I am still catching up after being away in the UK last week. I will…
Who should be sac(k)ed?
When I saw the headline on this article – Time to plan for post-Keynesian era – in the Financial Times yesterday (June 7, 2010) I wondered which Keynesian era we were talking about. It was written by Jeffrey Sachs who is well-known for his anti-stimulus viewpoints. The upshot of his argument, however, is that he recommends deficit reduction strategies because the bond markets will get upset otherwise. At the same time he advocates medium-term investments in green technology and education which I support but which will not be consistent with deficit reductions.
Sachs claims that:
Mainstream Keynesian economics is facing its last hurrah. The global fiscal stimulus championed last year by the Obama administration is coming undone, repudiated by the same Group of 20 that endorsed it last year. Now, against a backdrop of a widening sovereign debt crisis, we need to abandon short-term thinking in favour of the long-term investments needed for sustained recovery.
Keynesian stimulus was premised on four dubious propositions: that it was needed to prevent a global depression; that a short-run fiscal boost would jump-start the economy; that “shovel-ready projects: could combine short-term cyclical and long-term structural agendas; and, last, that the rapid rise of public debt occasioned by stimulus need not be a concern. That these ideas were so widely accepted was a testament to the perennial political attractiveness of tax cuts and spending increases.
Okay, so he is now calling the current fiscal response a “Keynesian stimulus” and this is the Keynesian era he is referring to. I beg to differ. What we have seen in the last two years is a mix of half-hearted fiscal stimulus with a blind belief that monetary policy would do the “hard yards”.
The reality is that in most nations, the stimulus has been too modest – because the treasuries were still harbouring neo-liberal persecptives. Further, the stimulus packages were not targetted at creating employment, which would have provided the greatest fiscal multipliers.
But having said that the overwhelming evidence that is now available from a variety of sources from the IMF, OECD, national treasuries and central banks is that the stimulus packages, deficient as they were, still provided the dominant spending boost to arrest the slide into depression. Please read my blog – Fiscal policy worked – evidence – for more discussion on this point.
Even the most recent National Accounts for Australia published last week show that if the public infrastructure projects, which accompanied the stimulus packages, had not been implemented we would have been in negative growth in the March 2010 quarter. And we would have been in recession throughout 2009 if not for the public spending boost to aggregate demand (indirectly via household consumption and directly via government spending).
This puts paid to the claim made by Sachs that:
In fact, the ubiquitous references last year to the Great Depression were glib; the policymakers had panicked. Adroit central banking could and would prevent depression.
The evidence I cited above also suggests that monetary easing played a much lesser role in maintaining sufficient aggregate demand to prevent a slide into depression. It is clear the central bankers didn’t hold the horses back with the huge cuts in short-term policy rates and in many nations significant quantitative easing initiatives.
But you just have to look at the behaviour of the spending aggregates to realise that the interest-rate sensitive components wallowed in the dumps over the last few years. The growth that has been observed since the crisis began has been overwhelmingly driven by public spending in one way or another.
Sachs then claimed that:
The hastily assembled stimulus packages were a throwback to naive Keynesianism. The relevant fact was that the US, UK, Ireland, Spain, Greece and others had over-borrowed for a decade, so a decline in consumption after 2007 was not an anomaly to be fought but an adjustment to be accepted.
It is true that in many countries, the form of the stimulus packages left a lot to be desired. In Australia, despite the strong contribution to growth, the public investment packages have been clumsy. But this raises an interesting question: Is this a basic flaw in using fiscal stimulus to underwrite aggregate demand when private spending has collapsed or is it a reflection of the neo-liberal dominance?
My view is clear. For years now the neo-liberals have been eschewing the use of counter-cyclical fiscal policy and as the dominance of inflation-targetting monetary policy was made concrete, fiscal policy was assigned a passive role. That is, it was used to reinforce the monetary policy stance. With this ideology prevailing, it is little wonder that governments ran down their capacity to implement large-scale infrastructure projects.
Government departments used to have large planning capacities and projects would be thought out in advance and would be ready – well-designed and costed – for when the fiscal tap had to be turned on. In general, the evaluations that have been done over the years point to these projects being well implemented and providing enduring benefits. I can think of many projects around the world that have been completed as part of a fiscal counter-stabilisation program which now provide huge financial and non-pecuniary benefits.
So there is no inherent flaw in the “Keynesian” approach to large-scale infrastructure programs being used as a primary platform for providing fiscal stimulus to an ailing economy.
And while I agree that the challenge in the downturn was to allow the private sector to reduce their debt exposures and realign consumption to more sustainable levels, this doesn’t negate the use of fiscal interventions at all.
Building public infrastructure is not a consumption activity but it does provide employment boosts to arrest the rising unemployment that the collapse in private spending has engendered. Typically, the unemployed are not the persons who hold the most debt. So well-targetted fiscal stimulus, aiming to provide jobs to the disadvantaged and, in turn, allow that cohort to maintain their minimum consumption standards doesn’t thwart the middle-class deleveraging efforts.
In a macroeconomic sense, the government has to go into deficit for the non-government sector to be in surplus. Deleveraging is enhanced if there is no collapse in output and income. The latter just ensure the excessive private sector debt becomes a debt crisis.
While I am sure that the sub-prime boom put loans into the hands of people who would never really be able to pay them back much less service them consistently, the reality is that the rising unemployment in the US worsened the debt crisis. Good debts became bad debts through unemployment.
Sachs further develops his argument:
The talk of a green recovery, in which the fall in consumer spending would be offset by investments in sustainable energy, made sense and still does. Yet it was quickly undermined by the politicians’ insistence on “shovel-ready” projects. The shift to sustainable energy systems is a vital but long-term task. It could never be a short-term jobs programme. Maybe in China there are shovel-ready projects of sufficient scale, but not in the US.
I agree that governments are failing to invest appropriately in green technology to replace coal. There are huge opportunities to fund R&D and manufacturing enterprise to develop and produce new green renewables. I would do all of that within the public sector.
But it is true this is a medium- to long-term strategy and would not have produced a many jobs overnight. I travel to the US a lot and have seen many of the big cities close up. My estimate is that the poor in China are not that much worse off than the poor in the US. The urban amenity in some of the US cities is appalling. The standard of housing in many cities, particularly the suburbs or shanty towns (trailer parts etc) is very low.
If you compare a Dutch city (very clean and orderly) to a US city (usually dirty and chaotic) you will realise that there is a deficit of labour being expended in the US cities. The regional landscape is also run down in the US. I could envisage millions of low-skill, labour intensive jobs being created by the public sector that could address many of these issues.
I would introduce a Job Guarantee immediately which would not only provide as many jobs as there were people wanting them but it also would have involved a much lower fiscal outlay. Please read my blog – When is a job guarantee a Job Guarantee? – for more discussion on this point.
Sachs then reveals his lack of understanding of monetary systems. In noting that the US government “inherited the largest peacetime budget deficit in US history” (so what!) he concludes that:
The US was not in a credible position to raise an already enormous deficit “temporarily” because the prospect for future deficit cutting was and remains extremely clouded. America has absolutely no consensus on how to restore budget balance, as it is trapped between a federal government that provides too few public investments and services and a public that is almost maniacal in its opposition to tax rises. One cannot build a credible long-term fiscal policy by starting off in the wrong direction, with larger rather than smaller deficits.
There is no such thing as an enormous budget deficit per se. Rising budget deficits usually signal a deterioration in the real economy (falling output growth and rising unemployment) but the actual fiscal outcome has no dimension that we delineate as improving or deteriorating or large or small. It is what it is. Given it is endogenously determined by the state of private spending, the dynamics of the budget balance just provides information about the state of the economy.
The path of the US deficit is largely dependent on the growth of the economy. It will fall when growth is sufficient. Stimulating employment growth and getting more people back paying taxes is the obvious source of budget retrenchment.
The policy emphasis in the US and everywhere should be on getting growth started. Policy makers would be well advised to stop publishing statistics about the size of the budget deficit. The sky won’t fall in if people do not know.
The US has no consensus on this because almost none of the influential commentators demonstrate an understanding of the real problems facing the US economy. They have become so obsessed with the financial ratios that they have lost sight of the fact that around 17 per cent of the available labour supply is idle.
Say it again: around 17 per cent of the available labour supply is idle.
That is a huge income loss to the economy (and a huge foregone tax take as well).
Finally, there is no sense in the statement that a budget deficit today reduces the capacity of a sovereign government to run a budget deficit tomorrow or the next day or the day after that. The components of the budget are flows and exhaust each period. The stock they leave – given that sovereign governments are not revenue-constrained but still insist on issuing debt to match their net spending – is the public debt stock.
But the public debt stock is our wealth and the interest payments are our income. Since when has rising wealth and rising income been something we should be scared off and want to reverse? None of the public commentary really reflects these realities.
At least Sachs understands that:
… draconian cuts in … [public] … spending … is the wrong approach. We should avoid a simplistic austerity … [program] …
Draconian cuts in spending will undermine growth and drive deficits up. Please read my blog – Amazing reversals – democratic repression – for more discussion on this point.
Sachs proposes a five-point plan for recovery:
First, governments should work within a medium-term budget framework of five years, and within a decade-long strategy on economic transformation. Deficit cutting should start now, not later, to achieve manageable debt-to-GDP ratios before 2015.
Trying to impose some time dimension on the budget outcome is mindless. The budget outcome reflects the dynamics of private spending (via the automatic stabilisers) and trying to “manage” the private spending cycle is likely to be counter-productive. It is a far better strategy for governments to support the private spending cycle – that is, make sure that when private saving intentions rise, net public spending also rises.
But introducing 5-year frameworks etc to satisfy the bean counters in some government department is not sensible.
Further, draconian cuts are only larger than smaller cuts. While there is a huge spending gap, it is counter-productive to introduce discretionary cuts to fiscal policy.
Sachs’ second point:
Second, governments should explain, and the public should learn, that there is little that economic policy can do to create high-quality jobs in the short term. Good jobs result from good education, cutting-edge technology, reliable infrastructure and adequate outlays of private capital, and thus are the outcome of years of sustained public and private investments. Governments need actively to promote post-secondary education.
There are many “high-quality jobs” already being performed in the public sector. The private sector doesn’t have a monopoly on high-quality jobs. Further, I am always bemused when we applaud private firms creating thousands of low-skill, low-paid and precarious jobs (K-mart, Walmart etc) but we then claim that low-skill public job creation is wasteful and meaningless.
As noted above there are countless low-skill jobs that can be produced within the public sector which provide productive and meaningful output and stave off poverty for those who receive them. I did a very large Australian study in 2008 identifying these sorts of jobs – the Report was entitled – Creating effective local labour markets: a new framework for regional employment polic.
I have also done work in South Africa on their public works program and despite its modest coverage (courtesy of the neo-liberal bean counters in the treasury there) – it produced more than a million jobs in the first five years and significantly reduced poverty among those who received the work.
The US is not above the rest of us in having low-skill workers who could be meaningfully engaged. Far from it!
Sachs’ third point:
Third, governments must of course also ensure social safety nets: income support for the poor, universal access to basic healthcare and education, a scaling up of job training programmes and promotion of higher education.
Agreed.
Sachs’ fourth point:
Fourth, governments should steer their economies towards needed long-term structural transformation. External-deficit countries such as the US and UK will need to promote exports over the next few years, while all countries must promote clean energy and new transport infrastructure.
I agree that “clean energy and new transport infrastructure” is an essential area that requires public investment.
I don’t agree that nations should deliberately seek to adopt export-led growth strategies. It is better to import than to export. And as long as other nations desire to accumulate financial assets denominated in your currency then why would you want to send more of your real resources to them and get less of their real resources?
Sachs’ final point:
Fifth, governments and the public should insist that the rich pay more in income and wealth taxes – indeed, a lot more. The upward re-distribution of the past 25 years has made our economies into extravagant playgrounds for the super-wealthy. Politicians of both the mainstream left and right in the US and UK have fawned over those who pay their campaign bills in return for low taxation. Even playgrounds should collect tolls – when it is billionaires in the sandpit.
I agree that there should be a major re-evaluation of the distribution of income. But I would be focusing on the command on real resources and using tax policy to modify that rather than seeing taxation as “funding” government spending. It clearly does not fund anything in a sovereign country.
But I would take this further. As I outlined in this blog – The origins of the economic crisis – the neo-liberal period has been marked by a fundamental shift in the relationship between real wages growth and productivity growth. The latter has outstripped the former by some considerable margin over the last 25 years or so in most countries.
This has provided a major redistribution of real resources to profits and that is one reason the financial sector has been able to proliferate. I would start with wages policy rather than taxation policy in redressing this imbalance. If we don’t redress it then we will be back in crisis again before we know it.
Sachs rightly says that to rebuild our economies “the watchword must be investment rather than stimulus”. Well investment is stimulus. I don’t see how an ambitious public investment program such as he has outlined will not involve (rightly) on-going budget deficits.
His position should come as no surprise. On March 14, 2010 he co-authored an article – A frugal policy is the better solution – with the now British chancellor George Osborne.
In that article they wrote:
Virtually all policy analysts agree that the path to renewed prosperity in Europe and the US depends on a credible plan to re-establish sound public finances. Without such a plan, the travails which have hit Greece and which are threatening Portugal and Spain will soon enough threaten the UK, US, and other deficit-ridden countries. In the recent duel of macro-economists, one camp has called for early budget consolidation, followed by further measures over five years. We agree. Others want more fiscal stimulus, delaying deficit reduction. We believe delaying the start of deficit reduction would put long-term recovery at risk. Such an approach misjudges politics, financial markets, and underlying economic realities.
So you immediately realise that they have no appreciation of the differences in the monetary systems that operate in the EMU and elsewhere.
You will note they talk about “politics, financial markets, and underlying economic realities”. My view is that politics are made and governments that demonstrate leadership can influence the political climate. The current situation is that the politicians are not leading but passively bowing to the demands of the bond markets and the mainstream economists.
This article just apes the mainstream viewpoint that bond vigilantes will bring down any government irrespective of the monetary system that is operating. My view is clear. If the circumstances were such that a sovereign government finds it inconvenient to bow to the wishes of the ratings agencies and the bond markets then they will defy them. They will because they can.
Just have a look at Japan. They didn’t blink when the ratings agencies were downgrading the sovereign debt to low-grade quality.
Further, if yields on public debt issues were considered to be excessive by the government you can be sure that the central bank would be out there operating in that segment of the yield curve in one way or another.
And ultimately, the government would revise the rules and stop issuing debt altogether. Please read my blog – Who is in charge? – for more discussion on this point.
As to the underlying economic realities, the article said:
The general notion that delay is beneficial in the short term because it provokes more spending today – irrespective of future debt burdens – is also wrong, in theory and in practice. If the starting position is a large structural deficit, further fiscal “stimulus” can darken consumer and business confidence by creating fears about future debt burdens. These fears may be translated directly into higher borrowing costs today for government and the private economy. There are many well-studied examples of “negative fiscal multipliers”, in which credible fiscal retrenchments in fact stimulated the economy, via greater consumer and investor outlays, by reducing borrowing costs and spurring confidence.
Sachs must have been listening to Barro too much when they were at Harvard together. Please read my blog – Pushing the fantasy barrow – for more discussion on this point.
The theory they invoke is Ricardian Equivalence which claims that consumers assume that the increased government spending has to be paid back. When? there is no explicit answer in their models – all the teaching models assume very short time periods so they can fit the graph on a PowerPoint slide! Totally arbitrary like all of the mainstream so-called “rigorous analysis”.
So with consumers armed to the teeth intellectually with their New Keynesian models the mainstream claims that as the government spends, consumers increase their saving and the net effect is zero.
The high-tech New Keynesian models that Barro uses are just fronts for ridiculously simple – almost banal ideas. These ideas are hidden behind a wall of second-rate mathematics to beguile the readers and to hold out a sense of authority.
As a trained economist with formal mathematical skills I can tell you that the mainstream models – particularly the ridiculous New Keynesian models – deserve no attribution of authority at all.
The models are predicated on several assumptions which have to hold in entirety for the logical conclusion to follow? Should any of these assumptions not hold (at any point in time), then these models cannot generate the conclusions that fiscal policy is powerless and any assertions one might make based on this work are groundless – meagre ideological raving.
First, capital markets have to be “perfect” which means that any household can borrow or save as much as they require at all times at a fixed rate which is the same for all households/individuals at any particular date. So totally equal access to finance for all.
Clearly this assumption does not hold across all individuals and time periods. Households have liquidity constraints and cannot borrow or invest whatever and whenever they desire. People who play around with these models show that if there are liquidity constraints then people are likely to spend more when there are tax cuts even if they know taxes will be higher in the future (assumed).
Second, the future time path of government spending is known and fixed. Households/individuals know this with perfect foresight. This assumption is clearly without any real-world correspondence. We do not have perfect foresight and we do not know what the government in 10 years time is going to spend to the last dollar (even if we knew what political flavour that government might be).
Third, there is infinite concern for the future generations. This point is crucial because even in the mainstream model the tax rises might come at some very distant time (even next century). There is no optimal prediction that can be derived from their models that tells us when the debt will be repaid. They introduce various stylised – read: arbitrary – time periods when debt is repaid in full but these are not derived in any way from the internal logic of the model nor are they ground in any empirical reality. Just ad hoc impositions.
So the tax increases in the future (remember I am just playing along with their claim that taxes will rise to pay back debt) may be paid back by someone 5 or 6 generations ahead of me. Is it realistic to assume I won’t just enjoy the increased consumption that the tax cuts now will bring (or increased government spending) and leave it to those hundreds or even thousands of years ahead to “pay for”.
Certainly our conduct towards the natural environment is not suggestive of a particular concern for the future generations other than our children and their children.
Barro’s theorem led to a torrent of empirical work, particularly after the US Congress gave out large tax cuts in August 1981, which was the first real world experiment possible (that is, if you consider the US as they do to be the real-world!).
The tax cuts were legislated to be given over 1982-84 to stimulate aggregate demand. Barro’s adherents all predicted there would be no change in consumption and saving should have risen to “pay for the future tax burden” which was implied by the rise in public debt at the time.
But, if you examine the US data you will see categorically that the personal saving rate fell between 1982-84 (from 7.5 per cent in 1981 to an average of 5.7 per cent in 1982-84).
Anyway, now we have a laboratory – George Osborne is in charge of fiscal policy in the UK and will pursue austerity plans. We will see how strong the British economy is by the end of this year.
Conclusion
The emphasis by Sachs on medium-term public investment in sustainable energy and education is fully supportable. But it doesn’t imply a reduced fiscal involvement in the economy. I would suspect it implies larger budget deficits.
But he is incorrect if he thinks that growth will come by engaging in discretionary budget cuts now while private spending is so weak. Employing such a strategy will only worsen things.
Governments should be firmly concentrated on stimulating and maintaining short-term growth at present. Targetted employment creation is the best way to achieve this while we wait for the animal spirits to return and private investment to recover.
After all, the high automatic stabiliser component of the deficits at present is just an indicator of weak private spending. That is the problem not the size of the deficits.
That is enough for today!
Bill,
I have a fundamental question about the validity of MMT. It relates to Barro and RE.
If, for unconstrained nations, government debts equals private sector wealth, then would you allow for the possibility that a point exists in which some of the incremental private sector wealth can become illusory?
Or, put differently, for a “heavily indebted” economy in longstanding stagnation is there a point at which the debt is understood by its citizens to be unlikely to be repaid? If so, then, even absent inflation, and absent currency repudiation, any further increase in this “ponzi” government debt equates to fake wealth. Is this in the realm of the possible?
If you do not allow for this possibility, then MMT’s key tenets holds up. But if you concede it, then, to say deficits don’t matter, you need to show that distorting influences of this illusory wealth on an economy is either negligable or that it is more than offset by the benefits that deficit spending brings about in the face of an output gap.
I would be very interested to hear your response.
respectfully yours,
Nick R
Kyoto, Japan
I read a post over on Brad Delong’s website today which outlined his argument for further fiscal stimulus. He argued for a dichotomy between ‘normal economics’ and ‘depression economics’. In ‘normal’ times, the gains from fiscal stimulus are limited because of higher real interest rates and the tendency of the fed to counter inflationary expectations. He used an example of a 30 year ‘real’ interest rate of 4 percent to demonstrate the high amortization costs of fiscal stimulus in normal times. Currently, he argues, the real rate on 30 year bonds is only 1.8 percent or so, which means the amortization costs are much lower and thus the gains from fiscal stimulus are greater.
I was surprised that this seems to be the best case mainstream progressives can make for fiscal stimulus. It uses a sort of financial cost-benefit analysis, and only seems to support fiscal policy when government can “profit” from its investments.
I am wondering what your views are on the concept of a “real” interest rate. I have a hard time understanding how there can be a “real” price for something that, by its very nature, is purely nominal. What is the purpose of a real interest rate in economics, what does it ration, and is it something that is particularly useful for MMT and other heterodox schools of thought?
I read that same piece over at Mark Thoma’s website and was so upset I wrote this comment:
http://economistsview.typepad.com/economistsview/2010/06/we-need-bigger-deficits-now.html#comment-6a00d83451b33869e20134836fb9fa970c
“In normal times, a boost to government purchases or a cut in taxes … raises interest rates, which crowds out productivity-increasing private investment spending and, dollar for dollar, leaves us poorer after the effect of the stimulus ebbs.”
Is Dr. DeLong kidding? Dollar for dollar? I’m sick to death of this whole “in normal times fiscal policy is completely useless, but now that we’re at the zero lower bound things are different,” meme coming from pseudo-progressives like Dr. DeLong. If this is the most Dr. DeLong can bring himself to say about fiscal policy I’d rather him just say nothing at all.
I don’t want to go into too much detail about why Dr. DeLong’s characterization of crowding out is extremely wrong headed, but the short of it is the neo-liberal theory of a “loanable funds,” market is mostly nonsense. Andy Harlass does a much better job of explaining this than I can here:
http://blog.andyharless.com/2009/11/investment-makes-saving-possible.html
In summary, money used for investment and consumption does not come from previous savings. In fact, just the opposite is true. The act of investing brings forth its own stream of income that can be converted into savings after the fact. Government deficit spending isn’t “crowding out,” private investment because there is no finite stock of money that either the government or the private sector has to draw on to finance it’s spending. It’s been a while since I’ve done any serious economic history reading, but I’m pretty sure this observation constituted a major break with the classical school of economics and Keynes’ justification for this argument took up a considerable portion of his General Theory. Isn’t Dr. DeLong supposed to be some sort of an economic historian or something? One would think he should know more about this stuff than some kid who took a few economic history classes as an undergrad.
Bill: Before seeing your post above, I noticed Sach’s daft article in the FT and attacked it on my blog. Great minds think alike.
Nick R: re your question “would you allow for the possibility that a point exists in which some of the incremental private sector wealth can become illusory?”
My answer is that in a sense the value of ALL fiat money is illusory. Thus there is no “point” at which this “illusion” suddenly becomes more of problem than it is anyway.
In fact even the value of “gold standard” paper money is semi-illusory in that citizens of the country concerned have normally never been able to turn up at their central bank and get lumps of gold in exchange for dollar bills, pound notes, etc.
So, instead of giving people “free” money through unemployment compensation, you would have them work for it through a “Jobs Guarantee” program so that society would receive some benefit from payments made (besides stemming contraction)? Sounds good. I am assuming you would have either a Jobs Guarantee program or unemployment compensation, but not both.
But a simpler solution to our “debt crises” is to just accept that government spending need not be debt based. Nick R raises a very good point about wealth creation.
I believe that, in most modern economies, wealth is created through some combination of export surplus, debt based government spending or private sector (fractional reserve) lending. This means that outside of export based economies (like China), net wealth is debt based.
This infers that in modern society, outside of export based economies, we must accept that either public or private sector debt (or both) must be allowed to grow –even to infinity– if the economy is to continue to grow.
Nick R ~ Time precludes a more thorough answer, but …
Nothing sends non-MMTers bonkers faster than the statement by MMT that “deficits don’t matter”. Most immediately exclaim that MMT advocates unrestrained spending (and so therefore we’re nuts, of course). But MMT doesn’t say unrestrained spending is OK; merely that spending is limited by available resources, not by governement revenues. The deficit number itself is meaningless. It conveys no useful information for policymakers.
In other words, MMTers are simply saying that other economists are MEASURING THE WRONG THING.
Hope that helps.
Furthermore, to assist the acceptance of the notion that government spending need not be debt based, I would create a new “drawing right” used for payment for all military expenditures and redeemable for dollars. It need not be any physical currency, rather, just electronic transfers to vendors, suppliers and military personnel for purchases, procurements and wage payments.
Bill,
Sorry for saying so, but NOW is the time.
Just look at this posting and it should be obvious that the deficit(debt)-terrorists are in control and the only way out is to espouse the greater truth.
That known to few and denied by many.
At the Teach-In when I explained that what MMTers call “self-imposed government constraints” are actually substantive, if not definitive, monetary and fiscal powers that are reflective of much more than the leftovers of the gold standard.
That greater truth is that it is NOT necessary, and NOT even preferred, that governments BORROW their deficit spending, thereby creating public debts using private sector savings.
That it is unnecessary is either a forgotten or un-recognized truth.
Although you have stated many times here that it is not necessary, you also continue to laud the resulting government debts in a way that is totally counter-intuitive to the average of your many blog-readers, and certainly to the general public when your blogs get re-distributed.
So, Bill, it needs saying, and it needs saying NOW.
The governments can, and under these circumstances MUST, issue the monies that are needed to meet the nation’s public-purpose undertakings through non-inflationary spending of debt-free money DIRECTLY into existence.
Do not stop at the NYFED on the way to the checking accounts of the American people, from whom we attain our monetary sovereignty.
To not do so provides strength to all the deficit-terrorists, and not just the better-meaning Jeffrey Sachs of the world, to point to the “limits” of government-sector borrowing and the need for “fiscal-restraint-cum-austerity”, lest the capital marketeers to bring the government sector down to a “flushable” size.
It is because the people do NOT UNDERSTAND this greater truth that the following is stated repeatedly by yourself and other MMT proponents.
“But the public debt stock is our wealth and the interest payments are our income. Since when has rising wealth and rising income been something we should be scared off and want to reverse? None of the public commentary really reflects these realities.”
My point exactly. And we need to change that.
“This article just apes the mainstream viewpoint that bond vigilantes will bring down any government irrespective of the monetary system that is operating. My view is clear. If the circumstances were such that a sovereign government finds it inconvenient to bow to the wishes of the ratings agencies and the bond markets then they will defy them. They will because they can.”
Will they?
Only if they have the will to do so, and only because it is RECOGNIZED that they can.
But THAT they can seems a vague truism incapable of entering the unfolding dialogue.
At the Teach-In you said maybe you need to do a blog on why the government should not issue debt when it spends what I call the “balances formerly known as deficits”.
Bill, it’s getting to be now or never.
Thanks for everything.
That joe bloke.
Ralph and Benedict,
Thank you both for your comments.
Ralph, I believe that as of now almost everyone in Japan believes that JGBs are \”money good\”. My question is what happens when people start to believe that that they are not. I think there is an inflection point where people begin to question the assumption that government bonds = private sector wealth. Or, more specifically, there is a point where they begin to doubt that their increasing bond holdings actually constitute wealth. Tell me why I am mistaken.
Is such an inflection point even possible under MMT?
And Benedict (by the way I love your name), is it treacherous to believe that long before a sovereign debt default or a hyper-inflation episode, an economy might reach a point at which its citizens come to believe that the national debt is \”excessive\” and therefore come to regard their wealth as unreal? And long before they get there, if we assume that they ultimately will get there, then can we analyze the economy as characterised by unreal wealth.
If not, why not? But if so, how can MMT work?
Again, my thanks,
Nick R
Kyoto, Japan
Nick,
Do you mean that a false perception of something can lead people in the wrong direction? If i’m right MMT simply describes the correct perception, and if people have an incorrect perception, MMT will still apply thus: If people percieve, as they do in the UK, that the Public Deficit is too high, they will cut spending or someother unnecessary activity, yet the result of this will still be described accurately by MMT.
Chas
Nick, Bill, Ralph, Benedict et. al.,
Further to my comment above (which might not be correct), it does sound quite important for people to understand the scope of MMT:
From Bill’s post above a difference he is elluding to between MMT and other ‘models’ (for want of a better word), these other models rely on assumptions about human behaviour, whereas MMT does not attempt to and so can show what happens in terms of sectoral balances accurately. (I don’t know how better to describe this.)
This though seems to imply that ‘human perceptions of wealth, productivity etc’; any irrational human behaviour; and any attempt to describe or forecast such behaviours or perceptions in economic terms is outside the scope of MMT – is this right?
Another thing MMT seems to include within it’s scope (If I’m right), are monetary tools available to sovereign governments with a fiat currency.
Can any of you help me add to this ‘scope of MMT’?
Thanks
Nick R: I accept that an inflection point is possible. The scenario you envisage is presumably something like: “people begin to lose faith in the value of bonds, thus their price drops, which further undermines them, which causes a mass exodus, which causes their value to collapse to nothing”. But can you direct me to an instance in history when this has happened?
One bulwark against the above outcome is that bonds (particularly those near maturity) are much the same as money. Thus for the bonds to crash, the value of money has to crash as well. And money is quite stable stuff: it takes a longish period of incompetent economic management to get inflation going (and unfortunately it takes an equally long time to stop it).
My hunch is that nothing short of wars and revolutions will totally destroy the value of government bonds, e.g. Russian pre-revolutionary bonds became worthless with the communist revolution in 1917.
Joebhed: I agree with your 23:42 post. I assume that Warren Mosler would as well since in this Huffington Post article of his he advocates a cessation of issuing Treasury securities (see 2nd last para):
http://www.huffingtonpost.com/warren-mosler/proposals-for-the-banking_b_432105.html
Also Milton Friedman in a 1948 American Economic Review paper (with which you are acquainted, I think!) advocated likewise:
http://www.jstor.org/pss/1810624
I’ve read a lot of insane reporting the last days. The best two notions to summarize all the reading are Bill’s “Democratic Repression” and Krugman’s “Madmen in Authority”. I started on Saturday with the announcement of the German government before deciding on their austerity measures that there won’t be any “Free Beer” in the future. Fair enough. Just now I pored over their austerity package and the only thing on my mind was: this is the bankruptcy declaration of neo-liberalism. After 30 years there’s simply nothing left to save. They must even consider meagre savings on heating subsidies for the poor in winter? The only way left is to start demolishing the fundamentals of the welfare state. I would like to ask Angie for my last Free Beer before falling into a deep mental depression.
Jeffery Sachs is a nice man and well-meaning. But after what his prescriptions did for Russia, I would think that if he were actually awake, he would either change his views or his profession. As an economist and policy adviser, he is a wanker.
NIck R, the Fed is now issuing policy statements based on perception rather than reality. There is absolutely no sign of inflation now or in the foreseeable future and the Fed is faced with looming deflation, but it is “concerned” with “inflationary expectations.”
Given a choice between perception and reality, I prefer policy-makers to be making policy based on reality instead of false perceptions.
Could a nation of idiots self-destrcut though? Of course. We may be about to see it happen.
@Tom
“Could a nation of idiots self-destruct though? Of course. We may be about to see it happen.” For sure. No problem. I think in the coming years Germany will be a posterchild for lessons in HOW-TO self-destruct and dispense expert advice to others on doing the same 😉
Nick R,
The the need for money creation arises from a time mismatch between expenses and income. Always. An agent who can increase the perception of his future income potential will be granted more credit. If that perception is mistaken, at some point, a correction will occur, such as cessation of payment.
MMT treats the Tsy’s liabilities are virtual, hence the gov is not revenue constrained. MMT considers that only demand pull inflation is the constraint. You can find evidence of this belief in statements such as :
“My answer is that in a sense the value of ALL fiat money is illusory. ”
To me, that falls short of convincing.
Richard Koo’s latest report finishes with the following ominous note: Premature fiscal consolidation is a threat to democracy
Pushing ahead with these misguided policies risks a collapse of social and economic foundations and could even threaten the survival of democratic structures. A good example is prewar Germany’s Brüning cabinet, which insisted on fiscal retrenchment and allowed the emergence of Hitler in the 1930s. The risk is especially high in Central and Southern European countries, which have a relatively short history of democracy.
I think that is too hard on Saks.
He advocates for a social safety net, including comprehensive health care, and advocates raising revenue by increasing taxes on the wealthy. I absolutely agree with this prescription.
I would refuse to deficit spend more than the trend rate until marginal rates were hiked to the Eisenhower levels.
With the current approach, unemployment remains elevated but corporate profits and wall street earnings have recovered — so we have proof that the effects of the deficit spending have been to enable the current wage inequality to continue.
Spend to your heart’s content, but drain the bulk of it back from those who are responsible for the demand failure. Once the median wages have recovered and upper brackets are high, and still unemployment has not recovered, then there is a reasonable case to be made for a deficit spending tsunami. But even then, I would address unemployment with a Job Guarantee, not by bailing out a rotten system that is unable to generate demand endogenously.
RSJ, not by bailing out a rotten system that is unable to generate demand endogenously.
I have to admit that I struggle with this. The radical in me wants to go to the wall, but that would mean a lot of suffering for a lot of families. Unfortunately, it is likely to take GDII to radically alter the system, and then there is no guarantee that the US will get another FDR instead of a Hitler.
I think that hiking taxes on the wealthy while providing health care and a JG is much more feasible, politically, than enormous money financed deficits. And it would be better for the economy and for social welfare. There would be less suffering, not more with a strong social safety net and high marginal rates, leading to lower levels of overall deficit spending — you would of course continue to deficit spend. This is what Saks advocated, and I agree.
The canonical example here is Japan — what on earth caused the private “sector” to desire so many assets in 1990, when they were doing just fine with the asset flows that they had for the previous 4 decades? A private sector that needs ever-increasing infusions of cash is a sick private sector. We can afford to cure the disease via punitive tax policy while providing a social safety net for all families. None of this would require enormous deficits.
RSJ . . . your approach can theoretically fit MMT (though not every MMT’er would agree with the policies proposed–some would, some wouldn’t), because you recognize that the concept of “sound finance” is inapplicable (i.e., govt doesn’t need revenues to finance spending, Ricardian equivalence is inapplicable, etc.). The problem with Sachs is that he’s a deficit dove, which doesn’t fit MMT and will at some point require him to abandon the proposals you agree with if the deficit gets “too big” or even if people start to fear it will get “too big.”
Keynes = General Theory
Keynesianism = John Hicks, Alvin Hansen, and practically everyone else.
Austrians even refer to Milton Friedman as a Keynesian and I tend to agree,
RSJ, I’m with you on the equality, not sure whether the income and wealth distribution is the underlying cause of Japan’s troubles though. As far as I know, Japan has always had a lower Gini coefficient e.g. than the US which holds before and after the 90s. I have a feeling that Japan has suffered from a general lack of ideas more than anything else which is something money cannot induce. While one can ease fears of the future and insecurity by supplying enough cash for everyone to stuff under their mattress, this will by no means automatically generate optimism and ideas to redesign the future. And the question is now, are we any better? But, as Scott has pointed out, I think your idea of adding cash and/or security/jobs to those with a propensity and willingness to spend / work while squeezing the air out of FIRE is fully in line with what MMT and most of its proponents are saying. It’s just not what’s actually happening.
Re Japan: I have no in depth knowledge of the place (maybe Nick R can elaborate) nor any proof of my theory but as per the cliché of the almighty Japanese company, the inequality of monetary distribution and with it lobbying power and other distortions probably lie less between individuals within society than between natural and corporate entities. In that sense neither the Gini coefficient nor progressive taxation of individuals would have a significant effect. Just a thought…
It is truly amazing the confidence economists have in the average citizens being foresighted and knowledgably about public financial matters. In the world normal people live in not even those who have economics as their profession and is paid top dollars for it have a clue, Moody’s having a failure rate of 80-90% in their ratings. The big owner Buffet neither have a clue, how could he know their where a real estate bubble he told testifying before US Congress.
“We own a lot of Procter & Gamble, but I don’t know much about the inner workings of Procter & Gamble.”
Buffet
As Buffet most people if not nearly all don’t have a clue about the inner workings of the public deficits, future taxes, debt and so on.
That people should make precise calculated rational decisions about these things is beyond ridiculous. One could recommend those economists to do what we do out here in the real world, use common sense.
Oliver,
My sense is that Japan doesn\’t lack ideas. It lacks the political will to implement them in a consistent manner. See Robert Feldman\’s piece a decade back.
http://www.wcfia.harvard.edu/us-japan/research/Feldman.CobwebsCRICS.pdf
This gets to the heart of what is wrong with MMT. The start-stop process of fiscal spending is not something one can simply will away as \”democratic repression\”. That is akin to saying Keynes\’s paradox of thrift is \”savings repression\” and must be stopped because people \”should know better\” than to hoard.
Concern for deficits has always been part of parliamentary democratic systems. Fiat or not. Public choice theory attempts to deal with these normative issues from a political science perspective. MMT just assumes them away. I am troubled by that.
Japan will ultimately default on its debt or it will inflate it away. There is no other choice. And this is starting to dawn on academics at Tokyo University, senior members of Keidanren, and large bond investors. The fact that this should be impossible for an \”unconstrained\” nation is completely irrelevant. It is what it is. There is nothing anyone can do about it.
After the debt is wiped away, Japan will end its twenty plus years of \”Lost Decades\”. Taking on more debt will delay the process. And the reason is …. the debt is now ponzi….so the private sector wealth is not real either.
Hope that helps,
Nick R
1.All taxes are an allocative mechanism especially those imposed against excessive behavior such as speculative rents. This does not stop the government to feficit spend which is an automatic endogenous function.
PRIVATE spending is not automatically financed by borrowing as it requires collateral of different capacity as assets are heterogeneous. Interest rates can change the value of this collateral, although I have shown elsewhere that in the presence of fiscal deficit spending interest rates CAN decline.
I can see what you’re getting at, but is it really people who are hoarding or are the deficits lying around as excess reserves and bonds in financial institutions that caused the trouble in the first place and that have no intention / incentive to extend loans? The question of ‘who’ and not only ‘how much’ is paramount in the whole discussion, I think. And would default help solve the public choice dilemma? What happens after liquidation? And who would suffer? I think Japan, along with its new friends in the West, has been keeping the wrong parts of society on life-support and, for lack of results, is now trying to restructure on the backs of people.
“My sense is that Japan doesn\’t lack ideas. It lacks the political will to implement them in a consistent manner. See Robert Feldman\’s piece a decade back.
http://www.wcfia.harvard.edu/us-japan/research/Feldman.CobwebsCRICS.pdf
This gets to the heart of what is wrong with MMT. The start-stop process of fiscal spending is not something one can simply will away as \”democratic repression\”. That is akin to saying Keynes\’s paradox of thrift is \”savings repression\” and must be stopped because people \”should know better\” than to hoard. ”
This CRICS thing is just saying that fiscal stimulus breeds complacency. As per Richard Koo, there are two problems 1) Balance Sheet recession 2)
The challenge of competing against China.
Fiscal stimulus was the right response to 1). It kept the Japan economy afloat while it de-leveraged.
There is no easy solution to problem 2). MMT says whatever gap in spending is required to keep the economy going, let the government provide it. Debt/GDP is bound to balloon, in this case.
Let’s be honest, we just don’t know how much public debt a country can handle.
Barro says very little, if r>g, MMT says as much as needed, until inflation shows itself. We know why Barro is wrong, because we can look at his assumptions and realize their are oversimplistic. MMT makes fewer assumptions, but then, again, saying the government is only constrained by inflation is a postulate, not a demonstration. Koo isn’t encumbered by theory as he says : let the bond market decide.
These issues are complex. Japan had amazingly low levels of inequality in the late 1970s, and today it is the fourth most unequal OECD member in terms of after-tax Gini (behind the U.S., U.K, and Italy). In terms of 90/10 ratios, it is number 3 (behind the U.S. and U.K.). In terms of 50/10 ratios, it is around number 6 or so. Then there is the pre-tax Gini, which rose from about .3 to .5 over that period. Taxes and transfers reduced that to about .4, however those transfers are almost exclusively to the retired population.
Social cash transfers to non-retired persons in Japan amount to less than 2% of GDP, roughly in line with Mexico and Russia among the G20. Even the U.S. (which is #4) has double the rate of social cash transfers to non-retired persons, at around 4% of GDP. The Scandinavian nations (also with large elderly populations) have social cash transfer rates of roughly 15% of GDP.
But the measures of inequality are only half the story. You can have large levels of inequality without household debt growth if the top earners spend all their incomes on goods. It’s only when the top earners do not consume their excess that debt growth drives the inequality. Similarly, if all the income cohorts begin to borrow more while simultaneously acquiring more assets then you can have rapid debt growth without a rising Gini.
For the U.S., it’s clear that middle class debt growth funded growing top incomes and top income asset accumulation, whereas for nations like Japan, it’s more accurate to say that the asset accumulation was widespread, although still skewed to top incomes. For the case of Italy, the income inequality is more “sustainable” — less dependent on ponzi borrowing — as top incomes consume more, and middle class households have not been rapidly increasing their debt levels.
In general when looking at inequality, we should distinguish between social/political sustainability versus financial sustainability. As long as the top incomes contribute enough to aggregate demand, the only problems are in the first category.
When the government socializes the debt or otherwise takes over the role of private sector borrowing, then it is converting the financial stability problem into a social/political problem. It is allowing the income inequality to escape the financial constraints, via the powers of fiat spending.
And even in those cases when the ponzi borrowing did not contribute to an inequality increase, by socializing the debt the government is not contributing to increased inequality, but it is preventing prices (and most importantly, wages) from adjusting to sustainable levels.
Because of this, there is never any escape:
Firms set their sticky prices at levels that assume a certain level of debt augmented demand, and real wages are set too low. Government income substitutions merely allows these prices to escape deflationary pressures. In the case of Japan, there has been slight deflation, but median wage shares continue to fall even faster, meaning that the Japanese economy requires more external cash infusions (whether from exports or deficit spending) than it did when the crisis began. Japan has dug itself even deeper into the hole.
Hence domestic the outrage at the bailouts, and much of the grassroots opposition to growing government deficits. I know that the rationales articulated in the media are different — open discussions of inequality are taboo. In fact, the U.S. is unique in that perceived inequality is less than half of actual inequality. But awareness of inequality is still there, even if it has been pushed out of the mainstream dialogue and, for many people, into their subconscious. It takes the form of knowing that in the 1970s, a single wage earner earning the median income could pay for medical care, buy a house, fund retirement, transportation, and college tuition for his children. It is easy in that environment to blame fiat currency for degrading the living standards of the middle class, and by extension, to oppose mention of the opportunities provided by fiat currency to help the economy. And quite frankly, the proposals advocated here — whether zero interbank rates or a JG — will do anything to restore the quality of life median earners had 30 years ago. These proposals will only serve to make the loss of welfare permanent, by preventing the financial adjustment from occurring.
The only thing that can fix the loss of living standards would be a radical restructuring of relative prices, so that the median wage can purchase twice as much output as it currently does. Socializing borrowing — e.g. having the government take over the role of supplying extra-wage income when households stop — will only prevent this adjustment from occurring. I truly wish that instead of focusing so much on the (obvious) fact that the private sector would like more money, we instead try to focus on how we can ensure that median wages buy a greater share of output. If we do that, the private sector would not need more external income.
Yes. And even on a gold standard, FDR was able to take us off the standard, devalue, and put us back on. I think if people agree on the fundamental economic problems, then issues such as “running out of money” are not going to constrain them from successfully addressing those problems.
The issue arises when people do not believe that there are any fundamental problems — e.g. problems in relative prices or the long run resource allocation mechanisms. It was only when the market process itself was widely questioned that we made real progress in the great depression.
To put it another way — in your “football” analogy:
As long as people believe that the game itself is legitimate, they will not be open to someone changing the score, regardless of how much you argue that “we wont run out of points”. They know that you don’t run out of points, but there are rules for when you increase points based on “real” things happening on the field.
Only when people get to the point where they believe the game itself needs to be changed will they accept an external adjustment in points, otherwise you will face objections of “fairness” or “morality” if you just go about changing points.
I don’t agree with those objections, but you kind of deserve it 🙂
Anytime there is an economic crisis, it is never because there are too few points, so by dodging the issue of what is happening within the private sector (and only looking at net financial assets), you are suggesting to the public that a mere external point intervention is going to fix the unfair game. Now, you will get push-back from both sides — those who like the game and think it is fair will accuse you of cheating, and those who don’t like the game will accuse you of using the powers of government to fund an unfair game.
An interesting attempt to relate inequality, private spending and debt with socialization to validate and sustain the inequality. However, the hypothesis is not clear. Otherwise, it can be a thesis material.
Furthermore, who sets the wage rates? Are worker aspirations critical and real wages are adjusted by price variation from the firms? If yes this is consistent with the asymmetry condition. How real wages and shares are falling in Japan in the presence of price deflation and low unemployment?
In a community paradigm instead of a market one, public behavior has different dynamics and criteria than private behavior usually discussed by economists. Public behavior of civic units is induced by responsibility subject to community solidarity and cooperation. Furthermore, public behavior is guided by the criterion of fairness and public practice is guided by the criterion of equity. No wonder that citizens as community members and not as market participants are responding to public policy in a different way that economists assume.
Nick R & Bx12: Bill again and again advocates NOT issuing debt.
“Let’s be honest, we just don’t know how much public debt a country can handle.”
So don’t issue any! Regardless, this idea that even if it was issued, at some point people would think it won’t be paid back is baloney. Bonds mature. You buy one, you will get your money on the due date. The government can issue more to cover the payback, but that’s a NEW bond. As for either defaulting or inflating their way out of debt, that’s a false choice. The “inflating debt away” option is just the government ceasing to issue new bonds when repaying old bonds, and you just assume that’s inflationary.
“saying the government is only constrained by inflation is a postulate, not a demonstration”
No, it’s a given because it’s derived by definition. Being a fiat currency issuer means you really do have infinite money. That’s what a fiat currency means. What other constraints could there be other than inflation? Bank accounts exceeding a 64-bit floating point number? Government keyboards worn out from typing numbers in?
Grigory, I already know these arguments, but thanks.
Grigory,
The problem with not issuing debt, and merely crediting reserves, is that it simply lowers the bar for a crisis. If the debt is ponzi, and not going to be repaid, and investors begin to understand this, then alternative unconventional monetary policies will be understood as equivalent to issuing more debt. The process will unravel either way.
The ultimate crisis coming to Japan might now require the recapitalization of the BOJ given its ongoing “rinban” operations.
Look, as long as a country can continue to borrow it will always be able to refinance its debt. So the question turns on how long investors will trust money in country once they come to believe that the debt is unsustainable.
I expect this capital flight/inflation dynamic to begin to play out in Japan over the following decade or two, depending on what steps policymakers take in the interim. If they simply ignore the debt, the outcome will be swifter and more severe.
Foreswearing all debt issuance doesn’t change popular beliefs about the long term sustainability of money. Nippon Life, the GPIF, or the Postal Bank will sell yen and move proceeds offshore once they finally become convinced that the endgame is inflation (or default). How could they not???
MMT lacks credibility because it ignores basic observations about budget deficits and political behavior. These psychological laws may be irrational, but like other economic paradoxes, this doesn’t mean that they are not real.
Nick R:
“The problem with not issuing debt, and merely crediting reserves, is that it simply lowers the bar for a crisis. If the debt is ponzi, and not going to be repaid, and investors begin to understand this, then alternative unconventional monetary policies will be understood as equivalent to issuing more debt. The process will unravel either way.”
Ponzi means taking money from later investors to pay back earlier investors. Crediting bank reserves is creating money ex nihilo. The two are not comparable. Government debt is merely promises to pay bondholders when the bonds mature. If the government stopped issuing bonds, eventually each and every single bond would mature, be paid back (by crediting reserves!), and disappear. Government deficit spending would NEVER need to be paid back. How could that even remotely be seen as anything close to debt?
“Foreswearing all debt issuance doesn’t change popular beliefs about the long term sustainability of money. Nippon Life, the GPIF, or the Postal Bank will sell yen and move proceeds offshore once they finally become convinced that the endgame is inflation (or default). How could they not???”
I understand your worry about investor confidence, but I really think you attribute investors far too much psychic power. If private demand is booming (due to deficit spending) and unemployment is falling, and GDP is rising, why would investors flee because of some theoretical inflation far down the line? If the yen dropped in price, wouldn’t that attract foreign investment? I suspect that inflation only becomes a problem when it occurs, not when it might theoretically occur in the future. After all, Japan has been issuing debt for 10 years and there’s still a deflation problem. Are we talking centuries here?
As long as the Japanese government demands taxes be paid in yen, there will always be a need for the currency.
MMT has credibility because it analysis the effects of aggregate stock flows and accounting identities that are true by definition. It’s more observation than proscription. It doesn’t matter what people think or do, public deficit will *always* equal private surplus.
Bx12: Thanks for the detailed reply, i just hope you washed that ear wax off your fingers before you touched your keyboard 😉
Sell Yen to whom?
We do not live in a gold standard world in which there are specie flows. It is impossible for Yen to leave Japan, just as it is impossible for Euros to leave the Eurozone. At best some current Yen holders sell their Yen holdings to those with Euros that want to buy Yen. When the former Yen holders want to spend their money (or pay pension obligations), they need to buy the Yen back.
In any case, only the names of the Yen holders change, but whoever holds the Yen will need to park them in some security. And the yield (in Yen) of that security will be the Japanese risk-adjusted return, which will also be the risk free return of JGBs.
This is something that people don’t understand. It’s not possible for China to “fund” the U.S., nor is it possible for capital to flow from one nation to another — not when there are fiat currencies. The United States can no more loan money to Japan than Japan can loan money to Greece. All that can happen is for the terms of trade to adjust.
And Japanese institutional investors know this. They know that they have Yen obligations and Yen assets. As long as the Japanese economy is such that risk-adjusted returns are in the 1-2% range, then this will be the yields of JGBs. The psychology of Japanese debt being “too big” doesn’t play a role in the capital markets — the yields are clear. The psychology of opportunity cost determines the yields.
In the eurozone, you can have specie flows. Euros can flow out of Greece and into Germany, and this can cause Greek debt yields to be different from sovereign German debt, and both can be different from the overall return prospects for the EZ. But this is technologically impossible with Yen, regardless of the psychology.
RSJ,
“It is impossible for Yen to leave Japan, just as it is impossible for Euros to leave the Eurozone.” Agreed.
But this is trivially true. It is just as true as saying that stock markets do not go down because “there were more sellers than buyers.” Both statements are mere accounting identities, not causal relationships. Stock prices can go down sharply.
If Nippon Life sold its yen holdings, by definition, someone would buy them. The question is not whether that would occur. The question is AT WHAT PRICE?
When currency repudiation eventually takes place the value of the yen will fall versus world currencies. And as this happens the wisdom of holding long term JGBs will be called into question. JGB bond yields will spike higher as risk premia skyrockets and inflation fears develop.
“And Japanese institutional investors know this. They know that they have Yen obligations and Yen assets. As long as the Japanese economy is such that risk-adjusted returns are in the 1-2% range, then this will be the yields of JGBs. ” Disagree.
(Unless you mean this in an equally trivially true, but meaningless way…..i.e, that in a crisis the risk-adjusted returns of assets will also skyrocket, so if nominal rates went to 9% then risk-adjusted returns would rise to low double digits. So what.)
Japanese institutional investors are not yet ready to admit that the system here is ponzi. When they come around to this type of thinking rates will rise and defaults will occur. This will transpire regardless of the subjective value they place on the risk-adjusted returns on assets.
Grigory,
We agree to disagree about the importance of psychology. I would point out, however, psychological observation is a significant part of what distinguished Keynes from the Classicists.
Ponzi related to the already existing debt. You are right that ponzi debt doesn’t apply when there is no debt!
As for your view: “If the government stopped issuing bonds, eventually each and every single bond would mature, be paid back (by crediting reserves!), and disappear. Government deficit spending would NEVER need to be paid back. How could that even remotely be seen as anything close to debt?”
I suppose the answer also hinges on behavorial grounds. In such a world there would be an enormous opportunity to create alternative forms of money (or script). I would rather hold EDY-Net e-money, or frequent flyer miles for that matter, then ever increasing amounts of helicopter money…..but, hey, maybe people would drink the kool-aid (or is it Kool Aid, I never can remember that?) longer than I suspect.
Nick R.
What distinguised Keynes from the classics is all in Chapter 19 of the General theory. You should perhaps read it sometime.
Cheers, Alan.
Nick R:
“I suppose the answer also hinges on behavorial grounds”
So you are saying the money will become worthless because the investors will abandon it eventually – and they will abandon it eventually because it will become worthless? This seems a little circular to me.
Rather difficult to abandon the governments money of choice when it’s the only acceptable means by which to pay taxes.
Accept governments otherwise worthless fiat money or go to gaol – that’s the only choice.
Grigory, self-reinforcing feedback loops are the hallmarks of modern “unconstrained” capital markets. Circular yes, invalid, hardly.
Fiat money combined with the perception of endless debt will be abandoned. Money is abandoned due to expectations of inflation. It has been the case since since the Northern Sung Dynasty’s paper money became nearly worthless (80 years after it was introduced) during the Mongolian invasion in the early part of the 12th Century.
Allan, you might be surprised to hear that what distinguishes the General Theory from Classical Economics is a just bit more than chapter 19.
RSJ:
Again, I’m mostly with you. American discourse hardly ever touches upon inequality. From a European perspective, there seem to be some deep rooted taboos at work, where striving for equality is associated with jealousy and other pejorative terms that conflict with the American Dream.
– For the U.S., it’s clear that middle class debt growth funded growing top incomes and top income asset accumulation, whereas for nations like Japan, it’s more accurate to say that the asset accumulation was widespread, although still skewed to top incomes. For the case of Italy, the income inequality is more “sustainable” – less dependent on ponzi borrowing – as top incomes consume more, and middle class households have not been rapidly increasing their debt levels. –
With globalisation, those transfers have become a lot more obscure, since the profit extraction usually begins overseas in low wage countries. So, in contrast to the 70s and before, it isn’t the voters & fellow countrymen / women who are being squeezed initially. In fact they are being ‘supported’ with loans, albeit not on sustainable terms. It has become a lot more complex because the consuming classes have been made perpetrators and victims in one, the ultimate load being borne in faraway places nobody cares to examine.
– The only thing that can fix the loss of living standards would be a radical restructuring of relative prices, so that the median wage can purchase twice as much output as it currently does. –
Consequently, this would have to be a global adjustment in favour of those who ‘put out’ if one really wants to address the underlying causes. Something even the most indebted consumers have shunned so far. Hence the ‘imports are benefits’ argument.
– Firms set their sticky prices at levels that assume a certain level of debt augmented demand, and real wages are set too low. –
Firms set their prices at whatever level they can get away with regardless of where demand comes from, and lobby to make sure they don’t have to pay higher wages.
Nick R,
Not an Austrian economist by any chance are you ?
“Fiat money combined with the perception of endless debt will be abandoned. Money is abandoned due to expectations of inflation. It has been the case since since the Northern Sung Dynasty’s paper money became nearly worthless (80 years after it was introduced) during the Mongolian invasion in the early part of the 12th Century.”
Actually that sounds more like fiat money has been and will be around for a long time – but the structure of our societies is what cannot be taken for granted – money is a representation of the value people perceive as reflected in their society. Lose confidence in the society, money (regardless of the form) has no meaning. New society, new fiat currency. Same song, new tune.
Sorry Alan, but why would you ask? Would that automatically discredit me? MMTers have a strange tendency to demonize people and policies that they dislike. Deficit Terrorists and Democratic Repression and all that. Maybe it comes with the territory. One has to be a bit tone deaf to political reality to believe in the plausability of endless deficits.
Austrians have something right. Markets matter in the long run. And distortions occur when they are ignored. So consider me Von Mises II if you are so inclined.
But, since you asked, I view the neo-Austrian call for hard money now at all costs as the opposite of MMT’s call for endless soft money. Both views are, to me, deeply flawed, but for very different reasons.
Am i supposed to say Cheers here, or will Kool-Aid (kool aid?, coolaid ??) suffice?
Pebird….you mean “same Sung different tune”.
Fiat money bascially dissapeared for a few hundred years after the ancient Chinese experiment. It has having an especially rough time over in North Korea at present…..people just aren’t taking to those endless “People’s Life Bonds” after the recent bout of hyperinflation. But that is not supposed to happen with unconstrained countries experiencing unemployment and an output gap regardless of how peripheral they may. Oops. Never Mind.
“Markets matter in the long run”?!
Is 30000 years a longer run than 30 years or not? I wonder how human civilisation managed to muddle through for so long without a magic hand of markets. Invented wheel, agriculture, computers, internet, nuclear power and so on. So what is so special about markets that does/did not allow human civilization to evolve? Markets do not matter unless you decide to give them power and then believe it matters to you in any run.
Nick,
I think your worries about Japan’s “unsustainable” debt are overblown. I would not waste a minute on that issue. Japan’s problem has a name and that is “Amigo-Capitalism”. Politicians and Business conspire since more than 20 years against the public good. The private sector of Japan is sort of two-tier capitalism. International and successful companies like Sony and Toyota for economic window-dressing and local companies (banking, insurance, construction, retail, …) looking for public hand-outs and protection courtesy of some politicians.
Now what about terms like “Deficit Terrorists and Democratic Repression” which seem to upset you. I think they are completely appropriate. Let’s have a short look at my current host Germany. They want to save 80 billions over the next 4 years. Fine. Where do they start looking for savings? I.e. heating subsidies for the poor in winter or children subsidies for unemployed living on meagre Hart IV. And for what? To satisfy the bond market who even not asked for this crucifies yet?
Grigory Graborenko wrote:
”
MMT has credibility because it analysis the effects of aggregate stock flows and accounting identities that are true by definition. It’s more observation than proscription. It doesn’t matter what people think or do, public deficit will *always* equal private surplus.
”
Could you please explain what you mean by “public deficit will *always* equal private surplus.
“” ? Let’s define the terminology first: “public deficit” and “private surplus”.
Thanks.
VJ
Nick, it’s a circular argument because you seem to insist that fiat money *will* inevitably collapse because of expectations, not that it could. You assume that the inevitability of it’s collapse is so well known and understood that people will eventually freak out despite the fact that most of them don’t even realize we *have* a fiat currency. Even if all these investors did have this incredible insight, wouldn’t the knowledge that it’s a self fulfilling prophecy stop them from behaving irrationally? On top of that, if they all fled the yen, where would they go? Are there any countries with a gold standard anymore?
MMT does NOT advocate “endless” soft money. It acknowledges that we already have soft money, and suggests we would get better results with higher flows in the right areas.
This idea that money needs to have some kind of intrinsic value makes no sense. Money is just a universally agreed upon medium of exchange. It’s a metaphor for goods and services. You talk about collapse as if people would stop working and factories would disappear overnight. Money is nothing more than a social compact, a promise, trust in a nation. Faith in civilization is what keeps faith in money going. That, and state power to collect taxes!
I’m curious as to what your preferred currency system would be.
VJ Kumar: My apologies, I assumed most people here are familiar with the blog and it’s concepts.
Public deficit being (government expenditure – government revenue)
Private surplus being (revenue from government – taxes)
If you want to split internal and external sectors, a private surplus would be (revenue from government – taxes + exports – imports)
These are all stock flows.
Since governments don’t have much control over trade balances, their discretionary fiscal stance is the best macroeconomic lever they have.
Austrians have something right. Markets matter in the long run. And distortions occur when they are ignored. So consider me Von Mises II if you are so inclined.
Right, and that’s exactly why I think Abba Lerner and Bill Vickrey’s market anti-inflation proposals are so useful.
“Prof. Vickrey proposes a penalty tax on excess markups, as a means of containing inflation. Starting from a proposal by Prof. A. Lerner to develop “a market in rights to raise prices, with those wishing to raise prices being permitted to do so only by purchasing the right from others willing to lower theirs to a corresponding degree”.
http://www.monetary.org/smudget.htm
Beowulf,
Vikrey’s market in rights to raise prices is fascinating. I never heard of this before. It reminds me of Warren Buffet’s proposal to create import certificates, only it is more radical.
http://www.freerepublic.com/focus/news/1053684/posts
Nixon’s wage and price controls failed, and one can envison many practical problems in implementing Vickrey’s idea….Also agency problems, information asymmetry, arbitrage inefficiencies, etc. It would also severely distort capital formation. And, of course, we don’t have an inflation problem at present. Still it is very creative and interesting. Thank you.
Grigory, my preferred money system is fiat money –not specie backed currency –but fiat money controlled by enlightened policymakers who recognize that the nature of this money gives them an especial obligation to preserve its purchasing power.
That is my preferred system, but the teachings of MMT make me fearful of its extreme possibilities.
Grigory, if you are Russian you will appreciate this paraphrase of Ivan in Dostoyevsky’s “Brothers Karamazov”, “Without hard money all things are permissable”. (Notice I didn’t quote Rasputin).
Nick R,
Could be a bit of a wait for the enlightened policy makers. Most of the grubs in this country controlling the top end would sell a rats arsehole to a blind man as a wedding ring.
Grigory Graborenko:
I am a newcomer and the previous message is my first one here.
Anyway, let Y be gross national product, PC – private consumption, PI – private investment and G government expenditure. Ignoring taxes (because they will just subtract from both sides of the expression below) and foreign trade for now, we have the following:
Y = PC + PI + G
If I understand you correctly, you just stipulate that G is private saving. I am not sure how such stipulation/labeling translates into actual household savings. Could you please elaborate ?
Thanks.
VJ Kumar,
Private Savings : S
Private Investments : I
Gov spending : G
Gov Taxes : T
In a closed economy,
S – I = G – T.
That’s fairly intuitive, if S – I >0 , that amount must be invested somewhere else : buying bonds, hence the gov must run a deficit by an equal amount.
P,
You are right that the determinant of wage income is key here. If wages were always equal to the MPL, then there would never be any problem with endogenous demand, except possibly for sticky prices, and in that case you just supply the private sector with whatever assets they need for full employment.
The point is that the MPL of an individual worker is indeterminate when you are talking about large groups of people working together to obtain a single revenue stream. Aggregate productivity is a function of the combinations of people and so each person’s MPL is ambiguous. In that case, the net result is that wages are first assigned to roles and then people fill the roles, rather than having each individual’s MPL determine the wage. It is “Role Based Compensation”. In that case, how much of aggregate profits is captured by each role is the result of power relations at the micro-level and the mismatches are externalized, leading to aggregate demand failures, and due to the possibility of debt growth, may not reveal themselves until a much later time.
I think in the U.S. what happens is that “worker aspirations” have been such that median wages rise to keep up with payment necessities and the top roles seize the surplus. In that environment, falling rates means that households can spend more with the same payments, and therefore they do not force wages higher even as their ability to purchase a share of output out of their wages shrinks. It’s difficult to escape from this trap.
This is not an economic theory, and I’m not trying to define a model here. But there is anecdotal evidence that the growth in household indebtedness tracks the lost purchasing power of the middle class. This isn’t meant as a proof, but the evidence is suggestive.
Richard Koo was mentioned a cple of times here. Let me quote from his book, p.77
More than Y25T of excess reserves was pumped into the banks under the QE policy. Banks may lend money against reserves, but only about Y5T in reserves is actually required by law to sustain the current money supply and loans outstanding. Consequently, the additional Y25T in reserves could potentially support a money supply 6 times as large as the existing one. A 500% increase in the money supply translates into a potential 500% increase in the price levels. … A CB charged with keeping inflation in check cannot countenance such as scenario.
Seems to me he needs to take the Saturday Quizz.
“A 500% increase in the money supply translates into a potential 500% increase in the price levels.”
You would think at this point in time someone would realize that using increased income to reduce debt levels would not increase prices – although it might piss off some bankers.
Wasn’t it Andrew Mellon who said “in a crisis assets return to their rightful owners.”
Nick R:
“It has having an especially rough time over in North Korea at present…..”
If North Korea is your example of the failure of the fiat currency system – then by all means go ahead and post away – you won’t get any rude criticism, but neither much attention.
But please explain how to use any commodity as a backstop for currency without an ethical state, which is the only criticism against a fiat currency – political not structural.
Austrians don’t believe in social trust – yet it is impossible to construct a monetary system without it. They don’t really want to accept personal responsibility – they believe if all things are permissible, they will succumb to the temptation. Hence, they construct a fetish god of gold – but they only deceive themselves.
“Consequently, the additional Y25T in reserves could potentially support a money supply 6 times as large as the existing one. ”
It’s actually this part that I think is wrong.
Nixon’s wage and price controls failed, and one can envison many practical problems in implementing Vickrey’s idea….Also agency problems, information asymmetry, arbitrage inefficiencies, etc. It would also severely distort capital formation. And, of course, we don’t have an inflation problem at present.
No, there isn’t an inflation problem at this time, but you don’t start digging a well when you’re thirsty. When an economy is at full-employment, any additional government spending will be inflationary, but even before we’d reach that point, inflationary expectations become a self-fulfilling prophecy. So a Vickrey markup warrants market that internalizes inflation costs would enable us to reach full employment without the command and control system that worked so effectively (but obtrusively) during World War II for Ken Galbraith at the Office of Price Administration. Actually, Nixon’s first job in Washington was as a junior lawyer at the OPA. Nixon’s later wage and price controls failed only in so far he wasn’t willing (or was politically unable) to go full-on Galbraith in their reach and scope.
And yes, the practical problems are an issue. I guess we’ll have to wait until some genius economist comes up an auction theory that could provide Treasury an efficient yet equitable way to create a financial market that provides socially desirable incentives. And THAT son of a gun will win a Nobel Prize…. Oh wait,
The Royal Swedish Academy of Sciences has decided to award the Bank of Sweden Prize in Economic Sciences in Memory of Alfred Nobel, 1996, to Professor James A. Mirrlees, University of Cambridge, U.K. and Professor William Vickrey, Columbia University, New York, USA, for their fundamental contributions to the economic theory of incentives under asymmetric information…
An essential part of William Vickrey’s research has concerned the properties of different types of auctions, and how they can best be designed so as to generate economic efficiency. His endeavors have provided the basis for a lively field of research which, more recently, has also been extended to practical applications such as auctions of treasury bonds and band spectrum licenses. In the late 1940s, Vickrey also formulated a model indicating how income taxation can be designed to attain a balance between efficiency and equity… Vickrey’s analysis has not only been momentous for the theory of auctions; it has also conveyed fundamental insights into the design of resource allocation mechanisms aimed at providing socially desirable incentives.
http://nobelprize.org/nobel_prizes/economics/laureates/1996/press.html
RSJ,
Yor discussion about wage assignment to roles in production and the inability to determine MP per worker and time is something I AGREE with and have pointed out in my comments in this blog and in my models with indirect employment (also stressed by PostKeynesians). However, wage aspirations have another aspect to deal with and this is identity (Akerlof, Kranton 2010). Identification in my work is to determine value for the identity seeker and this helps determine aspirations that can very well differ from market valuation of the job to be performed. This spread, an outcome of the conflict of values can be persistent and if we also assume imperfection (whose sources including asymmetry and in simple terms I have presented in comments here), then it is more consistent for money wages to be set by worker aspirations and real wages by firms that set prices. Workers search by money wage aspiration and firms form vacancies which they fill in response to product demand and the real wage.
As about the growth of household indebtedness you are correct about the loss of purchasing power but also the propensity to compensate for any loss of income given aspirations( It is like an “expected shortfall” concept with a probability of aspiration maintenance). This is, of course, bounded by their finacial leverage.
As about
Bx12:
1. What you show(s-i=g-t) is just an identity that does not clarify the savings/deficit picture much — there is no causality implied:
the household can choose to forgo buying the latest flat screen TV and increase its investing/saving potential
without any need for the government increase in deficit given constant Y (GDP)
2. Your government bond example is not correct: “buying bonds, hence the gov must run a deficit by an equal amount.”:
buying bonds is neutral in the accounting sense: the government asset(household cach) cancels the liability (government borrowing). Hence, no deficit spending.
3. The household may choose to buy gold or invest elsewhere, i.e. no need for the government running extra deficit to realize the household desire to invest.
Are there any more compelling examples of the government running the deficit other than making Wall Street bonuses bigger ?
Thanks.
VJ
Dear VJ Kumar at 6.37:
Bx12 correctly understands the underlying monetary operations of a fiat currency system which lead to the inevitable conclusion that a government deficit (surplus) equals the non-government surplus (deficit) $-for-$, without question. Underlying that identity are behavioural forces in all sectors which work to deliver that accounting reality. Sorry!
You said:
I suggest you go back to first principles to really get on top of the underlying forces in the monetary system. For example, suppose the government ran a surplus, what would be happening to the stock of financial assets held by the non-government sector denominated in the currency of issue? Once you answer that question correctly, then the answer to your question becomes obvious.
I suggest you read the following blogs – A simple business card economy – Barnaby, better to walk before we run and Some neighbours arrive.
Then study this suite of blogs – Deficit spending 101 – Part 1 – Deficit spending 101 – Part 2 and Deficit spending 101 – Part 3
best wishes
bill
bill:
The “accounting reality” is nothing but a trivial algebraic term shuffling of the original GDB identity: y = c + i + g restated
as (y-c-t) – i = g – t. Then, it is stipulated that the private sector _must_ hold government paper
(t-bond or currency), in addition or possibly instead of investing in the private sector, causing the government to print such paper.
But, there is no _must_, the private sector may choose to invest entirely into itself or may choose to support interesting
public projects.
“For example, suppose the government ran a surplus, what would be happening to the stock of financial assets held by the non-government sector denominated in the currency of issue?”
Well, that’s a trivial question: the investment ability of the non-government sector will clearly be depleted due
to overtaxation. However, not everything is lost: it is easy to imagine a sequence of treasury accounts
with the central bank through which the tax money can be diverted to worthy projects of the government’s choosing.
Whether or not the government would be better decision maker of how to invest extra funds
is open to dispute of course.
Likewise, with the deficit spending: the private sector savings in the shape of the government IOUs( either currency or
government bonds) does require a compensating deficit caused by printing the government paper. As I wrote earlier, people
can however choose to invest into factories or just hoard gold instead of hoarding public paper thereby not needing
the government to run a deficit.
Thanks.
VJ
Dear VJ Kumar at 11:18
You said:
Certainly, and then the private domestic balance will record a deficit (or a movement to deficit) and the public balance will be in surplus (or moving towards that) – and all that will be driven in a behavioural way by income adjustments via aggregate demand.
The national accounting identities cannot be violated.
best wishes
bill
bill:
‘deficit’ is not a swear word regardless of whether you talk about public or private deficit — the situation is more or less symmetrical.. There is nothing inherently bad about choosing to invest in the private sector rather than keeping public paper
under the mattress. Yes, you will have less government paper and therefore may run a deficit(or more likely will
run a lesser surplus) as measured in government IOUs. But, so what ? It’s just an investment decision which may be good or bad depending on the circumstances.
In a way, choosing to keep government obligations (and thus possibly running a surplus of such obligations) amounts to letting
the government decide as to where invest instead of making such investment decision on your own.
Thanks.
VJ
VJ Kumar, so what? If private sector can not decide on how and where to invest then government will decide and support the demand in the economy. And by the definition if you do not spend your cash and keep it in your wallet you increase demand for government “paper” which it must print to fill the leakage up.
Sergei:
“VJ Kumar, so what? ”
Precisely. I just do not see why having a surplus in government obligations is presented as being good without qualifications (at least, no one mentioned those qualifications in the current thread) — that’s a very simplistic point of view.
“you increase demand for government “paper” which it must print to fill the leakage up” — it does not follow from the mere fact of having
a positive current balance expressed in currency or T-bonds, there is no causality, such a balance may go up or down depending. on
the investment opportunities.