunk their ridiculous points. It’s about time. MMT is nonsense. You get so many operational aspects wrong it’s almost hard to believe that so many words have been wasted debunking it.
“I don’t know who this Ed Dolan is, but from his bio page I don’t see “commercial banking” anywhere on it.”
Dolan’s bio gives him strong credentials as an economist, which is more than adequate. In my experience practicioners (eg, bankers) seldom have a strong grasp on the underlying theorical basis of their field. We have academics to provide that part of the picture. (perhaps the most interesting example of this is scientists generally poor understanding both of the history and philosophy of science).
Also, IMO banking is one of the least well understand aspects of macroeconomics among laymen (although there is strong competition for that title). Krugman gives a strong rebuttal in these two articles at the NY Times:
Excerpt from the first article:
“You sound like the same spiteful person you accuse others of being”
No wonder the lay discussion of MMT goes in circles. These personal insults are chaff.
The personal characteristics of people (unfortunately) have no relation to their intellectual life, esp the validity of their views or the skill of their analysis. For definitive evidence of this see Paul Johnson’s Intellectuals: From Marx and Tolstoy to Sartre and Chomsky (1989). Or read about the personal life of Picasso, as in Picasso, Creator and Destroyer by Arianna Stossinopoulos Huffington (1988).
FM,
Krugman is clueless on banking. He’s changed his story so many times over the years it’s not even funny. I work in the credit unit of a huge European commercial bank. I know precisely how the banking world works. Dolan’s account of the way money is created is not correct. Neither is MMT’s.
In today’s world, almost every dollar we use is created by a private bank in the form of bank deposits. These deposits are created almost entirely independent of any government. The money supply in places like the UK and USA is privatised. And the governments in these places choose to use the money issued by private banks. There is no such thing as taxes destroying money or spending creating new money. Taxes take bank deposits from private sector actors and redistribute them to other people. I don’t care how MMT likes to misconstrue the reserve settlement and all the other nonsense they do. It’s a smoke and mirrors cover-up for a very simple transaction which requires a debit of a private account that then allows the government to credit another account using the aforementioned debit.
This isn’t hard to understand. In fact, it’s exceedingly simple. But MMT needs to create this government based view of the world in order to pass off their big government agenda. It’s a shame that they cause so much confusion and that people like me who actually see how this stuff works on a daily basis, have to come in and clean up the mess they leave.
“Krugman is clueless on banking. He’s changed his story so many times over the years it’s not even funny.”
You are in the wrong website for expressing such delusional statements. You are welcome to your opinion, and certainly to disagree with any authority — no matter how prominent. But you’re not God, nor has anyone given you a Nobel Prize in Economics. These sweeping verdicts depress the validity of your analysis, IMO.
Contrast your expression with Krugman’s. He says “As I (and I think many other ecnoomists) see it“, “usually central players”. Careful, cautious. In my experience that’s more common among experts, while the bombastic verdicts are more common among laymen operating outside their area of expertise.
These are complex matters, and in many ways are on the fringe of the known. Certainty is often an indicator of limited understanding.
Krugman won his Nobel in international trade. Your assertion that this makes him an expert on all things economics is wrong. It’s like a doctor winning an award in neurology and suddenly everyone in the field of cardiology claims he’s the “go to” guy for all things medical. Only in economics can people make such sweeping and inaccurate statements.
Krugman’s comments are easy to prove wrong. And since I work in a bank and know EXACTLY how the lending process works from start to finish I’ll tell you why he is wrong and has no clue how modern banking works. Krugman says “First of all, any individual bank does, in fact, have to lend out the money it receives in deposits. Bank loan officers can’t just issue checks out of thin air;” and goes on to claim that banks are constrained in their lending operations by the monetary base. These comments are patently false.
When a bank in the UK or USA makes a loan it does not check reserve balances. It does not call the central bank or check the reserve account first. It sees if the borrower is creditworthy and whether the loan is likely to be a good risk/reward and they issue deposits out of thin air. The loan creates a new deposit out of thin air. If the bank needs reserves it finds them in the overnight market or borrow from the central bank after the fact.
A loan is just an asset of the bank. When a bank makes a loan it must give up reserves so Krugman almost gets this right. But it doesn’t need the reserves first. Krugman rightly says the balance sheet must balance. Duh. The reserve balance and vault cash are assets of the bank. So the bank is contrained by its capital position, not by its reserve position. This is basic accounting. Krugman clearly doesn’t understand it.
The US Federal Reserve knows Krugman’s textbook definition of the money multiplier and the link between reserves and lending is wrong. See here: “Money, Reserves, and the Transmission of Monetary Policy: Does the Money Multiplier Exist?“, Seth B. Carpenter and Selva Demiralp, Federal Reserve, 2010.
I’d also caution you against listening to Dolan on some of this. He’s already made it clear he gets some of the basic accounting wrong. Being someone who works with accounts on a daily basis to make sure they don’t screw up my unit, I can tell you that there are very few economists who actually understand the operational details here. MMT actually gets a lot of the banking stuff right. So kudos to them on this.
“Your assertion that this makes him an expert on all things economics is wrong.”
It shows that he’s in the top rank of his profession. When you have similar honors we’ll treat your bombastic statements more seriously.
Trivia note: “There Is No Nobel Prize in Economics“, Yasha Levine (editor of eXiledonline), AlterNet, 12 October 2012 — “It’s awarded by Sweden’s central bank, foisted among the five real prizewinners, often to economists for the 1% — and the surviving Nobel family is strongly against it.”
FDO15 wrote, “The money supply in places like the UK and USA is privatised. And the governments in these places choose to use the money issued by private banks.”
(Trying to see if I understand, not making an argument:) Is this equivalent to saying those governments choose to sell bonds rather than “print” money to cover their deficits?
FDO15: Thank you for your informed contribution to this debate. I’d like to address a few points you make:
(1) “I don’t know who this Ed Dolan is, but from his bio page I don’t see “commercial banking” anywhere on it. ”
Well, at least I provide a bio page, so in that sense you know more about me than I know about you. Could you please give me a link to your bio page? It would help. Does it have anything on it about monetary economics? With all due respect, knowing about credit operations is not the same as knowing about monetary economics. That is like saying that auto mechanics is the same as physics. I’m not saying that an auto mechanic cannot possibly understand physics; maybe that’s her bed time reading. But the fact of being an auto mechanic is not evidence that she understands physics.
(2) “Taxes do not extinguish money. That idea is an accounting myth. When the US Treasury taxes you they do not destroy money in any sense. They are taking bank deposits and redistributing them to other people. They do not credit their own accounts until they have debited private accounts.”
Sigh. I wish you had read my earlier comments, but let me repeat them since you evidently did not.
I think you have it exactly backwards here. Taxes do extinguish money, and that is a tautological accounting fact. Here’s how I see the T-accounts. You tell me which part is wrong:
When I pay $100 in taxes (using bank money of course, not currency) I record a negative $100 on the asset side of my T-account, reduction in bank deposits, and a negative $100 on the liabilities side, taxes payable. Skipping over the intermediate step in which the the money goes through a treasury account in a commercial bank, the Treasury makes a +$100 entry on the LHS of its T-account, funds on deposit with the Fed. The balancing entry on the same side is minus $100 in taxes payable, a reduction in a Treasury asset. The Fed records a +$100 on the RHS of its T-account, increase in Treasury deposit, a liability of the Fed. The balancing item (again, skipping over the intermediate steps of clearing my original payment through the banking system) is a $100 reduction in commercial bank reserve deposits, also a Fed liability. Is any part of that wrong (except for the intermediate steps I have left out)?
If it is right, then collection of taxes has extinguished money in exactly the tautological sense that it has reduced the quantity of outstanding commercial bank deposits. My deposit with my commercial bank, as you yourself point out, is part of the money stock. The Treasury’s deposit with the Fed is not part of the money stock. QED.
However, even though (IMHO) you are wrong about the accounting tautology, you are right and the MMTers are wrong about the larger issue of whether any of this makes the slightest difference for fiscal and monetary policy. It does not. The only sense in which taxes extinguish money turns on the specific definition of money we are using, which includes commercial bank deposits but excludes Treasury deposits with the Fed. (Digression: M also includes paper currency in circulation but not paper currency in storage at the Treasury or Fed. In that sense, the “shredding” story where I pay my taxes in currency is also a valid accounting tautology.)
I think the whole problem comes with this highly technical term “money,” which we monetary economists use in a narrow sense to mean currency plus liquid bank deposits, but MoS uses to mean wealth in general (Wow! look at that guy in the Audi R8! He must have a lot of money!)
Let’s replace “money” with a more elastic term like “funds.” If we do, it would be valid to say that paying taxes “moves funds” from me to the Treasury, which temporarily “stores” the “funds” in an account at the Fed, and then “uses” the funds to buy ammunition for the troops in Afghanistan. In that sense you are right that “They are taking [“funds”] and redistributing them to other people.”
So both sides in this absurd debate about extinguishing money are right, and they would recognize that fact if they would just agree to use the word “money” in a consistent sense, or else agree to replace it with some other word like “funds” that they could agree on.
(3) You say: “When a bank in the UK or USA makes a loan it does not check reserve balances. It does not call the central bank or check the reserve account first. It sees if the borrower is creditworthy and whether the loan is likely to be a good risk/reward and they issue deposits out of thin air. The loan creates a new deposit out of thin air. If the bank needs reserves it finds them in the overnight market or borrow from the central bank after the fact.”
Well, Duh! Even, I, the monetary economist, know that, despite having not actually worked in a bank. Somewhere higher up in this thread (ah, here it is, lower down actually, in a reply to DAB at 3:56 on 13 October.) I pointed out that the old-fashioned textbook model in which each bank is individually reserve constrained has done a big disservice to the understanding of monetary economics. If you’ll check out my own textbook, you’ll find an explanation of how the process really works that is almost exactly what you say. Here’s a quote from the book (5/e Ch 8):
“Although the target reserve ratio places a constraint on lending for the banking system as a whole, the target ratio is not a strict constraint for any individual bank. . . Although at first glance, it might seem that a bank must wait until it has excess reserves before it can make a new loan, that is not true. . . Suppose some bank is already operating at its target reserve ratio when a customer comes in the door with a proposal to borrow several million dollars for a new wind farm. The bank has several ways of obtaining the reserves it needs to make the loan while maintaining its target reserve ratio. One option is to sell some other asset, for example, short-term, easily marketable securities. Another is to borrow reserves from some other bank that temporarily has more reserves than it needs. None of the means by which a single bank can get the reserves it needs changes the total reserves of the banking system. However, as the example shows, even if the total reserves of the banking system remain unchanged, no single bank has to wait passively for reserves to arrive before it can take advantage of new loan opportunities.”
Please tell me how that differs from what you said in your comment, or from how it looks to you from the front lines in your credit department. Maybe you don’t like the term “target reserve ratio,” I realize that is econ-speak, not bank-speak, but try to focus on the substance of what I say, not the terminology.
Fed liabilities are liabilities of the US government. When the Treasury has a positive balance in its account at the Fed, the US government has both an asset (Treasury) and an equal liability (Fed). i.e. net zero.
Therefore taxation and borrowing in dollars cannot provide “funds” for US government spending. You can’t spend a zero.
“You can’t spend a zero”. You also can’t spend if you can’t obtain funds from the private sector. An inability to tax is synonymous with hyperinflation or a dead currency. If there is nothing to tax then there is nothing to spend. Therefore, the government must be able to move resources from the private to public domain through taxation. It must always be able to obtain funds through taxation. These comments that taxation “extinguishes” money are meaningless in reality. Taxation is the public’s willingness to allow a government to move resources from private to public domain. Without this ability, the monetary system implodes. We all know banks create money from nothing. We also know the government has a printing press that it can always turn on. But this idea that taxes don’t fund government spending is totally meaningless. The ability to tax means the ability for the government to spend. Without the ability to tax it might as well be worthless widgets air into the economy.
MMT has no idea where a currency derives its value from. Therefore, MMT misinterprets the whole monetary system from start to finish.
Grammar fix:
” Without the ability to tax the government might as well be spending worthless widgets into the economy. “
When the government spends it issues government liabilities. When it taxes they are withdrawn and cease to be government liabilities. They don’t magically transform into government assets.
When the government borrows it swaps one type of government liability for another (basically).
Even though taxation and borrowing can’t logically provide “funds” for government spending they do of course have a purpose. If no one is willing to hold government’s liabilities or accept them in payment they will have no value. Taxation establishes a basic need for the government’s liabilities, and paying interest on government liabilities (borrowing) may give people more of an incentive to hold them.
Sorry but this is just MMT nonsense. MMT qualifies everything with a “per se” or a “basically”. No, there is no “per se” or “basically” in all of this. Taxation is the process of moving resources from the private sector to the public domain for public purpose. When the state taxes you it does not shred dollar bills as Mosler says. This is a public policy choice to take from some in the private sector so money can be redistributed to others for public purpose. It is recognizing that there are resources in the private sector and that we, as a community, can collectively pool those resources to create certain benefits for us all.
There’s no need for the smoke and mirrors around the accounting. Taxing is a very simple thing. It does not just establish demand for the currency. It allows the government to move resources from the private sector to the public sector. A government that can’t move resources from private to public domain has nothing, whether you want to call that funding or not is unimportant. The simple fact of the matter is, if the government loses its ability to obtain funding from the private sector (either through the sale of bonds or taxes) then it cannot operate. Whether it has a printing press or not is totally irrelevant in reality.
The whole process of issuing liabilities, taxing and borrowing can serve to move resources around (either within the private sector or into the public sector), but it also can serve to bring real resources into being. The government redistributes, but can also create – or help to create (just like any other part of society). You can have good governments and bad governments – a good government helps the private sector to be as productive as it can be, whilst investing in things that the private sector is not so good at.
I only said “basically” because in practice the process of borrowing can involve intermediate stages, such as the use of tax&loan accounts.
Wrong again Olly. What the government does is take EXISTING resources and leverages them up. So it takes strong boys from Missouri and sends them over to kill Iraqis. Or it takes smart women and puts them at work at Nasa building space ships. Or it takes money from some rich guy and redistributes it to some poor guy who needs to put food on his table. Government does not create wealth from nothing any more so than an entrepreneur does. They all use existing resources, leverage them up and create new wealth. Government exists to take resources from the private domain, move them to public domain for public purpose. This can create wealth, but only by leveraging existing resources which the private sector won’t use or can’t compete with the government to use.
You almost contradicted yourself in the space of one sentence:
“Government does not create wealth from nothing any more so than an entrepreneur does. They all use existing resources, leverage them up and create new wealth.”
I agree with your basic point that the creation of new wealth involves some leveraging of, or use of, existing resources. Both private and public sectors are involved in this process. The key is to try and find the optimum balance between the two, given the relative strengths of each.
“Almost”. “Basically”. “Per se”. Do you MMTers qualify everything you say with something that “almost” has meaning?
So you agree that your comment that the government creates wealth from nothing, was wrong. Good to know. Leveraging private resources would mean moving resources from private to public domain. How do governments do this? They take from the private sector through taxation or bond sales and move the resources. It’s called “funding” public purpose. I don’t know why MMT needs to pull this smoke and mirrors crap with the way they misconstrue terminology, definitions and basic understandings of things. It’s horrible economics and misleads amateur economists into believing the world works in a way that it most certainly doesn’t.
I never said that “the government creates wealth from nothing”. “Wrong again”.
I never said “leveraging private resources”. “Wrong again”.
You confuse real resources and financial assets and liabilities. “Wrong again”.
You assume that all resources originate in the private sector. “Wrong again”.
“I don’t know why” your brain is full of angry nonsense.
DAB asks: “If this is the case, that banks actually are or can be reserved constrained, then there should be examples of banks with available capital that are unable to make loans despite having credit worthy customers. No?”
This question confuses a lot of people, because it is really several questions in one.
The first part of the answer is that you have to be careful whether you are talking about individual banks being reserve constrained, or the banking system as a whole. Mainstream econ texts have done a great disservice by presenting a “story” in which reserves move from bank to bank as loans are made and checks are written, and the “story” is written in such a way that it looks like each individual bank is reserve constrained. Not really. I fact, a bank is never in a position where a customer walks in the door, and the bank has to say, “sorry, we don’t have any reserves today, come back tomorrow and maybe someone will have made a deposit and we can help you.”
The reason that doesn’t happen is that even if a bank had no excess reserves, it would make the loan anyhow and then borrow the reserves from someone else. Usually that someone would be another bank that had excess reserves. It could be the central bank. Or it could be someone outside the banking system that had excess to the Fed funds market, say, a securities dealer.
For that reason, it is better to say that individual banks are “liquidity constrained” than to say they are “reserve constrained.” Banks can’t operate without access to liquid funds when they need them, but that does not mean they have to meet all their liquidity needs by holding reserves in the form of currency and deposits at the central bank. They can hold other assets which have a high degree of market liquidity (like T-bills) and they can cultivate counterparties in various corners of the money markets, fed funds, eurodollars, repos, you name it.
Also, the liquidity constraint is not all-or-nothing like it is in the textbooks, which you are either over your required reserve ratio or you are not. Instead, as a bank pushes against the liquidity constraint, two things happen. One is that it may find it more expensive to meet its liquidity needs. The other is that it runs greater risks by operating with less liquidity. Still, it is a constraint, but one that is not a hard ratio, more like a supply curve with increasing prices.
Nevertheless, the textbook model is not all wrong, because even though it has the details wrong, it is right about the bottom line that the Fed can make liquidity more readily available for the banking system as a whole by using its instruments like open market operations and discount loans, and injecting more liquidity into the system can (except in unusual times like now) increase the willingness of banks to lend.
So people who tell you that banks are not liquidity constrained are, in a sense, right, but in another sense wrong.
I bet that isn’t the kind of answer you wanted, but it’s the best I can do.
Thank you for the reply. That does add more to the story but what I would expect.
I’d be interested in reading scholarly papers on lending constraints if you could recommend some.
Thanks again
There is an interesting paper published by Bank of International Settlements which explicitly debunks the theory that aggregate bank lending is reserve constrained. An alternative, more realistic model is proposed.
http://www.bis.org/publ/work297.pdf
One can imagine the Central Bank starving commercial banks from reserve funds but this would immediately lead to losing control over the overnight deposit rate and could lead to bank runs.
On the other hand, excess liquidity does not need to cause the overnight rate dropping to zero because the Central Bank can pay interests on excess reserves.
“The foreign experience with paying interest on central bank balances suggests that policy
rate floors can be effective lower bounds for market rates and that tightening by raising the
interest rate paid on central bank balances can help reduce or eliminate the need to drain balances to bring about higher market rates” see:
http://www.federalreserve.gov/pubs/ifdp/2010/996/ifdp996.pdf
The “communist monobank” still operates under disguise in China. This is not a free market economy but neverthless they have achieved a much better outcome that former Soviet Bloc countries which adopted a more orthodox approach to banking. I am personally not in favour of the Chinese model but we probably need to ask a question whether thight control over macroeconomic processes combined with a quite free-market system at the micro scale (e.g. very weak regulations affecting labour, relaxed attitude towards Intellectual Property) would not outperform the system based on loose control of the macroeconomic processes and moderate regulation affecting players at the micro scale. At least they did not have any issues with proprietary trading of investment banks and with toxic derivatives. Of course, balance sheets of the Chinese banks act as a graveyard for the worthless assets that is loans made to local governments or state-owned companies which cannot and will never be repayd. So far they suffered no ill effects of the “zombification” of the banks because they are all state-owned.
http://www.investmentweek.co.uk/investment-week/news/2127912/asia-managers-warn-threat-chinese-zombie-banks
In the end we (the Westerners, I live in Australia) have not only to cooperate but also to compete with China. We at least need to understand what’s going on there and why they are doing so well despite violating so many “unbreakable” rules of orthodox economics…
Adam K: Thanks for the BIS link. Abstract looks interesting, I’ll study it when I have time
You comment: “So far they [Chinese banks] suffered no ill effects of the “zombification” of the banks because they are all state-owned.”
China-watchers like Michael Pettis think it is only a matter of time before the ill effects are felt. I tend to find the argument convincing. See, for example
http://www.economonitor.com/blog/2012/08/has-the-great-rebalancing-already-started/
http://www.economonitor.com/blog/2012/07/what-is-financial-reform-in-china/
I regard Pettis as one of the more substantive China watchers, offering first-rate analysis on China and the substance of it often touches on things I don’t seen mentioned elsewhere. However, his forecasts as far as being generally bearish or bullish on macro outcomes are framed in a viewpoint of the China as solvency constrained in its own currency. As such, he reaches some conclusions about ill effects that require an initial assumption MMT rejects.
Michael Pettis is a Senior Associate at the Carnegie Endowment for International Peace and a finance professor at Peking University. He writes at his website, China Financial Markets, mostly about finance: applied economics, not theory. Analysis of what’s happening now, and forecasts of the near future (ie, the next few years). Little of finance/investment discussions wash into the peer-reviewed economic literature, until after the economic cycle has resolved itself.
geerussel writes: “As such, he reaches some conclusions about ill effects that require an initial assumption MMT rejects.”
Sorry, I don’t agree. Yes, maybe in the link I put up about financial reform there would be some things you might quibble with from an MMT point of view, but as I read him, Pettis’s main worries are about the real structure of the Chinese economy.
If you are MMT or non-MMT, you are going to get into trouble if you keep investing vast sums in infrastructure projects that don’t generate real benefits proportionate to their real costs — bridges to nowhere, high speed trains that no one rides, “tofu” buildings that fall down in earthquakes. It’s not just that you’re wasting yuan on those things — you’re wasting real labor, real steel, real concrete, and so on. Yes, you can print all the yuan you want, but you can’t print concrete and steel.
The flip side of the oversized and inefficient investment sector is an undersized consumption sector that delivers a lower standard of living than China’s people deserve, given the country’s past economic success. I don’t see that primarily as a financial issue, it’s an issue of the way real resources are allocated, although some features of the Chinese financial system, like negative real rates of return on bank savings, may exacerbate the imbalance.
“if you keep investing vast sums in infrastructure projects that don’t generate real benefits proportionate to their real costs — bridges to nowhere, high speed trains that no one rides, “tofu” buildings that fall down in earthquakes. It’s not just that you’re wasting yuan on those things — you’re wasting real labor, real steel, real concrete, and so on. Yes, you can print all the yuan you want, but you can’t print concrete and steel.”
Pettis’ critique goes one step further: many of those projects (overinvestment in both commercial and public infrastructure) are financed by debt, and many of these projects will not generate the yuan to replay that debt.
Also note, although he doesn’t make that point, that this critique also applied to Japan — which be the first and largest test of MMT. They’ve supported their economy since 1989 with massive borrowing. Japan’s government’s net debt to GDP ratio was aprox 130% in 2011. They’re suffering from chronic deflation, but anything but mild inflation might prove lethal to the solvency of their regime. This graph tells the sad story, from the IMF’s Japan 2011 ARTICLE IV CONSULTATION, 28 June 2011:
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Ed,
I greatly appreciate your contribution to these posts and accompanying threads. As a capstone, can you …
(1) Give us a brief summary of your opinion about the validity and utility of MMT in the larger context of current macroeconomic theory.
(2) Suggest what events we should watch for that will disprove or prove it (speaking broadly, of course).
(3) Point us to some articles in the professional literature that you believe shed light on both sides of the debate about MMT.
The ill effects I had in mind were the case Pettis makes (I can dig through and find some examples if need be) that the bad debt (domestic, yuan-denominated) will eventually get bailed up from private and local government to the the central bank/federal level where it will cause a central bank solvency/sovereign debt crisis. In short, that China can run out of its own money.
To the extent that real resources are wasted along the way, I think an MMT perspective would agree 100% with what you said about efficient real resource allocation being the primary issue.
“that the bad debt (domestic, yuan-denominated) will eventually get bailed up from private and local government to the the central bank/federal level”
That expression makes the outcome to be the result of natural law. In fact this is a guess about a political outcome. It’s not a guess in Pettis’ area of expertise. It’s not something about which China’s brief post-communist history allows reliable forecasting. Especially as decisions of their narrow ruling elite appear to be highly dependent on individual personalities, and this cycle’s outcome will depend on decisions of a new leadership now taking form — and about which we know little.
Ed,
Thank you very much for your comment. I am sorry I don’t have enough time to write more on this fascinating topic. Some of the issues raised by prof Pettis are not fake. Real resources crowding out and misallocation of investment due to soft budgetary constrains in a (post)-communist system are real issues. The question is whether the gain coming from near-full utilisation of productive capabilities is outweighed by the losses incurred due to these factors. The environmental limitations also play very important role in China – even today.
I disagree however with the financial part of the analysis. Banks are state-owned (despite of all the obfuscation). Precisely because of the soft budgetary constrains they can operate quite well with negative equity. Some of the bad debts are owed by the government sector (local governments). Looking at the balance sheets – how does this situation differ from the financing of government expenditure by money emission (what was the standard in orthodox communist countries)? The only significant difference is the presence of the private sector and the absence of conspicuous price controls. But under these arrangements there will be no debt crisis. The government doesn’t need to repay itself bad loans.
In my opinion the Chinese are experiencing soft landing due to the consequences of the deep recession in the EU (the main export market) and throttling of the growth of the housing bubble (financed by the private debt). The leadership indeed wants more reforms but it is hard to analyse their intentions now – because of the secrecy of the political process which mainly occurs behind the curtain. The “rebalancing” towards more consumer-oriented economy mentioned in prof Pettis articles is badly needed.
The fact that they stopped the housing bubble financed by private debt on its tracks suggests that they understand the root causes of the lost decade in Japan and the recession in the US. The Chinese cannot afford to allow for a higher unemployment. This would mean the end of the rule of CCP. It is all wishful thinking, they won’t.
Let me emphasise what in my opinion prof Pettis got wrong. They are not constrained by financing and they went into the investment spree on a purpose. They are constrained by real economic limitations and political cohesion. They do not live in the loanable funds world (which may not exist at all).
Just the first sentence of the analysis of the financial repression phenomenon gives away that it is about “financial crowding out”, the effect which doesn’t exist according to many economic schools of thought:
“Financial repression occurs when governments implement policies to channel to themselves funds that in a deregulated market environment would go elsewhere”
Let’s compare this with an example or rather anecdote given by prof Kalecki (it is my own translation from “Kazimierz Laski, Mity i rzeczywistosc w polityce gospodarczej i w nauczaniu ekonomii”, page 15)
“There exists a railway line which is utilised to a very low extent. There are very few jobs in that area and the unemployment rate is high. What should be done to change this situation? Right next to the existing railway line another one needs to be built. Orders for rails, sleepers, building work will be generated. This would lead to economic stimulation of the area surrounding the previously not fully utilised first railway line. Steelworks, factories making sleepers, buliding firms will need raw materials and other commodities to fulfil new orders generated by the investment. The fact that there are more jobs available and extra wages are paid would lead to an increase in consumer demand. Also – the demand for rail transportation services will increase what would increase the utilisation of the existing railway line. What would needs to be done when the second railway line is finished, when the extra demand generated by the initial investment peters out and unemployment increases again leading to losses of workers income? Then another, third line needs to be built”
This is obviously a joke but the jury is still out. Is it better to allow for some misallocation of real resources and operate close to the full capacity or is it better to maximise profits of individual companies while the whole economy is severely depressed? Time will tell. I am afraid that it way say something not very polite in Polish or rather Mandarin.
“In short, that China can run out of its own money.” – yes I agree this is the implicit conclusion reached by prof Pettis and other Western China-watchers. That conflusion is profoundly wrong.
First of all I would highly recommend reading: The Party: The Secret World of China’s Communist Rulers {by Richard McGregor, journalist at the Financial Times (2010)}. It is a real eye-opener. In short, China is a communist country without communism. My brief encounters with that country and long discussions with the mainland Chinese nationals living here in Australia fully confirm that diagnosis. The control structure of the communist party has been left intact. In the former USSR more power was in the hands of the Secret Services and the Party died out there. In China the Party never shared power with a semi-independent security apparatus and after the death of Chairman Mao, clensed itself from the ideological absurdities of Maoism and Marxism-Leninism. But bailing out the state-owned banks IS a natural rule in any communist (or reformed-communist, socialist-with-Chinese-characteristics) country.
There has never be deflation in any communist country. There were bouts of high inflation and even hyperinflation dure to latent “inflationary overhang” and endemic production inefficiency at any level, leading to the inability of the state-owned economy to satisfy basic consumer needs of the society. But we are talking about a state solvency constraint (in its own currency). This is actually the core issue addressed by MMT in a slightly different context.
As a someone who lived 22 years in a communist country I can assure everyone reading these words that there is NO state solvency issue in China. The leaders don’t believe in neoclassical economics. In the end money is electronic entries in the distributed database. It is not backed by gold on anything else. Give me the passwords to the databases and I can sort out the state insolvency issues with a couple of keystrokes. Would it lead to hyperinflation? We are talking about the opposite situation so there is zero risk of triggering high inflation. As long as there is no preexisting creeping inflation significantly eroding the real value of savings, people will not withdraw and start spending them in panic (in fact the Chinese are hoarding financial assets at a very high rate, they have high saving propensity). All the fiat monetary systems are potentially unstable due to the possibility of a rapid liquidation of the savings (I witnessed this in 1989/1990 in Poland). But the system is locally stable.
The real risk is that we are so afraid of non-existing inflation that we will starve OUR economies to death with austerity while the Chinese (obviously wasting some real resources, there is no doubt about that) will power ahead until they reach the level of saturation determined by the real constraints. They spend so much on education, R&D (and stealing advanced technologies) that they at some point of time will overtake the West in the field of technology in the same way the US won over the Soviet Union in the 1960-1980s.
The following article suggests that the technological gap (between the proxies of the East and the West, Iran and Israel) is narrowing dangerously: “‘Hezbollah drone photographed secret IDF bases’“, Jerusalem Post, 14 October 2012.
As a someone who actually works as an engineer on (civilian) control systems, I can tell everyone that this is a REAL risk.
“he following article suggests that the technological gap (between the proxies of the East and the West, Iran and Israel) is narrowing dangerously … As a someone who actually works as an engineer on (civilian) control systems, I can tell everyone that this is a REAL risk.”
That’s quite a risk! How can we live with the rest of the world without a tech gap that let’s us work our will upon them without fear of reprisal. Does world peace depend on the West’s ability to overthrow their governments, kill their people, sabotage their industry, invade & occupy their lands — as we have for two hundred years.
Let’s hope they have no hard feelings for our past actions. Perhaps that’s the real risk.
Like the debate over flat Earth vs round Earth, loanable funds vs no loanable funds, one of us is right and the other is saying it’s turtles all the way down. I say loanable funds is wrong. Consider a small isolated prairie town. Call it Toy town. There is one bank in Toy, the Bank of Toy. Toy is self sufficient. No goods or services come from outside Toy. Citizen Bob wants to build a house in Toy and all commerce is done by check. The BOT considers Bob a good risk based on his youth, his intelligence, his good health, his education , and many other risk factors and grants him a builders loan with progress payments to his account based on milestones as they are achieved. The first milestone is securing the lot to build on. Bob offers to pay farmer John $100k for a parcel of his farmland. Bob takes the memorandum of understanding with farmer John and the bank makes a loan to Bob provisional on his consummating the deal with John. The next day the deal gets done and John receives $100k from Bob. Bob signs the deed to the property over to the bank as collateral. Bob has to obtain the permits to build and submit the plans to the bank for approval. The bank knows the approved lot is worth more now than as farmland and views the spread as a cushion in case Bob flakes out and the bank has to sell the property. And so it goes, power and sewer arrive the same way, then lumber and labor, dry wall and wire. Eventually there is a new house the bank owns as security against Bobs note. The house is worth way more than the bank loaned out. Since all commerce in Toy is done by checking, no money ever leaves the BOT. All the bank ever does is move funds between various accounts at the bank. Wealth appears to derive from nothing. Where is the saved loanable asset that balanced the loan funded by the bank? Ok. Farmer John, but he got paid day one. The materials that got delivered from inventory I suppose represent saved assets temporarily contributed unsecured by vendors. Labor is not saved and loaned in any usual sense. Innovation (Bob is the first in Toy to put the dining room next to the kitchen. An architectural breakthrough. ) appears nowhere in the ledgers. In short, other than the land for twenty four hours, the rest was carried by vendors for the short time until they were paid, or it represented labor. The wealth created by the labor of free agents is not a saved asset. The economy grows by this process.
To model this evolution of economic growth you need a time dependent description of the banks accounting as it moves money from account to account as per Steve Keen. Neo classical economists ignore this inherent dynamic process of growth and wealth creation and substitute loanable funds and a static equilibrium analysis instead. Sounds like it’s turtles all the way down in that case to me.
From Wikipedia.
A well-known scientist (some say it was Bertrand Russell) once gave a public lecture on astronomy. He described how the earth orbits around the sun and how the sun, in turn, orbits around the center of a vast collection of stars called our galaxy. At the end of the lecture, a little old lady at the back of the room got up and said: “What you have told us is rubbish. The world is really a flat plate supported on the back of a giant tortoise.” The scientist gave a superior smile before replying, “What is the tortoise standing on?” “You’re very clever, young man, very clever,” said the old lady. “But it’s turtles all the way down!”
The Wikipedia entry on the turtle story says that this is quote from Stephen Hawking’s 1988 book A Brief History of Time. In fact the story is ancient, with its exact origin uncertain.
“why should we pay taxes to you bunch of clowns?”
Exactly the point made in Soft Currency Economics and all I’ve written after that. A fiat currency is only as good as the gov’s ability to enforce tax collection. The dollar is nothing more than a tax credit. And tax credits have no value if there are no taxes.
Warren Mosler
Mosler,
Thank you for dropping by to comment. Any thoughts on this thread would be appreciated.
As for fiat currency’s value, that is a basic in political science. A fiat currency’s value depends on the government’s ability to perform basic functions, with domestic security (against domestic and foreign threats) and tax collection at the top of the list. They are, so to speak, two sides of the same coin (ie, interdependent functions).
Which is why breakdown of these often leads to hyperinflation, “always and everywhere a fiscal phenomenon” (more or less true), as governments sometimes in extremis choose to print as the least bad available option.
Hey Warren,
I thought we agreed that IF taxes are necessary to create demand for dollars, the taxes didn’t have to be federal taxes, as there are plenty of state and local taxes to do the job. (Or was that Randy who agreed?)
Rodg
Whether or not tax collections extinguish money is really irrelevant to the bizarre essence of MMT pursuant to Mike Norman (Chief Economist, John Thomas Financial):
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Ed, not bad just a few corrections It’s neo-keynsians MMTers are keen on distinguishing themselves from post-Keynesian are generally well respected. Krugman doesn’t explain MMT well at all, he’d be one of your aptly named MoS MMTers. It is unfortuante that there are schools of thought rather than good economics vs bad, but it’s a convenient flag to throw up to help identify people who have common understandings of some things. :)
Thanks, Jeff. Your corrections are well taken. Please understand that this “post” was originally written somewhat in haste in a comment box and then “promoted” to a post by FM. The discussion has been interesting, and I hope to write further (and perhaps a bit less impulsively) on the subject soon either here or on my own blog.
Thank you for taking the time and effort to lead this discussion. Thanks also to all the people who contributed in the comments.
I believe many of us learned much about this corner of economics!
Yes, the dollar is a simple public monopoly, and therefore the govt is price setter rather than price taker.
Warren, this guy thinks mainstream economics is great, because it is, well . . . mainstream. He provides no proof other than the fact that most economists believe something. I gave him data, which he disputes on twisted semantic terms, then complains I give him no data, while he himself provides none.
Just be warned.
Rodg
Rodger,
That is not so, but it’s not worth going over this yet again. It’s all in the thread, in the unlikely event anyone cares.
As for Zimbabwe, when you take farm land from farmers and give it to non-farmers, the price of food skyrockets, and you have inflation — an inflation caused not by money “printing,” but by shortages. No mystery there.
The U.S., in its 240 year history, never has had hyper-inflation, but that doesn’t stop the debt-hawks from predicting it every time the federal government spends.
Anyway, most questions are answered at: http://wp.me/pDjPx-uU — a 10-minute read — in the event you wish to understand the facts.
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