When facts get in the way of the story

Every day now as the Australian federal election day approaches (August 21) the calls for fiscal austerity increase and the justifications become further removed from reality. I note The Greens, who are held out as our only hope are still running their neo-liberal line that budgets should be balanced over the cycle (see Neo-liberals invade The Greens! for more discussion on that). But the US political scene is even more moribund than ours if that is possible. Even the progressives are claiming there is a fiscal crisis. The facts speak otherwise.

Always start with facts

The US Bureau of Labor Statistics released the latest payroll data (August 6, 2010) which showed that:

Total nonfarm payroll employment declined by 131,000 in July, and the unemployment rate was unchanged at 9.5 percent …

There were 14.6 million Americans unemployed (6.6 million long-term) in July. The teenage unemployment rate was 26.1 per cent. Labour participation rates have been declining since April 2010 signalling a failing labour market. Full-time employment fell overall.

The alternative BLS measures of labour underutilisation, which broaden the narrow official unemployment to take into account underemployment and marginal attachment (including hidden or discouraged unemployment) show that the broadest U-6 measure (total unemployed, plus all persons marginally attached to the labor force, plus total employed part time for economic reasons, as a percent of the civilian labor force plus all persons marginally attached to the labor force) remains at 16.5 per cent and still higher than a year ago.

Conclusion: there is not enough activity in the economy to maintain employment and labour force growth.

Reason: Lack of aggregate spending. Please read my blog – What causes mass unemployment? – for more discussion on this point.

Solution: while private demand is weak the only solution is to increase public demand via increased net spending (deficits).

Is there any other solution? Answer: not if you desire stronger employment growth and declining unemployment.

After the facts you can start to appreciate the fiction

The New York Times editorial on Sunday (July 31, 2010) carried an alarmist piece – What They’re Not Telling You – which said:

There is a lot of heated talk in Washington these days about the deficit, unfortunately little of it serious. Playing on Americans’ deep anxiety about the economy, Republican politicians have seized the deficit issue as their own – eagerly blaming the stimulus and even an extension of unemployment insurance for the problem – while denying their own culpability for helping dig this deep hole with years of irresponsible tax cuts.

This is one of those regular narratives that have been creeping into the discussion as politicians and their defenders try to disown the situation – the goal? Spread the blame for “the problem”. Which problem? That hideous deficit that Americans should be fearful of.

My understanding of the US economy pre-crisis was that the deficit wasn’t excessive prior to the crisis. Excessive here in terms of Modern Monetary Theory (MMT) refers to a point where labour underutilisation rates are at full employment. The U-6 measure was still hovering around 8 per cent from September 2006 for some months after recovering somewhat from the recession in the early 2000s.

Inflation was also not out of control and largely being driven by energy prices (that is, not a deficit-nominal demand issue).

My conclusion that the US budget deficit was hardly excessive does not mean I supported the fiscal policy position at the time. The tax cuts for the rich were unnecessary and more spending should have been directed towards job creation.

Further, one could hardly suggest that the increase in the US budget deficit since the crisis was unnecessary. To say it was the result of lax policy is not the same as saying that the budget deficit did not have to rise to combat the falling private spending.

Both statements can be true. I didn’t like the composition of the stimulus packages and while Wall Street has rebounded and now making money again, it remains clear that the benefits of the stimulus packages were biased towards those experiencing the least disadvantage.

And, the fact that U-6 doubled since the crisis began and is stuck on 16.5 per cent at present, tells me that the stimulus was not large enough. The US federal government should be increasing its deficit right now.

So the only “deep hole” I can see in the US is the gaping real GDP gap and the resulting and shocking labour underutilisation data. Which sophisticated nation thinks it is acceptable to have 16.5 per cent of your willing labour force idle in some way or another? Answer: None. Only a nation operating under the destrictive spell of neoliberalism would envisage making such a situation worse by cutting back the very thing that is maintaining growth at present.

Please read my blog – We are in trouble – squirrels are falling down holes – for more discussion on this point.

The NYT editorial continued:

The deficit’s size is alarming. In the 2010 fiscal year, the government is projected to collect $2.2 trillion in taxes and spend $3.6 trillion, leaving a gap of $1.4 trillion.

If current tax and spending policies continue, deficits are estimated to remain near $1 trillion a year for the next decade. After that they will explode – to twice the size of today’s deficit as a share of the economy by 2050 – as health costs rise and the population ages, and outlays for Medicare, Medicaid and, to a lesser extent, Social Security continue to grow faster than revenues.

We agree the situation is unsustainable. But cutting spending right now on relief and recovery efforts would worsen the economic slowdown and the suffering of millions of Americans, while making only a tiny dent in future deficits.

What exactly is unsustainable about it? The commentators regularly repeat that a certain number on paper is unsustainable but they never credibly relate their concern to anything economic or financial. It becomes a matter of – if you repeat something enough times it becomes truth.

The deficits in the US might be politically unsustainable but that just means the politicians have to work harder to explain what the deficits are doing to underpin jobs and private saving and allow the public to see through the misinformation. The problem is that the politicians spread the misinformation themselves.

The so-called “gap of $1.4 trillion” is just a reflection of the private spending gap. Budget outcomes are driven in large part by the spending decisions of the non-government sector. If there is a high rate of labour underutilisation then you can be sure that the private spending gap is considerably larger than the actual budget deficit.

In other words, the deficit has to expand if the US government is to act responsibly and increase economic growth and reduce the terrible (and costly) waste embodied in the persistently high rates of labour underutilisation.

If I was to re-write that last paragraph it would go something like this:

The U-6 measure provided by the BLS is alarming. In the 2010 fiscal year, the government is projecting that the decline in U-6 will be modest, leaving a gaping loss of income to the American people.

If current tax and spending policies continue, then there will be a very slow recovery in the US economy perhaps even a return to recession which will ensure long-term unemployment in the US reaches record levels and persists for the next decade …

We agree the situation is unsustainable. Spending should be increased and targetted towards direct public sector job creation. This is the only way the US economy will return to robust rates of growth.

There is quite a difference between the two statements.

After claiming that “the biggest items in the budget (Medicare, Medicaid and Social Security make up about 40 percent)” have to be cut to restore fiscal sustainability, the NYT editorial said:

When it comes to controlling the near – term problem – trillion – dollar deficits every year for the next 10 years – the biggest help will be a return to solid economic growth and, with that, increasing tax revenues.

Growth will not be enough. There is no chance to put the budget on a sustainable path without significant tax increases, and not just on the wealthy. Few politicians, of either party, are willing to tell that truth.

Americans are right to worry about the deficit. They must also demand that their elected representatives do more than rail about the problem and begin a serious debate about the policy choices ahead.

So you can see that they are trying to be “progressive” here by arguing that growth will help bring the deficit down but fail badly in their attempt because they do not grasp the meaning and role of the deficits.

First, the health care issue is not a problem of fiscal solvency. If too many real resources are being expended on health care to the point of waste then cost control is necessary. But that has nothing to do with the claim that the government cannot afford to maintain health expenditures.

The US government can always fund health care and buy what health care products that are available. In doing so it might be party to an incredible waste of resources – unnecessary treatments; excessive use of expensive diagnostics etc – all driven by the greed of the big health providers and insurers. But that is a separate matter altogether and will not be solved by focusing on some “deficit number”.

Second, taxes only need to increase if the government wishes to maintain its current share of spending in GDP (its claim on real resources) and the growth in nominal aggregate demand is starting to outstrip the real capacity of the US economy to respond to it with real output increases.

At present and for the foreseeable future there is massive excess capacity in the US economy – capital and labour. There is no need to regulate aggregate demand via tax increases (which reduce the purchasing power of the private sector) at present and I suspect there will be no need for some years to come.

Of-course, the NYT is thinking neo-liberal and suggesting that the taxes are used to “fund” spending and so with some rigidity in program budgets (health etc) the deficit will only be reduced by more tax funding. The reality is that taxes do not fund anything.

A sovereign government is never revenue constrained because it is the monopoly issuer of the currency and so taxes are not required to “fund” the spending.

Please read my blogs – Taxpayers do not fund anything and Functional finance and modern monetary theory – for more discussion on this point.

The NYT editorial then considers some specific issues all of which miss the point completely. They ask the question “Does the budget have to be balanced?” and say:

An economically powerful country can prudently run some deficits. A reasonable budget goal would be to reduce annual deficits to the point where the debt – the sum total of annual deficits, now $9 trillion – is no longer growing faster than the economy. Once the debt is stable, the nation would most likely avoid the worst effects of persistent deficits, including sharply higher interest rates and slower growth.

Any sovereign country can “prudently” run some deficits if the conditions are requiring them. It has nothing to do with whether the nation is “economically powerful” – whatever that means. The US is currently not “an economically powerful country” given how much labour it is wasting and the atrophying of its capital stock.

Besides, it is dependent on China for financing! (I just had to write that – it was a joke! Please note that: a joke).

I would have written that paragraph as follows:

Any sovereign country can “prudently” run deficits if there is an external deficit and the private sector is desiring to save overall. A reasonable budget goal would be to maintain annual deficits to the point where nominal aggregate demand absorbs all the available real productive capacity including all willing labour resources. A responsible government will only examine real factors and ignore financial ratios (such as the public debt to GDP ratio).

Again, there is quite a difference between the two statements.

Of-course, the NYT editorial was influenced by the latest report from the US Congressional Budget Office (CBO) which was released on July 27, 2010. This major statement – Federal Debt and the Risk of a Fiscal Crisis – has given new impetus to the deficit terrorists. The full document is HERE.

It reads like an undergraduate essay on steroids where the primary source material was Mankiw’s Principles of Economics. It is totally mainstream in its macroeconomics and delivers an almost juvenile representation of what is going on. It is as flawed as the paradigm it is working within and delivers very little insight about what the real issues are.

In the full report, the CBO says that “Compared with the size of the economy, federal debt held by the public is high by historical standards but is not
without precedent”. There was an extraordinary footnote attached to that statement (thanks Gary!):

The size of a country’s economy provides a measure of its ability to pay interest on government debt, in the same way that a family’s income helps to determine the amount of mortgage interest that it can afford. Federal debt has two main components: debt held by the public, and debt held by government trust funds and other government accounts. This issue brief focuses on the former as the most meaningful measure for assessing the relationship between federal debt and the economy. Debt held by the public represents the amount that the government has borrowed in financial markets to pay for its operations and activities; in pursuing such borrowing, the government competes with other participants in credit markets for financial resources. In contrast, debt held by government trust funds and other government accounts represents internal transactions of the government.

You can see where the NYT editorial got the “economically powerful country can prudently run some deficits” thought from.

The statement that the “size of a country’s economy provides a measure of its ability to pay interest on government debt” is without foundation. That is, it is nonsensical, meaningless and vacuous statement (where tautology prevails).

A sovereign government of any size economy can always pay interest on government debt. They simply credit a bank account with the required income flow as they would do for any spending operation. The only issue is the sovereignty which requires the government has the monopoly over the currency issuance.

But the CBO’s ignorance (or culpability) is clear when they try to invoke the household-government budget analogy. I almost laughed when I read this. If this was given to me by a macroeconomics student (of any undergraduate or postgraduate level) as part of their assessment I would advise them to leave the course immediately after giving them 0/100.

For a government agency to be pumping out this absolute rubbish – it beggars belief. It shows how far the erroneous neo-liberal ideas drawn from error-prone and inapplicable macroeconomics textbooks have penetrated.

To repeat what I said yesterday (operating under the principle if something is said enough times it becomes ingrained) – there is no possible parallel that can be drawn between a household budget and the budget of a sovereign government. Mainstream macroeconomics starts with this flawed analogy between the household and the sovereign government as a means to justify the imposition of fiscal discipline on the government.

They argue that any excess in government spending over taxation receipts has to be “financed” in two ways: (a) by borrowing from the public; and/or (b) by “printing money”. They claim the second option is always inflationary so deficits have to be funded via debt-issuance.

Neither characterisation is remotely representative of what happens in the real world in terms of the essential nature of the operations that define transactions between the government and non-government sector.

Further, the basic analogy is flawed at its most elemental level. The household must work out the financing before it can spend. The household cannot spend first. The government can spend first and ultimately does not have to worry about financing such expenditure.

The CBO want us to construct public debt as the “the amount that the government has borrowed in financial markets to pay for its operations and activities” whereas in fact the opposite is true.

The debt is in fact an expression of the specific way in which we choose to hold the financial wealth that has been permitted by the deficits. Government spending is not constrained by debt issuance. The government never needs to issue this debt. It does every one a favour by offering us a risk-free annuity. Please read my blog – Market participants need public debt – for more discussion on this point.

Further, the government provides the financial resoruces that it borrows back. There are no finite savings available that government and private agents compete for. The CBO choose to perpetuate the mainstream textbook myth of crowding out. They should have done the quiz last week. Please read my blog – Saturday Quiz – August 7, 2010 – answers and discussion – for more discussion on this point.

In the CBO Director’s blog which summarises the Report you read:

In fiscal crises in a number of countries around the world, investors have lost confidence in governments’ abilities to manage their budgets, and those governments have lost their ability to borrow at affordable rates. With U.S. government debt already at a level that is high by historical standards, and the prospect that, under current policies, federal debt would continue to grow, it is possible that interest rates might rise gradually as investors’ confidence in the U.S. government’s finances declined, giving legislators sufficient time to make policy choices that could avert a crisis. It is also possible, however, that investors would lose confidence abruptly and interest rates on government debt would rise sharply, as evidenced by the experiences of other countries.

Unfortunately, there is no way to predict with any confidence whether and when such a crisis might occur in the United States.

The number of countries around the world is a very small number and they are all economies where the government is not sovereign. Pity they didn’t mention that. In all the advanced nations where the governments have not ceded their currency authority bond yield are low and stable if not falling. There has been no auction dramas and all of those that I see data for are oversubscribed each time a tranche of public debt is issued.

This CBO statement is thus a lie! The officer who wrote it should be dismissed.

There is also the possibility that interest rates will rise and that this will reduce aggregate demand via the balance between expectations of future returns on investments and the cost of implementing the projects being changed by the rising interest rates.

MMT proposes that the demand impact of interest rate rises are unclear and may not even be negative depending on rather complex distributional factors. Remember that rising interest rates represent both a cost and a benefit depending on which side of the equation you are on. Interest rate changes also influence aggregate demand – if at all – in an indirect fashion whereas government spending injects spending immediately into the economy.

But the crowding out story is not remotely correct. The interest rate rises may reflect the fact that central banks push up interest rates up because they believe they should be fighting inflation and interest rate rises stifle aggregate demand.

Then you see the CBO fuelling the fire a little with the “It is also possible … that investors would lose confidence abruptly” and that “there is no way to predict with any confidence whether and when such a crisis might occur in the United States”.

Has a crisis like this occurred in the past in the US? Answer: No! So why even hint that it “might happen”?

Will there be a fiscal crisis in the US? Answer: No!

And finally today there was this story – Republicans see balanced budget amendment as potent campaign weapon – published by The Hill, which is owned by some multi-millionaires (the Finkelstein family).

The report says that:

Senate Republicans are planning a new push for a balanced budget amendment to the Constitution when lawmakers return to Washington after the August recess … The amendment would bar the federal government from spending more than it collects in revenues each year. It would also require a two-thirds majority vote in each chamber to raise taxes.

You can imagine that if this becomes law then the US unemployment rate would be more than double what it is now. If that much spending (the deficit) had not have entered the economy then the US would look much grimmer than it already does.

A significant portion of the US deficit is being driven by the automatic stabilisers. So a balanced budget rule would force the discretionary component of the budget to become highly contractionary at the same time as private spending was collapsing.

Just look at the plight faced by American states at present because of their balanced budget limitations. It is clear that the cut-backs that the States have been making have undermined the federal stimulus – Please read my blog – The old line back to free market ideology still intact – for more discussion on this point.

But if the federal government had have been forced to follow suit the US economy would have entered a depression of the same scale as they endured in the 1930s.

Imposing any sort of rule on fiscal policy reflects a lack of understanding of how the monetary system operates and the role that budget deficits play in the expenditure stream. It also represents a failure to comprehend the link between spending and jobs and prosperity.

Please read my blog – Fiscal rules going mad … – for more discussion on this point.


Some serious educational failures are apparent in the public debate.

That is enough for today!

This Post Has 34 Comments

  1. What’s going on in Australia? Over lunch I read an article in “Der Spiegel” that the government of South Australia tries to lure people to come and work there with some interesting jobs: Shark-Counter, Koala-Bear-Catcher, … Unfortunately I can not apply because the offers are limited to British nationals aged 18-30. (That’s racist and age-discriminating!) Otherwise I would be very happy to work as beer-tester for the South Australian government. Here’s the link (in German): http://www.spiegel.de/wirtschaft/soziales/0,1518,711112,00.html

  2. While the reasons given and the conclusions drawn in the CBO report is completely flawed, the scenario presented is very much possible. The scenario I am talking of is that of the public debt hurtling toward 200 per cent of the GDP. And I believe that

    It is also possible … that investors would lose confidence abruptly

    throwing the world economies into a turmoil.

    Q: Why is Ramanan sounding so neoclassical ?
    A: Of course, not!

    The currency markets can become nervous about the growing public debt to gdp ratio and the dollar can fall without the Chinese having to dump the US Treasuries. I may hold 50% of a company’s stock, but its stock price can fall without me having to sell it. A nation cannot expect kisses and hugs from the currency markets if it is endemically running a trade deficit.

    This is a criticism of all the MMT positions about the monetary system. The Master John Maynard Keynes once said that according to Lenin there is no surer way of overturning a nation than to degrade her currency. And I think the MMT policy and proposals add cracks to the foundations of growth. I hope nobody takes it the wrong way. This is in no way a criticism of the job guarantee proposal, however.

    I have gone through the MMT blogs and literature in detail and know every argument that one can present to argue against me. Arguments such as “public debt is just a number” work only in the case of an closed economy. Also arguments such as “fixed exchange rate paradigm” completely divert the debate. Money is neither exogenous in a gold-standard regime and is nor so in other setups such as currency boards either. Government still spend by crediting bank accounts when the government transfers funds from its account at the central bank.

    It’s really enlightening to go back to good old accounting and then look at national accounts to find out that a nation can be a debtor in its own currency. Fixed exchange regimes just increase the financial fragility – borrowing Minsky’s phrase. But a nation found to be debtor from national accounting is still a debtor! It is equally enlightening to think of governments ‘borrowing’ from the private sector and the private sector ‘financing’ the government borrowing. And so is to think of taxes as funding government expenditures. It really happens that way. When taxes are paid, the funds are transferred to the government’s account at the “independent” central bank. I know the lateral way of thinking of taxes being “destroyed” but it doesn’t happen it that way. One can just say “You know what its as if the taxes left the system” instead of taking it literally and insisting on it.

    Of course the IMF made some nations borrow in foreign currency. But who promised you a rose garden ? Its an irony but a rule of nature – the debtor must borrow and agree to the terms and conditions and the creditor is under no such compulsion as JMK put it.

    Yes this comment is about international trade and trade deficits. Nothing wrong with trade deficits. We all like enjoying each others excellent products. Its human nature to come together and do business with each other and travel and explore the world.

    MMTers tend to think that nations borrow from foreigners in the fixed exchange rate regimes but do not borrow in the floating exchange rate regimes. Where did that come from ? The current account deficits is a deficit and needs to be financed. By hook or crook. In the case of the US, it happens automatically. Doesn’t happen with other nations. Plus trade deficits are not caused by the net saving desires of the foreign sector. Such a thing has no meaning. I desire to save $2T – does the US then run a current account deficits north of $2T ? Its a supply-sider argument. It requires incredible deep thinking to figure out supply factors to build a story which has demand-led dynamics and keep track of supply side factors. Similarly it does not make too much sense of talking about a net saving desire of the private sector. Its more appropriate to talk of the propensity to save. In fact as JMK said “Clearness of the mind is reached … propensity to consume”

    That brings me to the most interesting question “how can a nation be indebted in its own currency?” Of course it can be – it follows from the rules of accounting. One can summarize it this way: For a closed economy, income = expenditure. While it is true for the nation as a whole, it is not true for individual sectors. For some sectors to be in surplus, there should be atleast one sector in deficit. Similarly if one talks of stocks instead of flows, it is not difficult to see that one sector should be indebted to the other sectors till the stars all burn away. And since only the government has this ability, this sector should be the one. These quantities are changing all the time – what should the public debt be headed over time. The answer is anything which is consistent with full employment and price stability. Currency or money is the implementation of these abstract thoughts. Nothing new till now. However, if a government’s debt keeps increasing without limits, back to my point about punishment by the currency markets. Its easy to see now how interest paid to foreigners is a burden even though interest income paid by the government to its citizens is not! Its easy to say that the government “credits the bank account” and hence it is not a burden. However such arguments do not recognize what is happening in the other sectors. It also assumes that there is no upper limit to the public debt/gdp ratio. There may be none in the case of a closed economy (though it works out it doesn’t rise forever), there is in the case of open economies – the world we inhabit. Its easier to see it if one takes the view that taxes fund the government expenditures. Even if one insists that taxes do not fund anything and its “gold standard paradigm”, it doesn’t prove much. A trade which is unbalanced for long leads to increased government spending and leads to the public debt increasing faster than the national income. And precisely when high deficits are needed – the currency markets will be out there to ruin you! It also brings me to a point about “floating currencies”. A nation can do a managed float by adjusting its interest rates and more explicitly by having its central bank intervene in the fx markets on a daily basis. However, it is forgotten that there is an implicit adjustment – through international trade and fiscal policy. If currency markets are there to kill a nation for being indisciplined with international trade, then a nation necessarily need to go into austerity, whether MMT prescribes such solution or not. We are then back to discussions around how silly it was for the nation to issue debt in foreign currency, forgetting the fact that the debtor nation is the debtor and the creditor is under no such compulsion. Can MMT bail the nation out ?

    I have commenting on various occasions recently here and at WM’s blog. I have also detailed the dynamics which happen when a debtor nation runs into such troubles, only to be told that “we are not convinced with the PKists”. I suggest write a journal article finding loopholes in such arguments instead of merely stating that those arguments are in the fixed exchange rate paradigm – which they are not!

    I am afraid, I do not believe that a debtor nation can keep crediting bank accounts of its creditors forever and I genuinely think that one can run into a fiscal crisis – and I am standing on the shoulder of giants!

    There are of course solutions – such as talking concerted efforts and coordinated action and figure out new ways for nations to trade with one another. Fiscal policy will then come out to be the winner!

    PS: A lot is to do with the question “What is Money” – my answer – its an IOU whose value is determined in the currency markets.

  3. @Ramanan

    No need to hyperventilate. First FX markets are mostly wrong. The best way to deal with them from a MMT perspective is to simply ignore them. Second living in Germany I can assure you that in regard to X-M the only party who must constantly worry is the one who accumulates IOU. This is the favorite pasttime of the German private sector. Greece has some nice submarines and Germans have some IOU. Who’s better off?

  4. Ramanan: That’s a bit of a ramble from the usually lucid Ramanan! I think most of your concerns would be answered if you grasped the point that the extent to which the idea “debt” is applicable to money and national debt is very flexible and debatable.

    For example, money (or monetary base to be more exact) is in theory a debt owed by the government central bank machine to holders of said money. (U.K. £20 notes actually say “I promise to pay the bearer the sum of twenty pounds”). But the latter “promise” is complete nonsense. There is no possible way I can get anything from the British Government for my £20 notes.

    Or in the words of Willem Buiter, “These monetary (base money) ‘liabilities’ of the central bank are not in any meaningful sense liabilities, because they are irredeemable.”

    Plus all you’ll ever get from governments for national debt is the country’s currency. And in exchange for that currency, the government will give you nothing! So, to what extent is “national debt” a debt???? It’s a moot point.

    Money is simply units which the population generally agrees to be an acceptable medium of exchange and measure of value. It gains additional backing from the fact that government can demand payment of taxes in the relevant units (though some, e.g. I suspect Warren Mosler, would argue that this “tax” backing is the SOLE reason that money has value).

    Re your claim that there is a limit to how much money a government can create, my answer is that there is no limit as long as people are willing to hold such money. Indeed, governments MUST create additional money if people want to hold it, else you get “paradox of thrift” unemployment.

    Re your claim that the value of a currency is determined by the forex markets, the forex value of a currency is determined that way. But that is quite different to value of a currency WITHIN a a country. The latter is determined, to repeat, by the willingness of natives to hold the currency.

  5. Ramanan,
    You certainly sound disillusioned with MMT! But it could never solve everything.
    With respect to the foreign sector, my understanding of MMT is that it allows a country to fully employ its internal resources but that doesn’t mean the foreign sector could not be problematic. To import a country must still export to earn foreign currency to pay for its imports since it does not issue the foreign currencies. If it earns insufficient amounts to cover off all imports it can still import as long as foreigners are prepared to accept payment in the deficient currency. The drop in the value of the currency on foreign exchange markets expresses the loss of desire by foreigners to accumulate the deficient currency. However internal resources can still be fully employed.

    If the government deficit required to fully employ internal resources results in large net imports, the currency will decline. Import prices will presumably rise, lowering the quantity of imports and making people who buy them less well off. Compensating there will be full employment so many people will be better off. One can infer it is the less well-off who will benefit the most from this process. If it is basic foodstuffs that are being imported this may not be the case but this is an issue of politics and organisation.

    When foreigners accumulate your currency they have the option of demanding goods and services or buying assets in your country and that is a real cost. However as Warren M points out it is your country and your currency and you set the conditions for the sale. You may not even allow it at all. Of course you run the risk that foreigners may no longer want your currency in that case so there are limits to the restrictions that can be imposed.

    The United States gets a free ride to a large extent under the current regime of fiat currencies. It faces far fewer of the constraints every other country does because it supplies the world currency (see MMTers stuff and Michael Hudson’s superimperialism). Warren M. understandably focuses on the United States so in my opinion some of what he writes cannot be easily transferred to other countries, especially the less economically developed ones. There were definitely greater constraints for the US under the gold standard. When France demanded payment in gold for its US dollars in the 1960s the US put an end to the gold standard because it would have eventually run out of gold entirely.

    With respect to MMT and the functioning of monetary operations I think you would need to be more explicit in your criticisms. As far as I have been able to determine from a variety of readings in the literature and on central bank websites MMT accurately describes current central bank monetary operations and the consequences of these operations. Whether MMT descriptions of the functioning of the former gold standard within countries is entirely accurate is another issue but one that is not particularly relevant today in my opinion.

  6. In defense of Ramanan, he has been investigating this for some time and has brought some interesting points to the table in previous posts. I believe that he has legitimate questions. They are not unique to him, although he has ferreted them out.

    A basic question is over the contention that floating rates function automatically to adjust currency relationships without creating “stress” that can manifest in a variety of ways. “Stress” is intended here in the broad sense of economic, financial, or political difficulties. Ramanan has specified previously that he regards this eventuality as unlikely in the case of a country like the US in the near term, but it is a constant concern of more weakly positioned countries, which have to obtain foreign reserves to pay for vital imports, for example, and therefore they have to defend the exchange value of their currencies. Consequently, their internal policy is limited by external concerns even though they may be monetarily sovereign issuers of a nonconvertible floating rate currency.

    I have also questioned whether fx markets adjustments are always automatic and orderly. This seems to me to be akin to the neoliberal assumptions about “free” markets clearing seamlessly. This is basically the neoliberal claim about “free” trade and “free” capital flows being guided by “the invisible hand” of the market.

    I am not claiming that adjustments aren’t always automatic, but it seems to be a theoretical assumption that they are, since it is neither contradictory to hold that they are not, nor a tautology to hold that they are, at least as far as I can tell. What is the justification for these assumptions? The international asepct of MMT is something that I don’t understand sufficiently and would appreciate an explanation, or being pointed to a reference.

  7. Ramanan,

    The ECB released a report not that long ago titled: Chronicle of currency collapses: re-examining the effects on output, by Matthieu Bussière, Sweta C. Saxena, Camilo

    The following is a short abstract of the report.

    The impact of currency collapses (i.e. large nominal depreciations or devaluations) on real output remains unsettled in the empirical macroeconomic literature. This paper provides new empirical evidence on this relationship using a dataset for 108 emerging and developing economies for the period 1960-2006. We provide estimates of how these episodes affect growth and output trend. Our main finding is that currency collapses are associated with a permanent output loss relative to trend, which is estimated to range between 2% and 6% of GDP. However, we show that such losses tend to materialise before the drop in the value of the currency, which suggests that the costs of a currency crash largely stem from the factors leading to it. Taken on its own (i.e. ceteris paribus) we find that currency collapses tend to have a positive effect on output. More generally, we also find that the likelihood of a positive growth rate in the year of the collapse is over two times more likely than a contraction, and that positive growth rates in the years that follow such episodes are the norm. Finally, we show that the persistence of the crash matters, i.e. one-time events induce exchange rate and output dynamics that differ from consecutive episodes.

  8. Dear Tom,

    Well put about internal policy being limited by external constraints especially for strategic imports. Your defence of Ramanan is thoughtful and his concerns legitimate especially about external debt in a foreign currency. Regarding what can bail a foreign debtor out, there is still restructuring/rescheduling of debt which is not default but a step prior to default especially if the sovereign debt is not backed by collateral that counter parties can attach and the sovereign debtor has an advantage! If creditors have marked to market the restructured debt then any losses are already discounted and the parties can come to a settlement.

  9. Unbelievable!!!

    Too many people that want jobs cannot find them because the jobs do not exist. Governments have the ability to fix this problem using fiscal policy but are refusing to do so.

    That is the problem. That is the issue. That is what people bneed to focus on.

    A person that wants work but cannot find it could care less about the rate of inflation or how the market reacts.

    More perspective please.

  10. Keith,

    Thanks for your thoughful response.

    Of course, I am not raising issues about the MMT description of central banking operations. Scott Fullwiler has written detailed papers on the working of the Federal Reserve and are really nice to read.

    It is when the government finances enter the game, which I am talking of. Not only the operations but the way it is presented. Its alright if the economy is closed – however in the case of the open economy, there are some complications. Here is something from McCombie and Thirlwall’s 1994 book Economic Growth and the Balance of Payments Constraint

    It has been argued by some commentators that there is no need to be concerned about the current account deficit since the level of overseas borrowing is now determined by the private sector on the basis of commercial calculations about the costs and benefits of such a course of action. The only difference between borrowing domestically and abroad is that a risk premium is attached to the latter because of the volatility of the exchange rate. Any excessive borrowing overseas will be self-correcting as the cost of borrowing rises with an increasing risk premium as the deficit grows. The problem with this argument is that the resulting adjustments are neither smooth nor gradual. As the overseas debt to GDP ratio increases, the world financial markets become increasingly nervous about a collapse in the exchange rate with the consequent capital losses; once the exchange rate starts to fall, speculative actions are likely to be destabilising, leading to a rapid fall in sterling with the possibility of a vicious inflationary-depreciation circle occurring. The use of high interest rates to defend sterling has an externality effect of pushing the domestic economy into recession with adverse effects on investment and employment, even when there is existing unemployment. The Period of floating exchange rates from 1971 saw a number of spectacular examples ot the balance of payments constraining domestic macroeconomic policies. The sterling crisis of 1976 comes readily to mind, when the Labour government’s attempt to reduce unemployment in the face of excess capacity foundered on the balance-of-payments deficit and the collapse of sterling. Between early March and early June 1976, the effective value of sterling fell by a little over 12 per cent. Nevertheless, the government tried to keep interest rates low to encourage an increase in investment. As a result, sterling fell by a further 9 Per cent between early-September and mid-November. The fall in the exchange rate eventually caused a volte-face in economic policy; the minimum lending rate was raised from 9 Per cent in April to 15 Per cent in November 1976 and severe cuts in the PSBR were agreed with the IMP. Other examples include the failure of the ‘Mitterand experiment’ in 1982 at boosting growth, and the problems of the Italian economy during 1980-1981. The 1980s have also shown that even the US is not immune from pressures engendered by a balance-of-payments deficit.

    You are right about the comparison of the US with other nations. However it should be recognized that for a given fiscal policy, imports increase unemployment. This is precisely what happened in the US. The private sector grew through debt but that is not sustainable. One can argue that the US simply can relax its fiscal stance and solve all the problems. That is completely incorrect! Of course, it’s the need of the hour, considering the employment situation. However, it will worsen its indebtedness to the rest of the world! The US public debt keeps rising faster than the gdp growth if such a strategy is followed. There is no automatic mechanism to stop this process. The MMTers would say that great – imports are benefits. Its just wishful thinking that it can sustain till the end of time. Meanwhile neither do exports increase automatically if the dollar falls slowly. It is important to keep supply side factors in mind in describing a demand-led dynamical process.

  11. Ralph,

    I understand you. However, there are many angles to indebtedness. Solvency is a slightly different issue. Sustainability is another.

    An analogy with banks can be given. A bank can at any time pay its depositors, bond holders and equity holders withing restrictions. The restriction has been imposed by the regulators. In the absence, the bank can keep crediting bank accounts paying no attention to its capital adequacy and manage to borrow in the interbank market. Banks may be closed by the FDIC not because of their inability to borrow in the Fed Funds markets but because their adequacy ratios are below regulatory requirements. So banks have the ability to credit accounts ex-nihilo – say for coupon payments on bonds but these payments make the bank “indebted” and burdened. Indebtedness is slightly different from the ability to credit accounts. Banks have an upper limit in crediting account and a nation also has. If there is no upper limit, there is no burden.

    Weak analogy but my points is about sustainability – keeping in mind what’s going on in the other sectors. To highlight the fact that interest payment to foreigners is indeed a burden.

  12. Ramanan,

    I’m still having problems in understanding exactly what you’re criticizing.

    Can you point me to a particular MMT blog that says fiat currency issuers can’t experience foreign exchange crises?

    (as far as I can tell, that seems to be the implication of your criticism)

  13. Ramanan,

    I agree with your point. The West has been baited by the Chinese sending cheap cargo. It is like the reversal of the Opium wars. Deindustrialisation of the West is the name of the game. It is not enough just to keep people employed and the aggregate demand for the toys high. Once the USA loses its technological and scientific supremacy the game is over and the highly sophisticated weapons they possess will help exactly as much as they helped the USSR R.I.P. in 1991

    The key is the time lag of restoring productive capacities once the human capital and know-how is lost. It takes years or decades. Because of the looming natural resource shortages and environmental problems I dare to say that the Anglo-Saxon West has no chance to fight back at all.

    Only a massive investment in R&D related to energy efficient technologies can stop these processes. Somebody will solve these problems for sure. I bet these will be the Chinese, other Asians and maybe some Europeans.

  14. Ramanan,
    “One can argue that the US simply can relax its fiscal stance and solve all the problems” Consider:

    It can solve the current economic problems facing the just citizenry (Full Employment/Job Guaranty/Healthcare/Retirement Income Security, etc), fiscal can be used to remove the current forces that act to separate them from their spiritual needs to be creatively working to provide the means of subsistence for themselves and their families. I have confidence that the domestic sector alone can ultimately provide this.

    To your point though, I dont think it can solve the problems facing the Elites/Rentier class (these people are the ones whose interests/ lifestyles would typically put them in a position to be worried about things such as external funding, etc). And it certainly cannot solve their main problem in that they are sociopaths.


  15. Ramanan, one of central MMT claims is that imports are real benefits and exports are real cost. Hence in MMT world no country will be looking to export more than it needs to import. All trade will be balanced. No foreigners to “finance” current account deficit will be needed. So what you are actually trying to argue with is the neoliberal world superimposed with MMT implications and then you make claims that this combination can be unsustainable. Yes but nobody actually is trying to build such world.

    Besides, pure fx-speculation can and should be treated in the same way as any other speculation, i.e. taxed out as unproductive activity. Current system is a failure and should be fixed.

  16. Its about currency crisis and not about currency crisis.

    Policymakers of a nation will keep the possibility of future scenarios in mind and act accordingly. One of the possible future scenario for a nation is the a crisis in the external sector.

    This is because when there is a fiscal expansion, the trade deficit is likely to widen. Imports are proportional to national income. If the government tries to boost demand, imports increase, widening the trade deficit. This increases the nation’s indebtedness. If the currency devalues due to market forces, exports do not increase automatically because it is a supply side factor – the nation’s productivity and competitiveness. Just because it is cheaper in the other country’s currency does not mean that they will buy it. It depends on what the demand is in the other nation and their decisions to import. They will not buy it simply because it is cheap. Of course, it doesn’t mean that I am saying that price has no effect.

    If the currency does not depreciate, the nation is still in current account deficit and has increased its indebtedness to the rest of the world because of this. No problem till now. Not arguing against trade deficit if you get the impression. However, see McCombie and Thirlwall’s analysis above. (Wednesday, August 11, 2010 at 17:13)

    If there is an issue, nations necessarily have to go into austerity, whether the currency is freely floating or not. Because fiscal policy has implications on the currency.

    Does that mean fiscal policy is not useful ? Of course not!

  17. Anon,

    Its about the attitude to the foreign sector as if its not a problem. The MMTers sayings “there is no meaning to statements such as a nation living beyond its means in MMT”.

  18. Not a bonafide MMTer myself, more an interested party, but Rama has commandeered this discussion of Bill’s about the fallacies put forward by MSM commentators on the role of deficits and sustainability in national economies, as related to MMT, and turned it into a sky-is-falling question of whether deficit-mania can take over FX markets causing currency collapse.
    This is what I would say:
    Were ALL nation’s operating on MMT, then there would be nowhere for the FX traders to collapse the currency TO – relatively.
    And that’s true, even without MMT.
    That’s enough for now.

  19. Folks

    I have been thinking a little bit about it. Given the current reality that there is world trade and many many nations need to import even for day today subsistence, I just find the argument that fiscal ploicy alone with job guarantee will solve all the domestic sector problems.

    Consider a scenario and we have job guarantee. Consider most of the job guarantee jobs produce an X good which is in general useful to the society. Now also imagine that the X good that we produce from our job guarantee jobs is also produced by the foreign sector and incredibly more efficient than us, so that they price X much more competitively than us. In this situation if you don’t pay attention to your foreign sector policies the job guarantee is as good as waste. This is the kind of situation most countries find themselves in. US is a special case since it controls the cartel that produces oil and makes sure the oil is priced world wide in the IOU that it issues. This is not the case for other countries at all.

    We also have to realize that the forex market is not a true market. Countries like China manipulate the market to sustain their trade position and suprisingly MMT seems to take a position that what China is doing is fine.

    I am also now starting to think that even if you had job guarantee, this will be an incentive to keep workers earning less in both the countries(US and China) of either side of the trade deficit while the capitialists of both China and US rake in the moolah. I somehow get the feeling that fiscal policy is ensuring that there is wealth redistribution from the less privileded class (workers in both China and US) to the privileged class (Capitalists in both China and US)

    I think Ramanan raises and important point and would be thrilled to see a blog where Bill addresses these concerns in a careful SFC/National accounting consistent way. Thanks

  20. Consider most of the job guarantee jobs produce an X good which is in general useful to the society. Now also imagine that the X good that we produce from our job guarantee jobs is also produced by the foreign sector and incredibly more efficient than us, so that they price X much more competitively than us.

    Vinodh, this seems to me to be an assumption of poorly conceived job guarantee. If you assume that, it is easy to demonstrate resulting problems. But I don’t see why anyone would advocate such a poorly conceived jobs guarantee, so I’m not sure how it’s relevant.

    Infrastructure, education, R&D, and health services are not the kinds of fungible goods that are subject to foreign trade the way commodities or commodity-like products are, and they (infrastructure, education, R&D, and health services) are the very things I would think a well conceived jobs guarantee would target.

  21. WHQ:

    Thanks for your response. Yes it may have been a poorly thought out job guarantee in my case. But the fact that there is an enrichment of the rich class that’s going on at the expense of the fiscal policy in the trade deficit country is still true. If we end up doing infrastructure/education we may end up widening the trade deficit which is already problematic.

    As Sergei notes elsewhere in a perfectly MMT world there are no trade imbalances then the logic of extending fiscal policies arms to address a demand deficiency makes perfect sense. However the current reality is that there are huge imbalances in terms of trade and incomes.

    And I am not convinced by the MMT assertion that imports are benefits in the current world. Imports may be benefits for all the western nations that are reasonably well off income wise. This is however not the case of most countries in the world.

  22. But the fact that there is an enrichment of the rich class that’s going on at the expense of the fiscal policy in the trade deficit country is still true. If we end up doing infrastructure/education we may end up widening the trade deficit which is already problematic.

    I’m not sure how to interpret this, Vinodh, but I’m not an economist. How is the enrichment of the rich class at the expense of fiscal policy, and how does doing infrastructure/education widen the trade deficit?

  23. Ramanan: Thanks. Bill: Sorry my bad for having missed that one.

    WHQ: I am also not an economist. I am far from being one. However this is how I look it. For starters we have a huge trade deficit to begin with. let us now consider a situation where the govt decides to use it fiscal power to expand and create jobs and also say External sector is external sector I dont care about it. We have a job guarantee program in place so people get employed for creating infrastructure. However most of the things that are used for infrastructure creation has to be imported. So the trade deficit widens. Now where is the money going? it is going to the capitalists that make the people of China create the raw materials and the already enriched class here that owns a bunch of the stuff that is causing the trade deficit already. So essentially job guarantee while being welfare for lower classes that needs it is more a welfare for the already enriched classes. So if we try to go fiscal policy alone without paying any attention to the external sector, we will be worsening the current state of affairs.

    As many others like Ramanan have already pointed out, Concerted action needs to be taken to solve existing trade imbalances.

  24. For Ramanan.

    A few thoughts regarding foreign exchange market swings.

    I am much more sanguine than you regarding the effects of currency swings. Over the last two decades there have been remarkable swings in the value of the Canadian dollar versus the US dollar, far greater than those noted in the McCombie and Thirlwall book you quote above. In the early 1990s the Canadian dollar began a drop from the 88-89 US cents range to the mid-60 cents range by 2000, around a 25% drop. Then in the mid-2000s it rose by a startling 50% to about 95 US cents. I have provided a table of yearly numbers from 2000 to 2010 from the Bank of Canada website. Through these swings the Consumer Price Index for Canada remained very stable. Now that is not to say there were no effects within the Canadian economy. When the C$ was low manufacturing activity and employment rose substantially and when it almost reached par with the US$ manufacturing was decimated. However the effect on inflation was negligible. Now I realize Canada is a very wealthy country and its example probably won’t apply to much poorer countries but it certainly is comparable to the UK and France.

    My point is that in a wealthy country huge currency swings did not result in much change in inflation nor did it result in financial meltdown. It did have a major effect on the tradeable goods sector.

    Year CPI Canada$/US$
    2000 2.7 0.67
    2001 2.5 0.65
    2002 2.2 0.64
    2003 2.8 0.71
    2004 1.8 0.77
    2005 2.2 0.83
    2006 2.0 0.88
    2007 2.2 0.93
    2008 2.3 0.94
    2009 0.3 0.88
    2010* 1.5 0.97


    I note the blog does not like Word tables very much!

  25. Thanks for the explanation, Vinodh.

    I suppose I could see how the trade deficit could widen through the purchase of foreign raw materials for building infrastructure, at least in absolute terms. But I think the building of useful infrastructure is so supportive of domestic economic activity that its overall effect would be to grow the domestic economy over the long term such that the absolute effects of the raw-materials purchases would be outpaced by domestic growth. I also think that if purchasing raw materials from other countries leads to the greatest value to the domestic economy, it’s worth doing so. I also think that increasing productivity, as robust infrasturcture does over time, increases the ability to export later. In short, I think building (and properly maintaining) domestic infrastructure, even with (presumably cheaper) foreign raw materials, supports smaller trade deficits, certainly in relative terms, and maybe even in absolute terms, over the long run.

    As far as enriching the already rich, that’s somewhat unavoidable and not a bad thing in and of itself. So long as they aren’t sucking up a larger and larger share of the national income, I’m fine with the rich getting richer in absolute terms. I just don’t want the share of the pie to shrink for everyone else in the process. National income should grow and individual incomes should grow in all percentiles, with heathly distribution of income across the various income precentiles. I don’t see how building infrastructure prevents that. In fact, it’s a hell of a better way for people to make money, even rich ones, than through financial innovation that simply sucks money to the top without creating much value in the process.

    Plus R&D, education, health services… Hell, I’d pay musicians to play Mozart in parks and train stations under a jobs guarantee if need be. That would make life better, right?

  26. Vinodh
    The point is even if we try to attain full employment through the private sector we may still have the problem you stated. That does not however make the task of attaining full employment less worthwhile. It is a social justice that has to be met. I cant see how all nations can maintain a trade surplus. It would rather be prudent for countries to find a niche and be good at it so as to reduce attrition of skills or concentration of skills in one or two countries.
    Australia has such niches that however hasnt reached full potential.

  27. pb: I understand the JG and support it. But What I essentially try to say that the statement that CA deficit does not matter and we can get out of this by fiscal policy alone. And who talked about everybody having trade surplus? We are talking trade balance here. The essential thing I am trying to point out is we cannot wish away our CA deficit by just saying imports are benefits. otherwise I am quite sympathetic to many points of MMT.

  28. WHQ (@6:59):

    Domestic growth was quite good in the post dot com bubble era. But it did not cut down the CA deficit. In fact it ended up (financing??/getting financed by??/ depending on which point of view you take) by the CA deficit.
    I am completely for a fiscal intervention to prop up JG. However MMT in my perception misses the boat or is silent regarding
    Given the current imbalance I think if no steps are taken to cut down the imbalance, your healthy distribution of income percentages across the board will just be a pipe dream how much ever fiscal intervention you may come up with in my humble opinion. I am still reading Bill’s old blog and its comments. May be I will find something!

  29. I keep getting 8 as the answer to my math question. I guess it’s just a probability thing, given that we’re dealing with single digit addends.

    Anyway, Vinodh, without doing the reading to digest RSJ’s comments right now and just considering your 11:49 comment, I’d say that the dot com-bubble era was something that wouldn’t compare to the sort of JG regime I would advocate or that I would expect MMTists (like that, MMTists?) to advocate.

    The dot com bubble was, well, a bubble, caused mostly by speculation, as are most bubbles. That’s not to say we weren’t left with some value, because we most certainly were. But I don’t see that fiscal intervention targeting domestic infrastructure, public education, R&D, health and human services will work the same way at all. These things all require intense use of domestic human capital and leave behind long-lasting domestic assets of value, which will promote domestic growth for years.

    The dot com bubble was money chasing money, much like the housing bubble. They both resulted in some value – think Google and, well, lots of housing. But they were both highly speculative and unsustainable. I think it’s fairly obvious that the US needs to devote more resources to infrastructure, education, health and human services and R&D. There is nothing speculative or unsustainable about funding these things, as far as I can tell.

    I can understand why you would be concerned about an economic school of thought that ignored or didn’t fully consider the importance of trade imbalances. My guess is that you will find something sooner or later addressing that that puts your concern to rest, but I’m just don’t have the MMT chops to point it out to you.

    Thanks for your well-considered responses.

  30. Keith,

    Yes, I agree on some of your points.

    I have been writing continuously on this topic in the past 2 months or so and will take a break on this. Meanwhile you can see some of my comments here link_http://moslereconomics.com/2010/07/26/the-political-genius-of-supply-side-economics/ and many other posts 🙂

  31. Ramanan,
    I’ll take a look at your posts on Warren M’s blog. I was on vacation and missed them!

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