I am still catching up after being away in the UK last week. I will…
Budget deficits do not cause higher interest rates
I have always been antagonistic to the mainstream economic theory. I came into economics from mathematics and the mainstream neoclassical lectures were so mindless (using very simple mathematical models poorly) that I had plenty of time to read other literature which took me far and wide into all sorts of interesting areas (anthropology, sociology, philosophy, history, politics, radical political economy etc). I also realised that the development of very high level skills in empirical research (econometrics and statistics) was essential for a young radical economist. Most radicals fail in this regard and hide their inability to engage in technical debates with the mainstream by claiming that formalism is flawed. It might be but to successfully take on the mainstream you have to be able to cut through all their technical nonsense that they use as authority to support their ridiculous policy conclusions. That is why I studied econometrics and use it in my own work. It was strange being a graduate student. The left called be a technocrat (a put-down in their circles) while the right called me a pop-sociologist (a put down in their circles). I just knew I was on the right track when I had all the defenders of unsupportable positions off-side. But an appreciation of the empirical side of debates is very important if a credible challenge to the dominant paradigm is to be made. That has motivated me in my career.
The Australian Treasury released a paper last week – Reconsidering the Link between Fiscal Policy and Interest Rates in Australia – which “examines the empirical relationship between government debt and the real interest margin between Australian and US 10 year government bond yields”.
In English, that means they were seeking to examine whether increasing budget deficits pushed up interest rates which is one of the conservative claims to butress their case against the use of fiscal policy as a counter-stabilisation tool (that is, to correct aggregate demand failures).
An often-cited paper outlining the ways in which budget deficits allegedly push up interest rates is – Government Debt – by Elmendorf and Mankiw (1998 – subsequently published in a book in 1999). This paper was somewhat influential in perpetuating the mainstream myths about government debt and interest rates. Clearly Mankiw still believes in the logic given it occupies a central part of his macroeconomics textbook.
Elmendorf at the time was on the US Federal Reserve Board. It is a pity for the American people that he is now the director of the US Congressional Budget Office.
If you read the paper (and frankly it will waste your precious time to do so), you will note that the paper’s motivation was the rise in public debt between 1980 and 1997. The same sort of rhetoric was being used then as now – spiralling (out of control) public debt. Did the sky fall in then? Answer: No! The rise in the debt presented no problems – interest rates didn’t balloon and inflation didn’t become accelerate out of control.
Elmendorf and Mankiw state that the “conventional” view, which is “held by most economists and almost all policymakers”, considers that:
… the issuance of government debt stimulates aggregate demand and economic growth in the short run but crowds out capital and reduces national income in the long run.
Their depiction of the alternative to the convention view is – Ricardian equivalence – which alleges that:
… the choice between debt and tax finance of government expenditure is irrelevant … [because] … a budget deficit today … [requires] … higher taxes in the future. Thus, the issuing of government debt to finance a tax cut … [or any net spending increase] … represents not a reduction in the tax burden but merely a postponement of it. If consumers are sufficiently forward looking, they will look ahead to the future taxes implied by government debt. Understanding that their total tax burden is unchanged, they will not respond to the tax cut by increasing consumption. Instead, they will save the entire tax cut to meet the upcoming tax liability; as a result, the decrease in public saving (the budget deficit) will coincide with an increase in private saving of precisely the same size. National saving will stay the same, as will all other macroeconomic variables.
I have dealt with this view extensively in a number of blogs – Pushing the fantasy barrow – Even the most simple facts contradict the neo-liberal arguments – Deficits should be cut in a recession and We are sorry – for more detailed discussion on the folly of Ricardian equivalence
Ignoring the fact that the description of a government raising taxes to pay back a deficit is nonsensical when applied to a fiat currency issuing government, the Ricardian Equivalence models rest of several key and extreme assumptions about behaviour and knowledge. Should any of these assumptions fail to hold (at any point in time), then the predictions of the models are meaningless.
The other point is that the models have failed badly to predict or explain key policy changes in the past. That is no surprise given the assumptions they make about human behaviour.
There are no Ricardian economies. It was always an intellectual ploy without any credibility to bolster the anti-government case that was being fought then (late 1970s, early 1980s) just as hard as it is being fought now. Stacks of doctoral theses were written about it – justifying it, etc. None should have passed because they had no knowledge value at all. PhDs are meant to be awarded for advances in knowledge.
Everytime you read an article or chapter or whatever that invokes Ricardian Equivalence to justify its thesis – stop reading immediately and finds something better to do.
In terms of the “conventional” analysis, Elmendorf and Mankiw state that in the short-run an increase in the budget deficit (say via a tax cut with spending constant):
… raises households’ current disposable income and, perhaps, their lifetime wealth as well. Conventional analysis presumes that the increases in income and wealth boost household spending on consumption goods and, thus, the aggregate demand for goods and services … This Keynesian analysis provides a common justification for the policy of cutting taxes or increasing government spending (and thereby running budget deficits) when the economy is faced with a possible recession.
So far so good. This account is not at odds with Modern Monetary Theory (MMT) except that the decision to run budget deficits does not turn on the state of the business cycle. It depends on the state of non-government spending and saving decisions. The aim of the budget deficit is to ensure aggregate demand gaps do not occur which would undermine output and employment growth.
The prior choice that the government has to make is the mix of public and private activity at full capacity. How much public output is required to advance the socio-economic mandate that the political process has bestowed on the government? That is the question that has to be considered initially.
The answer sets the full-employment size of government. Then the government has to manage fluctuations in that size when private spending fluctuates. If private spending increases above this implied “size” then the government would tax the private purchasing power away. If the non-government spending fell below the necessary level (or rate of growth) then the budget deficit has to rise temporarily to fill the gap and maintain growth.
This is the way in which counter-stabilisation policy is conducted. But it may be appropriate (and typically will be) within this process for the government to continuously run budget deficits to ensure the non-government is continuously net saving in the currency of issue. So deficits are not just about bailing out recessions.
But then the wheels fall off in the Elmendorf and Mankiw paper. They say:
Conventional analysis also posits, however, that the economy is classical in the long run. The sticky wages, sticky prices, or temporary misperceptions that make aggregate demand matter in the short run are less important in the long run. As a result, fiscal policy affects national income only by changing the supply of the factors of production. The mechanism through which this occurs is our next topic.
This is the crucial point. The analysis belongs to the class of models that consider that business cycle fluctuations occur because the supplies of input vary as their owners (including workers) make optimising adjustments to the quantities they are prepared to supply. These fluctuations occur around the “natural rate of output” or “natural rate of unemployment” (the two concepts are linked via technology).
Only technology and population matter in the long-run and government spending cannot alter short-run variations in output. Ultimately, the economy sits on its long-run growth path which is invariant to government policy.
Elmendorf and Mankiw us the standard national accounting identities to make their case. So they say that national income (Y) is from the perspective of the households either consumed (C), saved (S) or taxed (T):
Y = C + S + T .
National income (output) is equal to aggregate demand (expenditure):
Y = C + I + G + NX
where I is domestic investment, G is government purchases of goods and services, and NX is net exports of goods and services.
Combining these accounting identities and re-arranging them, provides us with the familiar sectoral balances:
S + (T-G) = I + NX .
Which says that private saving (S) plus the government surplus (T-G) equals investment plus net exports.
Elmendorf and Mankiw call (T-G) public saving but that is an erroneous description of the monetary implications of a sovereign government running a budget surplus.
When individuals (households) save they postpone current consumption because they want to have higher future consumption. Saving is a time machine for non-government entities to allow them to transfer consumption across time. The obvious motivation is that they face a budget constraint – as users of the currency – and have to forgoe consumption now if they want to save.
For the monopoly issuer of the currency – the sovereign government – there is no such financial constraint on spending. It does not have to forgoe spending now to spend in the future. It can always spend what it desires at any point in time irrespective of what it did last period or any previous periods.
Further, when the government runs a budget surplus the purchasing power it extracts from the non-government sector doesn’t go anywhere – it is not stored in any account to use for later purposes. Just as a budget deficit (excess of spending over tax revenue) creates net financial assets (in the currency of issue) a budget surplus destroys net financial assets.
There is no store of purchasing power when the government runs a surplus nor does it make any sense for a government to think in those terms. It can always spend what it likes.
So it is nonsensical to characterise a budget surplus as being “saving”. It is more correctly described as the destruction of non-government purchasing power the non-government net financial assets.
But the sectoral flow equation is sound as written.
Elmendorf and Mankiw then correctly point out that:
… a nation’s current account balance must equal the negative of its capital account balance.
So net exports equals net foreign investment, or NFI, “which is investment by domestic residents in other countries less domestic investment undertaken by foreign residents”:
NX = NFI
This just means that the “international flows of goods and services must be matched by international flows of funds”. This equality is however subject to interpretation and the mainstream paradigm constructs it as meaning that nations with current account deficits (CAD) are living beyond their means and are being bailed out by foreign savings.
From an MMT perspective, a CAD can only occur if the foreign sector desires to accumulate financial (or other) assets denominated in the currency of issue of the country with the CAD.
This desire leads the foreign country (whichever it is) to deprive their own citizens of the use of their own resources (goods and services) and net ship them to the country that has the CAD, which, in turn, enjoys a net benefit (imports greater than exports). A CAD means that real benefits (imports) exceed real costs (exports) for the nation in question.
So the CAD signifies the willingness of the citizens to “finance” the local currency saving desires of the foreign sector. MMT thus turns the mainstream logic (foreigners finance our CAD) on its head in recognition of the true nature of exports and imports.
Subsequently, a CAD will persist (expand and contract) as long as the foreign sector desires to accumulate local currency-denominated assets. When they lose that desire, the CAD gets squeezed down to zero. This might be painful to a nation that has grown accustomed to enjoying the excess of imports over exports. It might also happen relatively quickly. But while the situation lasts the importing nation is getting real benefits and should enjoy them.
Please read my blog – Modern monetary theory in an open economy – for more discussion on this point.
The standard procedure is then to substitute the NX = NFI into the previous sectoral balance expression S + (T-G) = I + NX to get:
S + (T-G) = I + NFI
which they say:
… shows national saving as the sum of private and public saving, and the right side shows the uses of these saved funds for investment at home and abroad. This identity can be viewed as describing the two sides in the market for loanable funds.
Note the comments above about the erroneous contruction of public saving.
MMT constructs this version of the sectoral balances as saying for national income to be unchanged the leakages from the spending system [left-hand side => S + (T-G)] have to be equal to the injections [right-hand side => I + NFI]. If the actual leakages in any period exceed the injections then income will fall to bring the relationship back into equality. I could go on about this at length but haven’t the time today.
But more importantly, once Elmendorf and Mankiw introduce the loanable funds model to explain why budget deficits drive up interest rates you know they are entering the land of myths.
They motivate their discussion of the previous identity in this way:
Now suppose that the government holds spending constant and reduces tax revenue, thereby creating a budget deficit and decreasing public saving. This identity may continue to be satisfied in several complementary ways: Private saving may rise, domestic investment may decline, and net foreign investment may decline.
They claim that “private saving rises by less than public saving falls” which means that “total investment–at home and abroad–must decline as well”.
The fall in investment reduces the capital stock (reducing income and output) and increasing the interest rate. Why? Answer: according to the marginal productivity theory (MPT) the lower capital stock means the smaller stock of capital is now more productive and so the rate of return rises which forces all interest rates up as well as pushing real wages down.
Further, because they claim there is a “decline in net foreign investment” this requires a “decline in net exports” and a rising budget current account deficit – and so they think they substantiate the “twin deficits” argument. Please read my blog – Twin deficits – another mainstream myth – for more discussion on this point.
None of this is remotely what happens.
In terms of the above model [S + (T-G) = I + NFI], MMT suggests that as (T-G) falls (net public spending rises), national income rises which also stimulates saving (S). Further, it may increase imports which may reduce NX but in that situation the exchange rate pressure will increase international competitiveness and stimulate exports (X) and attract foreign investors (NFI).
The rising activity will also stimulate investment (I) as firms sense improved opportunities to realise profits by expanding capacity (this is known as the accelerator effect in the literature). With the central bank in charge of interest rates, the budget deficit “crowds-in” private spending.
So where do the mainstream economists go wrong? At the heart of this conception is the theory of loanable funds, which is a aggregate construction of the way financial markets are meant to work in mainstream macroeconomic thinking. The original conception was designed to explain how aggregate demand could never fall short of aggregate supply because interest rate adjustments would always bring investment and saving into equality.
In Mankiw’s macroeconomics textbook, which is representative, we are taken back in time, to the theories that were prevalent before being destroyed by the intellectual advances provided in Keynes’ General Theory.
Mankiw assumes that it is reasonable to represent the financial system as the “market for loanable funds” where “all savers go to this market to deposit their savings, and all borrowers go to this market to get their loans. In this market, there is one interest rate, which is both the return to saving and the cost of borrowing.”
This is back in the pre-Keynesian world of the loanable funds doctrine (first developed by Wicksell).
This doctrine was a central part of the so-called classical model where perfectly flexible prices delivered self-adjusting, market-clearing aggregate markets at all times. If consumption fell, then saving would rise and this would not lead to an oversupply of goods because investment (capital goods production) would rise in proportion with saving.
So while the composition of output might change (workers would be shifted between the consumption goods sector to the capital goods sector), a full employment equilibrium was always maintained as long as price flexibility was not impeded. The interest rate became the vehicle to mediate saving and investment to ensure that there was never any gluts.
The following diagram shows the market for loanable funds. The current real interest rate that balances supply (saving) and demand (investment) is 5 per cent (the equilibrium rate). The supply of funds comes from those people who have some extra income they want to save and lend out. The demand for funds comes from households and firms who wish to borrow to invest (houses, factories, equipment etc). The interest rate is the price of the loan and the return on savings and thus the supply and demand curves (lines) take the shape they do.
Note that the entire analysis is in real terms with the real interest rate equal to the nominal rate minus the inflation rate. This is because inflation “erodes the value of money” which has different consequences for savers and investors.
Mankiw claims that this “market works much like other markets in the economy” and thus argues that (p. 551):
The adjustment of the interest rate to the equilibrium occurs for the usual reasons. If the interest rate were lower than the equilibrium level, the quantity of loanable funds supplied would be less than the quantity of loanable funds demanded. The resulting shortage … would encourage lenders to raise the interest rate they charge.
The converse then follows if the interest rate is above the equilibrium.
Mankiw also says that the “supply of loanable funds comes from national saving including both private saving and public saving.” Think about that for a moment. Clearly private saving is stockpiled in financial assets somewhere in the system – maybe it remains in bank deposits maybe not. But it can be drawn down at some future point for consumption purposes.
Mankiw thinks that budget surpluses are akin to this. As noted above – budget surpluses are not even remotely like private saving. You should clearly understand by now that budget surpluses destroy liquidity in the non-government sector (by destroying net financial assets held by that sector). They squeeze the capacity of the non-government sector to spend and save. If there are no other behavioural changes in the economy to accompany the pursuit of budget surpluses, then as we will explain soon, income adjustments (as aggregate demand falls) wipe out non-government saving.
So this conception of a loanable funds market bears no relation to “any other market in the economy” despite the myths that Mankiw uses to brainwash the students who use the book and sit in the lectures.
Also reflect on the way the banking system operates. The idea that banks sit there waiting for savers and then once they have their savings as deposits they then lend to investors is not even remotely like the way the banking system works.
Please read the following blogs – Money multiplier and other myths – Building bank reserves will not expand credit and Building bank reserves is not inflationary – for further discussion.
This framework is then used to analyse fiscal policy impacts and the alleged negative consquences of budget deficits – the so-called financial crowding out – is derived.
In relation to the diagram above, Mankiw asks: “which curve shifts when the budget deficit rises?”
Consider the next diagram, which is used to answer this question. The mainstream paradigm argue that the supply curve shifts to S2.
Why does that happen? The twisted logic is as follows: national saving is the source of loanable funds and is composed (allegedly) of the sum of private and public saving. A rising budget deficit reduces public saving and available national saving. The budget deficit doesn’t influence the demand for funds (allegedly) so that line remains unchanged.
The claimed impacts are: (a) “A budget deficit decreases the supply of loanable funds”; (b) “… which raises the interest rate”; (c) “… and reduces the equilibrium quantity of loanable funds”.
Mankiw says that:
The fall in investment because of the government borrowing is called crowding out …That is, when the government borrows to finance its budget deficit, it crowds out private borrowers who are trying to finance investment. Thus, the most basic lesson about budget deficits … When the government reduces national saving by running a budget deficit, the interest rate rises, and investment falls. Because investment is important for long-run economic growth, government budget deficits reduce the economy’s growth rate.
The analysis relies on layers of myths which have permeated the public space to become almost “self-evident truths”. Obviously, national governments are not revenue-constrained so their borrowing is for other reasons – we have discussed this at length. This trilogy of blogs will help you understand this if you are new to my blog – Deficit spending 101 – Part 1 | Deficit spending 101 – Part 2 | Deficit spending 101 – Part 3.
But governments do borrow – for stupid ideological reasons and to facilitate central bank operations – so doesn’t this increase the claim on saving and reduce the “loanable funds” available for investors? Does the competition for saving push up the interest rates?
Answer: No and no!
But we need to be careful. MMT does not claim that central bank interest rate hikes are not possible. It is possible that a poorly managed central bank will interpret a rising budget deficit as being inflationary and push up interest rates. There is also the possibility that rising interest rates 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 having said that, the Classical claims about crowding out are not based on any of these mechanisms. In fact, they assume that savings are finite and the government spending is financially constrained which means it has to seek “funding” in order to progress their fiscal plans. The result competition for the “finite” saving pool drives interest rates up and damages private spending. This is what is taught under the heading “financial crowding out”.
A related theory which is taught under the banner of IS-LM theory (in macroeconomic textbooks) assumes that the central bank can exogenously set the money supply. Then the rising income from the deficit spending pushes up money demand and this squeezes interest rates up to clear the money market. This is the Bastard Keynesian approach to financial crowding out. Please read my blog – Those bad Keynesians are to blame – for more discussion on this point.
Neither theory is remotely correct and is not related to 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.
So the Elmendorf and Mankiw claim is summarised like this (from the Australian Treasury paper):
… a budget deficit reduces national saving, which implies a shortage of funds to finance investment. This would place upward pressure on interest rates as firms compete to finance their investments from the existing pool of domestic saving.
But from a macroeconomic flow of funds perspective, the funds (net financial assets in the form of reserves) that are the source of the capacity to purchase the public debt in the first place come from net government spending. Its what astute financial market players call “a wash”. The funds used to buy the government bonds come from the government!
There is also no finite pool of saving that is competed for. Loans create deposits so any credit-worthy customer can typically get funds. Reserves to support these loans are added later – that is, loans are never constrained in an aggregate sense by a “lack of reserves”. The funds to buy government bonds come from government spending! There is just an exchange of bank reserves for bonds – no net change in financial assets involved. Saving grows with income.
But importantly, deficit spending generates income growth which generates higher saving. It is this way that MMT shows that deficit spending supports or “finances” private saving not the other way around.
The Australian Treasury paper also notes that “a budget deficit may not reduce the domestic capital stock as the adjustment can occur through higher capital inflows – which may not necessarily change interest rates”. Pretty basic really even without the extra MMT insights in the preceding paragraphs.
In discussing the conventional view, Elmendorf and Mankiw offer the parable of the debt fairy to compute the “crowding out of capital” effects? They ask us to:
Imagine that one night a debt fairy (a cousin of the celebrated tooth fairy) were to travel around the economy and replaced every government bond with a piece of capital of equivalent value. How different would the economy be the next morning when everyone woke up?
How cute! A debt fairy who can just alter the maximising decisions of the private sector overnight and force portfolio choices upon that same sector that presumably do not correspond with the profit-seeking circumstances that prevailed when the investors eschewed the decision to accumulate physical capital and invested in bonds instead.
The debt fairy in fact has no application to the modern monetary system. The
Had they invested in physical capital the public deficit would have been lower anyway and the debt-issued lower.
But even they have to admit that this construction is erroneous (you can read why if you are interested).
The Australian Treasury paper acknowledges that the state of mainstream theory is such that:
the theoretical ambiguities about the connection between debt and interest rates … [provide no robust conclusions].
That is, the mainstream theoretical literature is so dependent on extreme assumptions and total falsehoods about the way the real world monetary system operates that the major conclusions are without theoretical authority
Most of the results in the mainstream literature require extreme assumptions to derive the main conclusions. Even within the logic of their own flawed models if you relax one of these key assumptions the whole analytical edifice collapses and the conclusions are no longer supported by the theory.
Virtually none of the assumptions that underpin the key mainstream models relating to the conduct of government and the monetary system hold in the real world. This means that the mainstream macroeconomic conclusions cannot be typically based on the theoretical models. At that point they become ideological.
In terms of the New Keynesian models which drive the Elmendorf and Mankiw reasoning and now represent the “conventional” view of monetary systems, the claimed theoretical robustness of their models always give way to empirical fixes in response to anomalies.
This general ad hoc approach to empirical anomaly cripples the mainstream macroeconomic models and strains their credibility. When confronted with increasing empirical failures, the mainstream economists introduce these ad hoc amendments to the specifications to make them more realistic. I could provide countless examples which include studies of habit formation in consumption behaviour; contrived variations to investment behaviour such as time-to-build , capital adjustment costs or credit rationing.
Further, the New Keynesian authors (like Mankiw et al) appear unable to grasp is that these ad hoc additions, which aim to fill the gaping empirical cracks in their models, also compromise the underlying rigour provided by the assumptions of intertemporal optimisation and rational expectations. At least, they never admit to this and leave the unsuspecting (usually uncritical) reader thinking that the conclusions are valid.
Please read my blog – Mainstream macroeconomic fads – just a waste of time – for more discussion on this point.
Next time you hear a politician or some conservative start raving about crowding out ask them a few questions:
1. Why are you assuming the pool of domestic saving and/or foreign saving is finite?
2. Don’t banks lend to credit-worthy customers?
3. Where did the funds the government borrows come from?
4. Why have interest rates been around zero and long-term yields not much higher in Japan for two decades despite rising budget deficits?
See their eyes roll and enjoy the moment?
Australian Treasury Paper results
Anyway, the Australian Treasury Paper cites a number of empirical studies that “find” that rising deficits drive up interest rates. I know all of the papers cited well and each one is deeply flawed in both conception or empirical application. None of them hold water.
I won’t describe the econometric method the Paper employs but it is standard and the results are not biased one way or another by the choice of estimation technique. We could quibble about some technical matters but it would be “chess playing” rather than a constituting a substantive attack on the results.
The Australian Treasury Paper concludes that:
… in the long run, the real interest margin rises by around three basis points in response to a one percentage point of GDP increase in the stock of Australian general government net debt … In the short run, however, Australian fiscal variables do not have a statistically significant impact on the interest margin. Importantly, the results indicate that a number of US economic variables, namely inflation and the current account, exert the most powerful influence on the real interest margin.
So domestic budget deficits do not drive up interest rates. The long-run effect (a stylised econometric state!) is virtually zero. The short-run effect is zero!
Zero means nothing – no relationship – go away!
I posted the following graph in an earlier blog – Twin deficits – another mainstream myth – but it is worth repeating. It is based on Reserve Bank of Australia data and shows the relationship between the federal budget deficit and the overnight interest rate from 1977 to now. The different colours indicate the period before (blue) and after (green) the exchange rate was floated.
You will appreciate clearly – there is no relationship. This graph could be reproduced for the advanced world and you wouldn’t find a robust relationship. So that avenue for the TDH is missing.
The Australian Treasury Paper used advanced econometric analysis to find the same thing. Good on them but they could have just looked at this graph and reflected on the way the monetary system operates to reach the same conclusion. I am happy though that they have jobs and are free from the ravages of unemployment!
In his Melbourne Age article last week (September 18, 2010) – Treasury backflip on deficit link – economic correspondent Tim Colebatch describes the Australian Treasury Paper as providing:
… a stunning backflip from Treasury’s earlier views … [which] … challenges a large body of work by other economists that find a strong link between fiscal policy and interest rates.
Conclusion
Lets hope that within Australian macroeconomic policy circles, at least, this insight becomes the norm.
Also all you macroeconomics teachers and lecturers out there – toss out your Mankiw textbooks and start teaching your students something that is closer to the truth. Otherwise, you should resign.
That is enough for today!
I have made the same arguments against crowding out arguments made at the State government level.
The logic used by Mankiw is very twisted indeed.
I have seen other public finance textbooks that describe public sector borrowing as increasing the demand for funds (private savings), and thereby increasing interest rates, but not reducing the quantity of “loanable funds”. Basically the x axis in these models is “quantity of funds” rather than ‘loanable funds”- which does not imply a finite supply of savings like Mankiw does.
Of course these arguments make assumptions about the elasticity of supply of loanable funds. If suply is highly elastic (i.e. you are an open economy, and there are lots of Chinese/ Germans willing to make you loans for worthwhile projects at the prevailing interest rate) you should also expect no crowding out from increased government debt.
This is picked up by your points that:
“1. Why are you assuming the pool of domestic saving and/or foreign saving is finite?
2. Don’t banks lend to credit-worthy customers?
3. Where did the funds the government borrows come from?
4. Why have interest rates been around zero and long-term yields not much higher in Japan for two decades despite rising budget deficits?”
So my conclusion is that MMT type views about public debt and deficits are becoming more widely held in Australian policy circles at both a state and Federal level- and the paper cited proves this.
it seems pretty self evident to me that the move to a budget deficit causes interest rates to fall, not rise. the private sector have more money in their hands, so less demand for and greater supply of loanable funds – thereby putting downward pressure on interest rates. conversely, by stripping money from the private sector, budget surpluses cause greater private sector demand for debt to satisfy aggregate demand – so pushing up interest rates.
in the case of a budget deficit, a government might feel the need to offset falling interest rates by issuing debt – so debt issuance intentionally tries to raise interest rates. it seems strange to me that the mainstream autistics argue the opposite of this position when it fits so neatly with their silly demand and supply pictures.
but it also occurs to me that the recent popularity of sovereign wealth funds as dumping grounds for surpluses, like the future fund, suggest that budget “surpluses” don’t kill private sector purchasing power, they just shift purchasing power from those most in need of government services (eg the unemployed) to the bankers and other benefactors of public investment in domestic and foreign equity markets… budget surpluses and the whole neoliberal paradigm just smacks of institutional corruption.
It is quite possible for households to using their saving to pay down gross debt (there are numerous ways to accommodate this in sector balances terms), just as is possible for governments to use their saving to pay down gross debt. In both cases it is saving and it is a surplus. In neither of these cases is saving stored – in both cases it goes “nowhere”. Households can also spend whatever they like within their assigned bank credit limits – and they spend by crediting bank accounts as well.
The difference between government and household finance is not one of substance (in the nature of saving or spending), but of degree. Households have credit limits imposed by others. Governments have credit limits that are either self-imposed or effectively non-existent.
As you describe it, the mistake made by Mankiw in his interpretation of the Sectoral Balance equation seems to hinge on treating a dynamic relationship in a static manner. That is, he lowers (T-G) but holds S constant, whereas MMT claims that T-G going negative would necessarily produce a positive change in S. Have I got that right?
I am very interested in the sectoral balances issue and basically understand it, for someone who is math-and-equation-challenged. I don’t always understand which way the various sectors have to go, positive or negative, to balance the others. Assume a situation where , as now in the U.S., we have, and will continue to have for a while, a current account deficit and a yearly fiscal deficit. If the deficit hawks had their way and we moved somehow to a balanced budget, assuming the CAD stayed the same, how would domestic savings/investment have to change to support that?
As in the 9/18 quiz:
“When an external deficit and public deficit coincide, there must be a private sector deficit. This suggests that governments can only run budget deficits safely to support a private sector surplus, when net exports are strong.” ANS: “So the answer is false because the coexistence of a budget deficit (adding to aggregate demand) and an external deficit (draining aggregate demand) does have to lead to the private domestic sector being in deficit.” AND ” With the external balance set at a 2 per cent of GDP, as the budget moves into larger deficit, the private domestic balance approaches balance (Case B). Then once the budget deficit is large enough (3 per cent of GDP) to offset the demand-draining external deficit (2 per cent of GDP) the private domestic sector can save overall (Case C).”
Hmm, I am understanding it more just typing this, but I am having trouble distinguishing between savings and investment: “The budget deficits are underpinning spending and allowing income growth to be sufficient to generate savings greater than investment in the private domestic sector….” Why is it seemingly that domestic savings and investment offset each other where to me it would seem they would add to the domestic sectoral balance.
This phrase the “private domestic sector being in deficit” means people saving? Like a savings rate of 3%, or by “deficit” is it meant people spending more than they earn?
It is possible that a poorly managed central bank will interpret a rising budget deficit as being inflationary and push up interest rates.
Unfortunately calling it possible is a huge understatement. Budget deficits do cause inflation (and hence interest rates) to be higher than they would otherwise be.
Unless you think that any central bank with an inflation targetting policy is by definition poorly managed, it is also probable that a well managed central bank would come to that conclusion. There may be an exception during a recession, but the Australian economy’s well past that stage now. And the effect is likely to be confined to the short term, but that doesn’t mean it can be ignored.
Is economics the only “science” that doesn’t care about empirical results? Actually, they care in that they can reinterpret results to fit which ever model they happen to be interested in.
The RBA paper “examines the empirical relationship between government debt and the real interest margin between Australian and US 10-year government bond yields.”
The fact that they found no relationship between between REAL interest rates and deficits does not mean there is no relationship between NOMINAL interest rates and deficits.
Most savers and borrowers face NOMINAL interest rates.
As Aidan mentioned above, persistent budget deficits can cause inflation, which leads to higher nominal interest rates.
If interest rates went up to 15% I don’t think many people would gain much comfort if you told them: “Don’t worry mate, inflation is running at 13%, you’re still only paying 2% real interest on your mortgage.”
anon – if you think that something being self-imposed vs. externally-imposed is not a difference of substance, then I believe you are on the wrong blog.
“As Aidan mentioned above, persistent budget deficits can cause inflation, which leads to higher nominal interest rates.”
Surely only if interest rates are used to deal with inflation.
Persistent budget deficits are there to deal with persistent surpluses elsewhere in the identity. Once those surpluses stop being persistent then the deficit needs to stop as well.
The challenge is to design a counter cyclical policy structure that the politicians can operate without subverting it. One of the beauties of Job Guarantee vs. Warren’s tax cut proposal is that the cost of the Job Guarantee is determined by private sector activity. The only political involvement is to set the level of the minimum wage.
Tax cuts however have to become tax rises at some point if they are to behave counter cyclically. That is politically difficult to do.
Anon – How can a federal government who issues its own currency save in that same currency?
It cannot. It can only spend.
pebird,
I fully agree with anon.
anon,
“. . . and they spend by crediting bank accounts as well.”
Remember about the discussion about Gold Standard and crediting bank accounts? Now one more: the People’s Bank of China has an account at the Fed and let us say that it needs to make some payment. It also spends by crediting bank accounts – just like the US Treasury.
Excellent, Ramanan.
The dynamics whereby a household spends using its commercial bank are not essentially different than the dynamics whereby a government spends using its central bank. Both types of spending result in the crediting of bank accounts. As noted, the difference is one of degree in the level of credit limits or borrowing limits in each case.
The ironic thing is that households are less constrained using commercial bank credit to spend (e.g. credit card limits) than governments are in using central bank credit to spend (only in the MMT counterfactual of no bonds).
And more ironic for pebird – the difference between the actual bank credit arrangements for households and the self-imposed bond borrowing requirements for governments is a difference of substance when it comes to characterizing the actual availability of the bank credit channel for these different borrowers.
Making progress.
Ramanan,
It’s a hell of a thing spending by crediting bank accounts …
… we all spend by crediting bank accounts …
http://www.youtube.com/watch?v=3zKCIf-vfbc
Does the loanable funds doctrine assume a 100% capital requirement?
“… we all spend by crediting bank accounts …”
Does that make people vulnerable to a “currency tax”?
Bill,
Do you know this book:
E. J. Nell, and M. Forstater, Reinventing Functional Finance: Transformational Growth and Full Employment, Edward Elgar, Northampton, Mass., Cheltenham, 2003.
Any thoughts on it? Do you agree with its version of MMT?
Regards
Frank,
Glad to see you here. You will get more precise answers and less disruption here than at the other forum.
I can answer this question:
“This phrase the “private domestic sector being in deficit” means people saving? Like a savings rate of 3%, or by “deficit” is it meant people spending more than they earn?”
This means the latter: people spending more than their income.
I can’t spend by crediting my bank account. I have to make a deposit and then the bank credits my account in that amount and only in that amount. If the deposit is a check drawn on another bank, it may take the bank some days to get around to crediting my account, during which time I do not have access to the funds. What on earth are you talking about?
anon says:
Wednesday, September 22, 2010 at 22:05
I think the contention to your comment comes from definition of government saving in the sentence. “just as is possible for governments to use their saving to pay down gross debt.” Do you mean Bill’s or Mankiw’s definition?
Aidan says:
Wednesday, September 22, 2010 at 23:30
“Unfortunately calling it possible is a huge understatement. Budget deficits do cause inflation (and hence interest rates) to be higher than they would otherwise be.”
There are different types of inflationary inbalance (e.g. supply shock/ excess wage inflation). Wouldn’t a targetted response be required depending on the root cause? I think issues arise from the blunt instrument of interest rates and misintepretation of the signals.
The only fact I am sure about. The application of current economic theory is wrong. Either the theories are wrong or it is being twisted for erroneous purpose.
Why can we NOT have a stable predictable economy. When companies analyse WW demand for commonly used MNC products. At an aggregate level, demand is relatively stable. Changes in aggregate demand are small and take a long time to materialise. Well managed companies are rarely surprised and have plenty of time to respond to changes in economic trajectory. Capital investments and factory size are regularly reviewed and tweaked to manage excess capacity. It is not difficult science and it is generally managed efficiently.
I refuse to believe the whole economy is uncontrollable and unstable when aggregate human behaviour is so predictable and consistent.
My No1 suspect: The science of economic measurement and control is fundamentally flawed.
Tom Hickey:
“I can’t spend by crediting my bank account.”
“Yes, you can !”
Everyone spends by crediting one’s bank account — there is no other way to spend.
Dear Andrew (at 2010/09/23 at 11:36)
You will discover that I have a chapter in that book on the open economy. I agree with most but not all the contributions that are in that book of readings.
best wishes
bill
“Crediting bank accounts” as I understand the way that MMT’ers use the phase implies increasing financial assets. Only the government and banks as public/private partnerships can do this, and only government can increase net financial assets. Only they have access to the spreadsheets that do the markup. My keyboard is not hooked into that loop (FRS). Is yours? If it is, please tell me how to do it.
Bill,
I’ll give it a look one day.
First, I have to check if my budget is constrained. 😉
Gamma: If not, then there would be nothing preventing a government from funding all spending through currency issuance and not levying any taxes. This would obviously produce rampant inflation. I am not saying MMT is advocating this, but what would prevent this from happening?
MMT (functional finance aspect) does recommend funding all spending through currency issuance and not levying taxes to close an output gap through fiscal policy should a very severe gap develop (like now in the US and UK). Then as the gap closes, as indicated by approaching full employment, taxes would be reinstated and spending reduced in order so as to establish full employment/optimal utilization along with price stability. That is the basic idea of functional finance.
Inflation (general price increase over time) only occurs when effective demand outpaces the capacity of the economy to meet demand with supply. Before this occurs, taxes are applied to withdraw nongovernment net financial assets to quell demand and reduce the inflationary pressure.
The government requires the services of a bank in order to participate in the payments system. The government’s payments do not clear against a cookie jar sitting next to the Speaker of the House.
The government’s bank is the central bank.
When the government “spends by crediting bank accounts”, it means that its payments will clear back to its account at the central bank. The government is using the services of the central bank in doing so. That is operational reality, not cookie jar fantasy.
Households also spend by crediting bank accounts. One example is credit card spending. I use my commercial bank in the same way the government uses its central bank. My expenditure by credit card is effectively an instruction to credit the bank account of the expenditure recipient. The spending clears back to my credit card balance with my bank.
Another example is preauthorized debit. My expenditure again is an instruction to credit the bank account of the expenditure recipient. The spending clears back as a debit to my deposit balance with my bank.
And so on. The analogy is clear. Both the government and I require the services of a bank to participate in the payments system. We both spend by crediting bank accounts, using our respective banks in the process of clearing those payments.
The analogy has nothing whatsoever to do with the subject of net financial assets per se. But that subject can be analogized as well. When I spend, I create net financial assets for the rest of the world, where the rest of the world is defined as all balance sheets except mine. Work it through. When I spend by using my credit card limit, that’s exactly what I’m doing. I’m increasing my own net financial liabilities, while increasing net financial assets for the rest of the world. So that analogy works as well.
Again, the difference between governments and households is one of degree, not of substance, insofar as the payments process and balance sheets and constraints are concerned, and the way these things are usually discussed in MMT. The degree reflects the difference in the operation of credit limits, as noted above.
In the prevailing system, there IS a substantial difference between the availability of bank credit to a household and the restriction on governments to borrowing bonds. But that difference is in the reverse orientation to what is usually presumed in MMT. That difference is more constraining on governments than it is on households. It can be neutralized by invoking no bonds.
anon:
“When I spend, I create net financial assets for the rest of the world, where the rest of the world is defined as all balance sheets except mine”
But your balance sheet can run out because you cannot “print” money. The government always has this option – it’s asset column is infinity. That’s the substantial difference.
The central bank, as Bill often states, is part of the government. It’s not a private corporation – it’s administered by government appointed officials. It’s independence is a smokescreen.
The fact that you can make tortured analogies between governments and households do not make them equivalent.
anon, when households spend by creating credit in sellers bank account they also create an equivalent (or larger) debt in their own account. Because the central bank is part of government and fiat money production is a government monopoly, the government is under no obligation to create an equivalent debt to its spending. Currently they do, out of fear of inflation; but this is a self-imposed policy, not an external imposition as is the demand that households pay their credit card bills. Governments can’t be forclosed upon or faced with debt collectors if they fail to act on the debt the way households can. I think that’s the difference between chartalist (MMT) and circuitist ideas that you aren’t grasping.
I was just doing a 5 min bit of research on Argentina.
From the data in Wikipedia. The last few years they have been having inflation % in the mid teens with interest rates in the mid to high teens. Official unemployment % is in high single digits. I believe (but did not confirm) that they run a persistent spending deficit.
While I fully applaud their increases in employment and per capita income. Personally I find it difficult to envisage persistent (stable?) inflation of 15% per anum. Can anyone tell me what is going on. Is this MMT at work? I understand Warren Mosler and Bill have done work in South America.
If MMT is implemented today in say Australia or UK, would we expect to see persistant inflation as high as 15%. Frankly, that frightens me and would not be an obvious vote winner. Using Argentina as a selling point would be a hard sell to any layman.
A bit more lazy research and maybe I can answer my own question.
http://en.mercopress.com/2010/08/19/argentine-economic-activity-expands-11.1-in-june-over-a-year-ago
So Argentina also enjoys stellar growth. High inflation is a respectable trade off. It must be hard to manage pay administration.
Mrs. Kirchner is right up there with Christine O’Donell too. That’s some Country!
Ok folks- with this whole ‘deficits cause inflation’ non-sense, MMT, as far as I can see, never said that deficits can’t cause inflation. In fact, it specifically states REAL RESOURCES is what matters i.e. nominal demand exceeding available supply. The issue is not a FINANCIAL issue at all. The issue here is shifting our language away from the latter, and toward the former. It also takes the view deficits, although not always, for the most part are endogenous driven.
By this measure, we aren’t headed with an inflationary orgy. Contrast the 1970s with today:
* 1970s private debt was no where near as high as it is today; any deficit spending today will probably go toward paying off private sector debt and thus inflation would hardly be an issue – this is partly what explains why the hell happened in Japan.
* Capacity utilisation in the 1970s was far higher (in fact, shortly before the 1973 and 82 recession it hit 91% and 83%); not an issue today (capacity utilisation is far lower)
* no oil shocks or huge supply side shocks as of yet
* transfer payments as a % increase were far more rapid
It is true deficits may lead to NOMINAL increases in interest rates (as they did in the 1973 period as transfer payments exploded), but probably put downward pressure on real interest rates – in any event, businesses/households still accure the cashflows needed to valdiate business debt and as far as I can see as the 1975 budget deficit exploded interest rates were going down…
So the issue in Argentina is this: are there enough REAL resources to go around? They have had quick alot of chronic failures on the supply-side to my understanding.
Tom: I agree with your description of functional finance, but I think you’ve put it in too extreme language, as MMTers often do.
You talk about “funding all spending through currency issuance and not levying taxes….”. Assume for the sake of argument ALL the additional currency issuance is fed straight into the pockets of employees. In a country where government takes about 40% of GDP, the result would be a near doubling of employees’ take home pay. That strikes me as a recipe for chaos.
I’d be comfortable with boosting employees take home pay by 5% or 10%, but not anything approaching 100%.
Anon, Ramanan
when you spend you spend with commercial bank money which is the creature of commercial banks. They create it with their keyboards and full point. Nothing needs to happen elsewhere apart from your expenditure popping up on some other account in the banking system.
When government spends it creates money in the settlement system via crediting account with central bank money (reserves). The expenditure process is accompanied by the conversion of central bank reserves into commercial bank money at the exchange rate 1:1.
It is an enormous difference in substance which money you actually have and spend: private sector liabilities or government liabilities.
“you cannot “print” money”
When I spend by credit card, I am crediting the bank accounts of others by instructing my bank to do so. Using my credit line increases banking system deposits as a result. It is analogous to the effect of government spending on banking system deposits. Both actions have “printed” money in the form of new bank deposits.
“it’s asset column is infinity”
You’re not so bad at tortured descriptions yourself.
“Governments can’t be forclosed upon or faced with debt collectors if they fail to act on the debt the way households can”
Right – I agree with what you’ve said, and nothing there contradicts my main point on operational similiarity.
“When you spend you spend with commercial bank money which is the creature of commercial banks. They create it with their keyboards and full point. Nothing needs to happen elsewhere apart from your expenditure popping up on some other account in the banking system… When government spends it creates money in the settlement system via crediting account with central bank money (reserves). The expenditure process is accompanied by the conversion of central bank reserves into commercial bank money at the exchange rate 1:1.”
Nice point on reserves, but it’s really irrelevant to my point. Both the government and I spend by crediting commercial bank accounts. The fact that the government’s initial liability is the medium of exchange (reserves) and mine is a credit card balance or a mortgage or a consumer loan is not the issue. Moreover, that initial government liability is replaced by a bond unless you’re operating in the counterfactual world, but that’s not relevant here either. The point is that both governments and households spend by crediting bank accounts. Both depend on banking functions and bank payment systems to do so. There is no fundamental operational difference here. Both are capable of creating net financial assets for the rest of the world relative to their own balance sheets in that world. This is operational. And both are currency issuers to the degree that they instruct the crediting of commercial bank deposit accounts using their own banks to do so. Both increase commercial bank deposits, which are effectively the same as the medium of exchange, or currency. The initial intermediating role of reserves and the subsequent role of bonds in the case of the government are analogous to the household liability created when the crediting of bank accounts was instructed.
anon, no, government can spend with freshly printed cash. It does not need banking system to spend. You can not. So you can drop banking system from the economy and it will not change the accounting or operational realities of the private sector.
“government can spend with freshly printed cash”
Here we go again – more MMT argument by counterfactual fantasy.
OK. Let’s suppose the government spends entirely by distributing currency (which right away contradicts the MMT mantra that government spends by crediting bank accounts – but let’s adopt your new rules here).
So the government now spends by distributing currency. If I’ve provided the service to the government, I redeem the currency I’ve received at my commercial bank, for a bank deposit. My bank redeems the currency at the CB for reserves.
Same difference.
The government requires the banking system to the degree I use the banking system.
But now you’re probably going to come back and say that neither of us requires the banking system or its commercial bank deposits – i.e. another step up the counterfactual fantasy ladder.
Tom:
“”Crediting bank accounts” as I understand the way that MMT’ers use the phase implies increasing financial assets. ”
X spends by paying to Y through bank B.
X credits X’s cash account on X’s books.
Y debits Y’s cash account on Y’s books.
B intermediates by debiting X’s account and crediting Y’s account on B’s books.
One spends by crediting and ‘saves’ by debiting one’s cash account (plus Dr/Cr some other account) — bookkeeping 101.
Ralph: I agree with your description of functional finance, but I think you’ve put it in too extreme language, as MMTers often do.
I was just stating the principles, Ralph. Practice would turn out to be different relative to circumstances; fiscal policy can be tightly targeted to incentivizing and disincentivizing flows to accomplish specific goals. But in general, to address inflation FF says to decrease spending and raise taxes, and vice versa for disinflation. Really, in a deflationary environment there is no reason to tax other than to incentivize/disincentivize specific flows. For example, even in a deflationary environment, taxes that disincentivize negative externality would be not repealed under FF.
One spends by crediting and ‘saves’ by debiting one’s cash account (plus Dr/Cr some other account) – bookkeeping 101.
I’m not sure that the MMT economists are using the phrase this way, but I will leave it to them to clarify, since they are the ones using it. But that is not my understanding of what they mean.
Anon, methinks what you are saying boils down to Mitchell-Innes’ insight that the State Theory of Money (Knapp, tax-driven money) can be understood by the Credit Theory of Money. His articles and the book Wray edited on them are great.
Of course, Anon-money is usually good, but unless you are a TBTF Wall Street bankster, you trillion dollar check is worth a little less – to Some Guy like me – than Tim Geithner’s. So Geithner-geld – USGov $ liabilities – is a bit more important in the economy.
That governments are constrained compared to households in “borrowing” – actually asset swapping for the gov – seems either insufficiently described or wrong. What governments are theoretically, initially, solely constrained in is spending, like any check-kiter. They get around it by the power of taxation (forging checks with your signature 😉 ).
I’m not sure that the MMT economists are using the phrase this way, but I will leave it to them to clarify, since they are the ones using it. But that is not my understanding of what they mean.
That would be odd because, as I understand, one of MMT’s claims to glory is consistent accounting. Consistent accounting terminology would be the first step in the right direction one would imagine.
In the above example, substitute the treasury for X, Boeing selling stuff for Y, the feds for B, and you will get the same flow as in household spending. Households are less restricted in ‘crediting’, as anon noticed, because usually they can obtain an automatic loan (overdraft allowance) that the treasury cannot — the treasury balance at the feds has to be such as to make payment settlement possible at all times. According to the current law, the treasury account does no have any overdraft allowance with the Feds.
Currency issuance is a constitutional prerogative of Congress. Congress delegates this to its agencies, the Treasury and Fed. Dollars are created either by printing currency/minting coin or by the Fed creating bank reserves by marking up spread sheets. All dollars come back to this process. Only the Fed has the password that gives access to its spreadsheet. Banks can neither create reserves by marking up spreadsheets nor create physical currency, and neither can the public.
The Treasury credits bank accounts using the reserves the Fed creates for settlement. The Fed can just credit bank accounts and supply the needed reserves for OMO (lending against collateral) and QE (purchases of assets). All other transactions have to clear using existing reserves, since neither banks nor the public have the Fed’s password to its spreadsheet, or if they do, they are in trouble since they are not authorized to use it.
As I understand it, this is what MMT’ers are referring to.
Tom,
I think you will find that MMT, in saying that the government spends by crediting bank accounts, means nearly always that the bank accounts of bank customers are credited.
True, such a credit results in a matching reserve credit as a bank asset, unless/until drained by bond issuance. But the reserve effect is quite secondary to the primary issue of spending by crediting bank accounts. Only a tiny proportion of government spending would be directed to the banks themselves as recipients, in which case the reserve credit is the exclusive credit. But almost all government spending is directed toward crediting non-bank customer accounts first – i.e. increasing commercial bank deposit liabilities.
It is the crediting of commercial bank deposit liabilities that finds its direct analogy in the case of a household who draws on a credit line such as a credit card facility in order to credit the commercial bank account of the non bank expenditure recipient.
Tom,
Perhaps you may think of this as Part II of the “Marshall’s longest” discussion.
My impression is that the discussion there may have served to help consolidate your own thinking re the most constructive role for the “no bonds” idea in the conceptual paradigm for MMT. Perhaps I’m wrong. But if not, there may be other possibilities for further clarification.
Tom Hickey @ Thursday, September 23, 2010 at 13:55
“Inflation (general price increase over time) only occurs when effective demand outpaces the capacity of the economy to meet demand with supply. Before this occurs, taxes are applied to withdraw nongovernment net financial assets to quell demand and reduce the inflationary pressure.”
So how do you measure the “capacity of the economy to meet demand with supply”? Unemployment? Obviously not because virtually all economies experience inflation and unemployment simultaneously. Right now there is high unemployment in many parts of the world, but almost all countries are experiencing positive inflation (apart from a couple of notable exceptions such as Ireland and Japan).
In Australia, unemployment is 5% and inflation is 3%.
So at what level of unemployment or inflation do you re-instate taxation? Or do you have some other measure in mind?
So how do you measure the “capacity of the economy to meet demand with supply”? Unemployment?
As I understand it, this is Bill’s measure. Bill emphasizes that inflation is a general price rise and that is only possible with effective demand in excess of the ability of supply to meet it. Unemployment indicates underutilization of capacity, so the economy can still expand to meet demand. There may be imbalances in various sectors of the economy responsible for price rises in those sectors, but that does not constitute general price elevation. Prices can go up on some things even in a depression due to supply shortages.
Anon: Perhaps you may think of this as Part II of the “Marshall’s longest” discussion.
My impression is that the discussion there may have served to help consolidate your own thinking re the most constructive role for the “no bonds” idea in the conceptual paradigm for MMT. Perhaps I’m wrong. But if not, there may be other possibilities for further clarification.
This is partially the case, I would agree. But I think that the major point needing clarification here is what MMT’ers actually mean by the phrase in question.
I have no doubt that “crediting bank accounts” means crediting deposit accounts in commercial banks. That’s what Treasury does when it disburses funds electronically, or sends checks that get deposited, and it is what happens when the Fed purchases securities for QE. This gets done by government marking up spreadsheets in the FRS for clearance.
All other crediting and debiting of bank accounts is just shuffling money around endogenously. Only government is exogenous, and it influences the endogenous system through its spreadsheet, to which it alone has authorized access. That is the basis of the horizontal-vertical relationship of government and nongovernment financially, and it is what make government the monopoly currency issuer and nongovernment the currency users.
wow, anon, is it really the basis of your argument?!
“Only a tiny proportion of government spending would be directed to the banks themselves as recipients, in which case the reserve credit is the exclusive credit. But almost all government spending is directed toward crediting non-bank customer accounts first – i.e. increasing commercial bank deposit liabilities.”
Be honest with yourself and everybody else here. What you are referring to is the function of the banking system, not government. At the current level of technology there is no reason as to why only banks are allowed to have accounts at the central bank and therefore have access to the payment system. It used to be a valid reason in the past but not any more. But even beyond purely theoretical arguments, local government are allowed to have account at the central bank. Or you consider this tiny?
Tom,
I am a currency issuer using my bank when I draw on my line of credit. I spend using my bank by crediting bank accounts. It’s the same mechanism as the government applies using the central bank.
I am exogenous relative to the rest of the world. I create net financial assets for the rest of the world when I spend using credit.
I have no problem per se with the MMT exo/endo paradigm. I understand it completely.
My point is that it is not the only possible use of such a paradigm. The MMT paradigm and its meaning for the terms exo and endo is strictly a function of choosing to split the world between government and non-government.
I can just as easily apply a split between households and non-households, using a comparable paradigm, as I have just done.
Sergei,
You appear not to understand what government spending means.
It means the government purchases services from non-government.
My point is that the dollar volume of services that government purchases from banks is very small in the context of total government spending. The former are executed by payments that affect only bank reserve accounts; the latter are executed by payments that affect non-bank deposit accounts with banks as well.
I have no doubt that “crediting bank accounts” means crediting deposit accounts in commercial banks.
The phrase is ambiguous without answering the question: crediting by whom ?
X has a cash account on X’s book which corresponds to X’s account at bank B. X may have a cash account under X’s mattress, but that’s irrelevant.
X spends by crediting the cash account on X’s book and instructing bank B to transfer X’s money from X’s account elsewhere. Bank B debits X’s account and credits an account elsewhere..
X receives money from elsewhere. Bank B debits an account elsewhere and credits X’s account. X debits X’s cash account on X’s books.
Rocket science it ain’t.
anon: The MMT paradigm and its meaning for the terms exo and endo is strictly a function of choosing to split the world between government and non-government.
I can just as easily apply a split between households and non-households, using a comparable paradigm, as I have just done.
anon, you lost me here. There is no essential difference between the monopoly currency issuer and currency users? Or am I failing to understand you point? This is the basis of MMT, after all.
VJK, my understanding of the way that MMT’er’s use “crediting banks accounts” implies “crediting bank accounts by marking up spreadsheets.” I have access to neither the FRS spreadsheet, nor to my bank’s spreadsheet. My bank account gets credited by my depositing funds, not by my marking up the spreadsheet myself. When government credits accounts, including its own (Treasury) account, it does so by marking up a spreadsheet at the FRS, excluding the fact that the CIA often uses suitcases full of $100 bills instead. My actions are in no way the same as the government’s. That, I think, is the MMT point in talking about “crediting bank accounts by marking up spreadsheets.”
Tom,
My very original point was – some things that are taken to be a question of substance are better defined as a question of degree.
I can create money in the endogenous system by using my bank to spend from credit. The government therefore is not a monopoly issuer of the currency in that sense. The money I create using my commercial bank is as good as the money that the government creates using the central bank. We both spend “from nothing”, operationally.
The real difference between us is something else.
First, the government is huge and I am small. That’s a big difference in natural spending capacity.
Second, the nature of any constraints on spending is quite different. But contrary to MMT, NEITHER of us is operationally constrained. The government is not unique in this regard. There is nothing operational that prevents me from creating money using my bank anymore than the government using its bank.
The question becomes, what sort of upper bound is otherwise imposed to spending in either case?
In my case, the upper bound is the limit set by my bank, based on credit analysis.
In the case of the government, the (correct) upper bound is the limit set/implied by MMT, based on real economy constraints.
But in neither case is there an operational upper bound. Credit analysis is no more an operational aspect than is the idea of real economy constraints. The upper bound is policy imposed in both cases.
Yes, the government is different. But let’s try and parse why it’s really different.
Tom:
“crediting bank accounts by marking up spreadsheets.” as stated does not make any accounting sense, operational or otherwise.
My bank account gets credited by my depositing funds on your bank books. On your imaginary/real household[quick]book the same cash account is debited (and your revenue account is credited) by your action although perhaps not recorded.
anon, it is different because it is the monopoly issuer of currency, per the US Constitution. It uses the central bank to do this. Banks can create deposits by making loans, they cannot issue currency in the sense of increase nongovernment net financial assets using the central bank. I simply use the currency. I cannot generate new financial assets by making a loan, since I do not have access to the FRS. The loan I make is not against my capital, it is my capital. When I borrow from the bank, I participate in their capacity to create deposits. I cannot create the deposit myself. I don’t have access to their spreadsheet. As VJK implies above, the transactions take place through banks as an intermediary. This is because non-banks like me cannot do this directly.
VJK, this all transpire through bank intermediation because non-banks do not have access to the settlement system where the spreadsheets are marked up.
Tom,
“Banks can create deposits by making loans, they cannot issue currency in the sense of increase nongovernment net financial assets using the central bank.”
Now you’re just pushing words around from MMT phrases.
The government/central bank is a monopoly issuer of its own liabilities.
It’s not a monopoly issuer of the stuff that’s used to credit bank accounts.
It’s not a monopoly issuer of the stuff that’s used to credit bank accounts.
That’s what banks would like to think, but they are public/private partnerships in which government allows them to quasi-create state money. A lot of people think that the state should not permit this fiction at all but rather create all the money itself, holding that money created from bank loans/deposits is just fictitious money and the basis of most financial problems, since they involve excessive leverage. I have not formeda n opinion on this yet, but it is a worthwhile viewpoint to consider.
“I cannot create the deposit myself.”
Neither does the government, without the use of the central bank. The credit that the government creates does not clear back to a cookie jar next to the Speaker of the House. The credit must clear back to the central bank for it to be accepted in the banking system at large.
There’s no difference in the sense that I require my commercial bank; the government requires its central bank.
If you then revert to the “no bonds” operational counterfactual, then the government essentially merges with the central bank. There’s still no difference. It’s the banking function that’s required for the government to spend by crediting bank accounts, the same as it is for me.
“A lot of people think that the state should not permit this fiction at all”
That’s fine if you like. Eliminate commercial banking, nationalize it all, and have everybody bank with the central bank.
That still doesn’t change my point; if anything it strengthens it. Both the government and I can issue currency using our bank – the central bank. I’m on par with the government as far as that’s concerned. We have different credit limits, as I discussed above. But it’s not the government that’s the monopoly issuer using the central bank, because I use the same facility to create money by spending from credit.
There’s no difference in the sense that I require my commercial bank; the government requires its central bank.
Commercial banks cannot create reserves required for settlement. All financial transactions are settled either in physical currency or bank reserves. The government has complete control over the monetary system through the cb, which is why the cb should explicitly be an agency of government instead of the weird hybird that the Fed is. It does not take no bond for government to merge with the cb. Bonds are just a fiction as Warren points out: Reserves are zero intrest bonds and bonds are interest-bearing reserves, with currency interchangeable with reserves in the FRS.
But it’s not the government that’s the monopoly issuer using the central bank, because I use the same facility to create money by spending from credit.
But you can only do this if credit is extended to you. That is a difference.
I assume that when MMT’ers say that a monetarily sovereign government with a nonconvertible floating rate currency “credits bank accounts by marking up spreadsheets,” it means that government creates its currency/reserves without the operational need for revenue, finance or asset sales; it just pushes some buttons. The implication is that nongovernment, including the banking system, cannot do this without creating corresponding obligations. The government does not obligate itself through its liability creation other than to accept its liabilities at its payment offices in satisfaction of obligations to it. Perhaps I am wrong about it, but that is what I hear when MMT’ers say this. But maybe they mean something entirely different.
That’s fine if you like. Eliminate commercial banking, nationalize it all, and have everybody bank with the central bank.
There are other options. For example, Libertarians, following Milton Friedman, would like to see commercial banks issuing private money, each bank able to issue its own.
Tom,
You’re not responding to the points.
Reserves have nothing to do with it. They are a facility for interbank payments among commercial banks competing for business. They’re a sideshow in the comparison between households and governments spending by crediting bank accounts.
“But you can only do this if credit is extended to you. That is a difference.”
It’s not a substantial difference at all. We both require banks to clear our payments, as discussed. The only reason it’s not credit for the government is that the government is required to cover its payments with bond borrowing to avoid going overdraft. If you want it to go overdraft, that’s equivalent to credit. And if you want no bonds, or you if want to merge the government and its central bank, that’s substantially equivalent to credit from the central bank.
Thanks, JHK, I clearly don’t understand the issue here.
JKH, what is the MMT’ers point in taling about crediting bank accounts. Now I am confused.
anon,
“Now you’re just pushing words around from MMT phrases.”
you should check for instance with link_http://www.bis.org/publ/cpss55.pdf
This clearly has nothing to do with MMT.
Tom Hickey:
“Crediting bank accounts” – I think much of this is about making the appropriate distinction between the wrong idea that the government requires some sort of storehouse of money, and the right idea that the government doesn’t need such a storehouse of money – because it can always issue it in the general sense of being a currency issuer (i.e. issue it as a balance sheet liability of sorts). I.e. the power to credit bank accounts doesn’t depend on such a storehouse.
JHK, Tom: money != credit
Everything government issues is money
Everything commercial banks issue is credit
To say there is no difference in substance meaning to deny fundamental difference between monopoly issuer of money and a multitude of issuers of credit. There is always just ONE issuer of money. It is unique. Central bank was created to ensure on par convertibility between Money and commercial bank Liabilities.
JKH: “Crediting bank accounts” – I think much of this is about making the appropriate distinction between the wrong idea that the government requires some sort of storehouse of money, and the right idea that the government doesn’t need such a storehouse of money – because it can always issue it in the general sense of being a currency issuer (i.e. issue it as a balance sheet liability of sorts). I.e. the power to credit bank accounts doesn’t depend on such a storehouse.
OK, I can see that, and it is a point that Warren makes in using the phrase. Thanks for pointing it out.
Here is Warren using this notion relative to functional finance and the irrelevance of taxation for funding.
Should there be a time when we see demand starts threatening the price level, then it can come a point where it makes sense to raise taxes, but not to pay for China, not to pay for social security, not to pay for Afghanistan (we just need to change the numbers up in bank accounts) but to cool down demand. We have to understand that taxes function to regulate aggregate demand and not to fund expenditures. [emphasis added]
Maybe this will help a little bit or maybe not:
http://neweconomicperspectives.blogspot.com/2009/11/what-if-government-just-prints-money.html
I don’t think households can run deficits like federal government unless of course there is no such thing as bankruptcy laws. Just saying.
Tom and JKH,
Just like to add my two cents to the discussion re credit and money. This is a nice quote which I think covered the MMT and Circuitist position of money and credit:
“…According to Ingam, saying that all money is essentially a credit is not the same as saying that all credit is money. In other words, he argues that not all credits are final means of payment, or settlement” (Credit and State theories of Money, pp. 10 – 11)*
Both governments and banks issue credit, but it is the governments ability to impose that which is necessary to pay taxes that allows it to position its credit at the top of the ‘money pyramid/hierarchy’ which also makes its credits money, where money is a means of settlement and final means of payment.
*Unfortunately my notes aren’t available on my computer, and the notes I do have aren’t very detailed. hence the poor referencing. I believe it came from the introduction possibly written my Wray and Stephanie Kelton.
Tom: “All financial transactions are settled either in physical currency or bank reserves”.
Just an aside, but is this really true?
If I make a payment to a customer of the same bank by requesting a funds transfer, there is no involvement of reserves, just a simple reallocation of bank deposit liabilities from my name to the recipient’s name.
Furthermore, if a bank pays me interest on my account, it credits me with a deposit (again, no reserves involved) and adds to my stock of net financial assets, in the same way that the govt would add to my stock of net financial assets by paying me interest on a government bond.
Whoa … right over my head! High class semantic ping pong.
Can anyone condense the argument in simple terms?
My Grandad said, if you can’t say it simple terms you don’t really understand it.
Dear all (at various times in the last few days)
There are a lot of intellectual gymnastics evidenced in the comments lately – playing on a word or two and trying to conflate the inconflatable.
First, the non-government sector is always financially constrained in its spending whether it uses credit cards or not. In addition, it faces real constraints – availability of goods and services to purchase. The sovereign government sector is never intrinsically constrained financially although it may impose voluntary constraints on itself for whatever reason. It also faces the same real constraints that non-government spending confronts.
Second, non-government sector financial transactions never create changes in net financial positions denominated in the currency of issue. Sovereign government transactions with the non-government sector always create net changes in the financial asset position in the non-government sector (denominated in the currency of issue) – assuming no offsetting transactions.
These are the differences between the two sectors that are at the basis of an understanding of macroeconomics. They are central to the way that Modern Monetary Theory (MMT) constructs its narrative.
Attempting to conflate these differences by nuance misses the fundamental point. Sorry.
best wishes
bill
“These are the differences between the two sectors that are at the basis of an understanding of macroeconomics.”
Bill, I understand that, insofar as the MMT framework for macroeconomics is concerned.
But a household that borrows to spend or acquire a real asset generates a net financial asset for the sector that is defined in the same context as the rest of the world (all balance sheets other than that of the household). It is a small point of logic (and finance, and economics), not relating specifically to the MMT framework.
This is also not necessarily in conflict with the MMT framework, or with an understanding more broadly of macroeconomics.
Thank you, Bill. I was getting frustrated reading through all the semantic arguments. I’m new to MMT, but I think I understand the difference between bank credit (horizontal money) and government money (vertical money). Horizontal money always nets to zero on the balance sheet. Vertical money doesn’t necessarily net to zero; it depends on the government issuing a matching liability as a bond, which historically it has always done.
What’s your view on significantly nationalizing the banking system? Private bankers have proven themselves to be selfish liars that failed at their most important job — assessing risk and creditworthiness. Commercial banks would still exist, but they’d only be able to make loans out of accounts held at the central bank, which would set a credit limit and interest rate individually for each bank according to the bank’s assessed credit score.
I think Anon is heading in the right direction.
One is left with the impression when reading about reserve accounting in MMTsphere that the reserve creation makes the government sector different. One is left with the impression that if the government spends directly from funds borrowed from the private sector or from tax receipts credited at its account at a commercial bank, the situation is different.
There is simply nothing wrong with the view that the government spends the funds paid in taxes and borrowed from the private sector.
These things are important I believe as there is a potential to create misunderstanding for oneself and others. Statements/questions such as “Where did the private sector get the reserves to purchase Treasuries” and “Where did the Chinese get the dollars in the first place” though not incorrect, can lead to completely different behavioral assumptions about economic dynamics.
I remember Marshall’s latest and the discussion of the Euro Zone problem around that time. The reasons provided was that the Euro Zone government borrows first and then spends, unlike the US government. I believe this explanation is a semi-explanation. The right explanation ? – A simple auction failure leading to difficulties in payments and rolling over existing debt. It has nothing to do with reserves accounting!
Anon and Ramanan,
Regarding your last posts:
So what?
Anon said it doesn’t relate to MMT, so what is the relevance in a discussion regarding MMT?
Dear Ramanan (at 2010/09/24 at 20:06)
You allege:
There is nothing wrong with this statement if you wish to continue to deceive the reader about the true nature of the monetary system and the opportunities it presents the sovereign government. It is a beautiful statement for reinforcing the myths that the neo-liberal paradigm has foisted on the world and which leads to policies that causes unnecessary poverty and suffering.
It is also quite simply not a correct description of the financial arrangements that underpin our monetary systems. In my writing I prefer to deal with the facts and tease out truths – not perpetuate conservative lies.
best wishes
bill
“so what is the relevance in a discussion regarding MMT”
I said it didn’t relate specifically to MMT. Specifically was the operative word.
Actually, it’s an idea that is larger than MMT. MMT is based on a specific sectoral division of the economic universe, starting with government and non-government, and working down from there. There is nothing wrong with this and a lot that is right – maybe everything, according to MMT.
But the idea I discussed is universal to any sectoral breakdown.
If you are afraid of a simple idea that is true, then you have a problem. It may indicate too much fragility and defensiveness in the exposition of a downstream idea that is more complex.
“It is a beautiful statement for reinforcing the myths that the neo-liberal paradigm has foisted on the world and which leads to policies that causes unnecessary poverty and suffering.”
Bill,
It has the potential to reinforce those myths, but it is not an incorrect statement, and it is not necessarily so.
One can make such a statement and still combat wrongheaded thinking of the same type debunked by MMT.
I would recommend that two fundamental ideas be emphasized by MMT:
a) The thoroughly wrongheaded approach of “monetarist” economics toward dealing with the risk of inflation (i.e. the wrong emphasis on an increase in money balances or in deficits per se)
b) The correct approach toward dealing with the risk of inflation (real constraints and the correct interpretation of unemployment, etc.)
You have dealt with these points at huge and effective length in numerous blogs, but still my preference would be to see a heightened emphasis on their central role in the overall paradigm for the MMT message. My impression now is that more than enough emphasis is placed on an explanation of the working of the monetary system, including some semantic baggage that tends toward overkill and oversimplification. E.g. out of many: too much emphasis on “taxes going nowhere”, which in my view frankly is a trailer park interpretation of a very simple, very general but somewhat more elegant concept in finance, which is that income can always be applied toward the reduction of a net liability position. Conversely, more emphasis might be placed on thoroughly debunking the very dangerous “inflation is always and everywhere a monetary phenomenon”.
ParadigmShift: Tom: “All financial transactions are settled either in physical currency or bank reserves”.
Just an aside, but is this really true?
Granted that there are exceptions due to intrabank transactions that are just bookkeeping entries at the bank, the exception to the rule does not necessarily disprove the rule. The fact is that most financial transactions involve either exchanging currency directly or interbank activity that requires exchange of bank reserves in the FRS. Even intrabank transactions are generally temporary since very few people leave their funds sitting in their bank without using them eventually, and then most often transactions involving currency or reserve settlement are involved. It is an unusual person that just does business with their bank, in fact, I would say rare.
In your example, if an intra bank transfer occurs between customers, unless both are perpetual savers, the funds will be spent in transactions and the probability is very high that these transactions will be either currency transactions or interbank transactions requiring reserve settlement. Similarly, if the bank credits an account with interest, eventually that will be used in transactions involving currency or reserve settlement. People don’t save to save, they save to eventually spend.
Ramanan: There is simply nothing wrong with the view that the government spends the funds paid in taxes and borrowed from the private sector.
I think that this is the crux of it. MMT holds that there is something wrong with this view operationally, since a monetarily sovereign government with a nonconvertible floating rate currency simply issues currency without funding itself with taxes or financing itself with debt. This is the operational reality. Offsetting specific expenditures with taxes $-4-$ (balanced budget amendement) or offsetting deficits in general with Treasury issuance creates an accounting fiction that taxes are funding expenditure and bonds are financing deficits, but that is not what is happening operationally.
That is the basis of the operational insight into the modern monetary system that MMT is built on, as I gather it. It looks to me like you are proposing another theory, similar to the mainstream view, which has a different view of monetary operations.
Tom,
If you keep assuming overdrafts, then I do not know what to argue. No amount of jugglery with reserve accounting proves that the government spends first. The MMT proposal is equivalent to providing unlimited overdraft to the government.
Bill,
Never denied full employment. The punch is lost if described my way but it is accurate – its accurate because governments end up assuming a lot of international debt in its books.
Ramananan and Tom, I find it very hard to get my head around there being a “theory” let alone two alternative “theories” about what someone currently does in an office in London or wherever. Is the dispute just semantics? Is there really any theoretical dispute about the actual mouse clicking that takes place???? When the banks were recapitalized after the crisis by the government central bankers making the appropriate mouse clicks was what was occurring “spending” according to MMT terminology but “issuing itself an overdraft” according to mainstream nomenclature (I’m just using that as an example because it was such a huge impromptu act of spending/overdraft-issuing that had no reference to any taxation or bond issuance ). At the time I thought that the infinite overdraft facility (to use Ramananan’s terminology) of our governments was the key difference between now and the gold standard 1929 crash and was why the big banks are now invincible so long as they maintain government capture. A lot of the phrases used by the government such as “taxpayers money” etc are presumably to bolster confidence in the currency. I wonder whether that is actually necessary. My impression is that retail investors/savers actually are more likely than ever to keep long term savings as cash because all other asset classes are now such a volatile minefield. So long as enough money is too scared/wise to venture out of cash savings, the currency presumably will cope with the grand MMT future of having >100x GDP government debts. I’m sure that such a future will be impoverished however with a ruling class making zillion dollar speculations in much the same way as ancient Egyptian priests conducted sun worship together with a kind of soviet style state organization to provide the daily bread (or not) for the serfs. .
Ramanan: f you keep assuming overdrafts, then I do not know what to argue. No amount of jugglery with reserve accounting proves that the government spends first. The MMT proposal is equivalent to providing unlimited overdraft to the government.
You are claiming that political restrictions alter the operational reality of a fiat currency. Conversely, MMT’ers hold that this is not the case, as I understand it. This is just an imposed accounting fiction that disguises the existing operational reality, which does not change owing to the restraints because the restraints do not alter the nature of the modern monetary system. You have to go to convertibility or fixed rates to change it essentially.
Tom,
I am not a big fan of the usage of the phrase ‘fiat’. “Money is credit-led and demand determined” is my preference. For any type of institutional setup. I understand the limitations of most setups and you cannot assume any messed up understanding on my part. Now the essential point I am trying to make here is that as Anon pointed out the overkill is an overmuch.
My statements are perfectly consistent with the “Flow of Funds”. For example it uses the concept “Net Lending by (sector)” and the government number is typically negative which means it is a borrower whether you like it or not. You cannot claim your description to be consistent with the flow of funds if the terminologies are not consistent.
Describe reality the way it is instead of making statements such as the US Treasury and the Fed have made arrangements to make sure that cheques do not bounce keeping in mind the no overdraft rule and the no monetization rule. Describe it by saying that there is always an option to break this rule or mint PLatinum coins of any denomination. No amount of reserves accounting jugglery to prove that cheques don’t bounce is correct I am afraid. Do not try to sneak in the proposed change into the argument.
I understand that people need to know that there is no storehouse – but you know what? People already know this!
Coming back to the nature of money, I am fully aware of the endogeneity and understand it well.
More importantly statements such as “the government does not borrow” have the potential to be magnificently misinterpreted in the case of open economies. I won’t pursue that path for now.
anon said:
>But the idea I discussed is universal to any sectoral breakdown.income can always be applied toward the reduction of a net liability position.<
There is no liability position for the government. That is the definition of fiat currency!
Lets try this again!
anon said:
“But the idea I discussed is universal to any sectoral breakdown.”
I think you need to prove the utility of *every* sectoral breakdown for this to be significant. Showing an individual household as its own sector is useful for what, exactly?
“income can always be applied toward the reduction of a net liability position.”
There is no liability position for the government. That is the definition of fiat currency!
“There is no liability position for the government”
Not true.
Government is obligated to redeem bank reserves (it’s liability) in exchange for tax payments.
anon said:
“Government is obligated to redeem bank reserves (it’s liability) in exchange for tax payments.”
Not all dollars in existence are owed as tax payments.
If I have one dollar in my pocket and I have paid my taxes already, what will the government exchange for that dollar?
“what will the government exchange for that dollar”
a tax credit
stone: When the banks were recapitalized after the crisis by the government central bankers making the appropriate mouse clicks was what was occurring “spending” according to MMT terminology but “issuing itself an overdraft” according to mainstream nomenclature (I’m just using that as an example because it was such a huge impromptu act of spending/overdraft-issuing that had no reference to any taxation or bond issuance ).
You seem to be confusing deficit spending with Treasury overdrafts. According to US law at present, the Treasury is not permitted to run an overdraft at the Fed (central bank), even though the Fed is also an agency of the government involved in money creation along with the Treasury. The Treasury must offset deficits with tsy issuance to obtain the necessary reserves for settlement prior to crediting bank accounts. MMT is saying that operationally Treasury spends first and then drains excess reserves from the interbank market into saving as tsy’s through tsy issuance in $-4-$ deficit offset as the law requires, so that the Fed can hit its overnight target rate. MMT’ers holds that the no overdrafts rule and $-4-$ deficit offset requirement are a voluntary political restraint that can be altered at will rather than an operational change affecting the monetary system, just as a balanced budget amendment would be if enacted as proposed. Ramanan is disagreeing with that position, as I understand him, holding that these modifications are operational changes. I don’t see any disagreement over the facts or accounting, so I would say that it is probably a semantic difference.
MMT’ers recommend that to clarify this confusion, which makes it seem that the Treasury (government) is borrowing its funds (reserves) from the central bank, who sells the debt to the public at auction (as also required by law), it would be advisable to make the implicit consolidation of the Treasury and Fed explicit by folding them into one agency, since both are government agencies acting cooperatively. This consolidated agency could be either the Treasury or the Fed, and ending the public/private aspect of the central bank and making it purely public. There is really no good reason for not allowing government to run overdrafts, which is simply a bookkeeping fiction, since government is dealing with itself in this matter. The present contortion is holdover from the gold standard era, and this simply obfuscates what is happening operationally under the present monetary regime, which is that government is funding itself without financial (operational) constraint. This obfuscation is at the basis of a lot of bad policy and bad politics, based on ignorance and disingenuousness about how the modern (post-1971) monetary system operates.
The MMT’ers argue that language is important for understanding, and semantics can conceal the operational reality behind the political restraints, serving to confuse the issue and lend support to the mainstream view, which the MMT’ers regard as erroneous in addition to being misguided. MMt’ers hold that these restraints cannot change the nature of the monetary system, only give it the appearance of running like a fixed rate one in order to constraint the fiscal power of government.
Ramanan: I am not a big fan of the usage of the phrase ‘fiat’. “Money is credit-led and demand determined” is my preference. For any type of institutional setup. I understand the limitations of most setups and you cannot assume any messed up understanding on my part. Now the essential point I am trying to make here is that as Anon pointed out the overkill is an overmuch.
Ramanan, I am not saying you don’t know what you are talking about or that your understanding is messed up. What I am saying is that MMT as “modern (post-1971) monetary theory” is about the operational difference between a convertible fixed rate monetary system (the previous system) and a nonconvertible floating rate system (the present system). Since the disagreement does not seem to be over the facts or the accounting, it is likely to be semantic. I think it probably stems from definition. MMT defines monetary systems operationally and categorizes systems on that basis generically. What you seem to be saying is that voluntarily political restraints imposed specifically alter the operational reality. MMT’ers disagree. This became clear, I thought, in “Marshall’s latest,” so I don’t know that anything new is being stated here. But maybe you are seeing something that I am missing.
anon said:
“a tax credit”
Great. If I wanted one of these tax credits today, could I go and get one or do I have to wait until the government decides my tax liability for next year? What can I get if the government decides my tax liability is zero?
I understand now. I still don’t take away anything useful from your point.
“What can I get if the government decides my tax liability is zero”
A tax credit.
The tax credit is your asset, good for paying taxes in the future.
The government can’t decide on your tax liability for next year, until next year has come and gone.
“I understand now. I still don’t take away anything useful from your point.”
It was you that introduced the question.
If you understand now, you are enlightened.
Most would consider enlightenment to be psychically useful.
Anon,
You said:
You have dealt with these points at huge and effective length in numerous blogs, but still my preference would be to see a heightened emphasis on their central role in the overall paradigm for the MMT message. My impression now is that more than enough emphasis is placed on an explanation of the working of the monetary system, including some semantic baggage that tends toward overkill and oversimplification. E.g. out of many: too much emphasis on “taxes going nowhere”, which in my view frankly is a trailer park interpretation of a very simple, very general but somewhat more elegant concept in finance, which is that income can always be applied toward the reduction of a net liability position. Conversely, more emphasis might be placed on thoroughly debunking the very dangerous “inflation is always and everywhere a monetary phenomenon”.
This a public blog. Some of us might live in trailers!
It’s appropriate to break the concepts down into simplistic terms (or analogies) for people without an economics background to understand. I think you are smart enough to understand what is meant when a layperson refers to concepts like “printing money” or “taxes disappearing down a black hole”. There was no real need to labour on the semantics and a legalistic bankers description of the monetary system. Nevertheless, you are knowledgeable and precise, so it was a good exercise for the smarter posters to hone their debating skills.
After several reads, I think (??) I get your main points. they appear valid to me. In my view, ideas have to be explainable on a bumper sticker to get popular credence. May I hazard an attempt at simplification of your points?
From a different perspective. A household budget can be considered unconstrained and a Government budget constrained. We should not take the broad assumption of household constraint and unconstrained Government budgets to dangerous extremes.
MMT would garner greater support if more emphasis was placed on….. How to run an expansionary monetary policy AND manage inflation.
I’m curious to know if I am getting the arguments, so I’d appreciate feedback. I have been hit and miss with my understanding so far 🙂
Tom, it seems like you are saying:
“All financial transactions are settled either in physical currency or bank reserves, except those that aren’t”.
which would of course be tautologically correct, but consequently a much weaker statement.
The semantic to-and-fro about “spending by crediting bank accounts” got me a bit lost, I must admit. It seems to me that both commercial banks and the government spend by “crediting bank accounts”, but that the difference lies in the consequences of the change in equity of the entity doing the spending, since, unlike commercial banks, the gov/CB can (I assume) operate with negative equity. Or am I missing something?
anon said:
“A tax credit.”
Let’s say I accept your strange definition of liability. What is its utility? Does it allow us to predict anything interesting? What?
“From a different perspective. A household budget can be considered unconstrained and a Government budget constrained.”
What is the utility of this perspective? There must be utility in this perspective for it to have any value because another perspective (the MMT perspective) has a great deal of utility.
Andrew,
Thanks for your question.
As Bill said, there are some gymnastics going on here, and I am not innocent of that charge. The points are rather subtle in the context of MMT.
The essence of the unconstrained/constrained differentiation in MMT is that of currency issuer versus currency user. Simplified, the unconstrained issuer can practise the causality/order of spending and then issuing currency to pay for the spending. The issuer issues bonds today in order to drain the money that otherwise would be left in the system by spending. A feasible alternative financial architecture would be not to issue bonds at all. By contrast, the constrained user must go and get the money, by bank borrowing or issuing bonds, for example. The constrained user doesn’t have the freedom of being an issuer.
In this context, MMT views the universe of currency issuers as comprising fiat currency issuing governments. That’s fine as far as it goes.
I’ve raised several points.
The first is that the currency issuing function is at its core banking function. In the case of a government, it relies on its central bank to do the first order issuing via bank reserves. MMT explores the possibility that central bank independence could be eliminated, with that function essentially combined with the government treasury. The balance sheet of the combined entity looks like the liability side of the modern central bank, but with additional liabilities corresponding to the cumulative government deficit. The bottom line either way is that currency issuance is a banking function, and the government requires a banking function in order to be a currency issuer.
My second point is that banking more broadly includes commercial banks, and what they do for the other sectors. They provide credit. E.g. a household that takes out a new loan to spend on consumer credits puts in motion a banking function that results in new bank deposits. That functionality shares some similarity to the central bank currency issuance function.
To see this more clearly, suppose the banking system consisted of just a single central bank and no commercial banks. Then the non government sector would borrow from that single bank and create money in the same way that the government does.
Moreover, there would be no bank reserves in such a mono-bank system. The only unique purpose of bank reserves is to create an interbank settlement facility in a competitive multi-bank system. At its root, the essence of currency issuance shouldn’t really depend on a multi-bank reserve requirement. It is interesting that MMT relies heavily on reserve based explanations for many of its expositions of how the monetary system works. Is there a case for a different approach?
So my observation is that households and others are effectively currency issuers when they borrow to spend. My suggestion is that a different differentiation might be possible in explaining MMT – instead of currency issuers and users, the idea of issuance limits. The issuance limit for non government is based on the usual credit risk analysis. The question then becomes, what is the issuance limit for government? MMT responds that there isn’t one – that’s the nature of not being constrained. And in a way, it’s easy to see this.
Yet there is a limit prescribed by MMT itself, and that is the notion of real constraints on government spending. So at some level, the real constraint for government parallels the credit risk limit for non government. That comparison would be my starting logic for MMT, rather than issuer/user. Issuer/user is a powerful differentiation, but it could be tweaked along the lines I’ve suggested.
In terms of some of the other issues, MMT applies strenuous effort to demystify popular misperception, using such phrases as “spending by crediting bank accounts” and “taxes go nowhere”. My point is that there are simple finance descriptions for putting this demystification effort into more standard phraseology, without necessarily jeopardizing the value of MMT insights into the nature of the monetary system.
For example, the reason taxes seem to go “nowhere” is that government income (taxation) at the transactional level is used to reduce financial liabilities (it reduces reserves in the current system). Taxes go nowhere in the same way that income used by a household to pay down its mortgage goes nowhere. There is no substantial reason to reject terminology such as “income” or “saving” when describing government financial activity.
(It is counterproductive in my view to debate whether or not something that appears on the liability side of a central bank balance sheet, such as reserves, currency, debt, and tax credits, is a liability or not. That sort of debate is not the point. There can always be a response to it, as in my example earlier. The important idea is some reasonable and practical coherence in explaining monetary operations in their full scope, without resorting to the “nowhere” type of vocabulary. Once that is cleared, it seems to me the more powerful ideas in MMT focus on the rejection of monetarist thinking in understanding the inflation process, and the inclusion of a real constraint centered framework (employment and capacity).)
“What?”
You’re trolling.
Anon,
There are Post Keynesians who have written in detail in the way you have described.
You are discovered Post Keynesianism by youself. Very nice.
Thanks for your considered reply Anon,
I think I do get most of your points. I sense (to a large extent) you are striving for correctness in terminology. Which is important explaining and selling MMT to a highly educated audience.
You say.
The question then becomes, what is the issuance limit for government? MMT responds that there isn’t one –
I’m sure MMT is correct in it’s logic, but I also feel there must be a point at which the social utility of an expansionary policy is impaired by excessive spending. I would regard this as a form of constraint. Why spend so much you do more damage than good.
Andrew,
Right.
Perhaps social utility falls under “real constraints” in a soft way.
That is why Warren is always quick to say ‘not operationally constrained’, no? Only constraints are real? Doesnt that cover it?
Resp,
(quick partial version of much longer unpolished post):
Anon: As MDM and I have brought up, the book to consult is the one Wray edited on Mitchell-Innes. In particular the phrase MDM quotes – all money is credit, but not all credit is money. Individuals do not issue (high-powered) money / currency = Government Credit, but personal credit – e.g. Anon-money. Yes, you can create net financial assets for the rest of the world, but they are your liabilities, of interest only to you and your creditors – not government liabilities, not NFA the way the term is usually used here. They are not currency. That is what happens if you do the split at you vs rest of world, not at the government vs nongovernment. The personal split eliminates all the currency & bonds held by everyone else as it is balanced out by government liability. So it is of no (macro)economic interest, unless you are a government – King of Anonia? 🙂
If you can exchange your personal liabilities for bank money, the bank has the IOU asset you created, you have the bank money, but still nets to zero government money creation. Only when you demand currency for your bank account do you get government NFA, and then the bank’s reserves decrease by the same amount. No net effect. Only if you cause discount rate borrowing – realistically only if you are a bank – will you be able to willfully cause the creation of new government NFA, which always necessitates government action, as Bill indicated, September 24, 14:11. When Bill says “net financial positions denominated in the currency of issue” he means net financial positions of the nongovernment relative to the government of course. Such pedantic clarifications need to be said and understood once; to repeat them always would make everything unreadable. And of course, no one, not even God can change the true net financial position of every entity taken together. It is always Zero – The same good old zero that appears on those sector balance equations.
Paradigm Shift: The semantic to-and-fro about “spending by crediting bank accounts” got me a bit lost, I must admit. It seems to me that both commercial banks and the government spend by “crediting bank accounts”, but that the difference lies in the consequences of the change in equity of the entity doing the spending, since, unlike commercial banks, the gov/CB can (I assume) operate with negative equity. Or am I missing something?
The government can do whatever it allows itself do. The CB can operate with negative equity for the simple reason that government accounting is a fiction relative to nongovernment accounting. The terms do not apply in the same way in real terms. Negative equity for nongovernment is a big deal, but no problem for government. Governments regularly operate “at a loss,” e.g., in deficit; therefore, they build up massive debt that gets rolled over. The Treasury cannot run out of money and the CB cannot go bust. That’s why an “MBA/CEO president” is a joke. The state is neither a business nor a bank. It is a social and political institution that human beings developed in order to meet social and environmental needs.
The real issue for government is managing money relative to real resources in order to balance private sector needs and “happiness” with promoting public purpose. Government creates state money, and banks are allowed (chartered) to participate in this process through loan creation (which puts capital at risk) at the pleasure of the government, since they are public/private partnerships operating under government charters.
What is the government’s actual equity? The ability to tax. If effect, the state owns everything through its ability to tax. Libertarians are quite well aware of this.
Government accounting is the way that government accounts for operations. It is in control of its operations in a way that nongovernment is not. However, government chooses to use accounting procedure that mimics nongovernment accounting procedure. That should not cause us to confuse government with nongovernment operationally when there are hierarchies operative that result in essential differences. Therefore the accounting terms are analogous at best, if not equivocal.
Some Guy,
King of Anonia works for me.
As does the Anonia/non-Anonia sector financial balances model.
I wouldn’t be making these comments if I wasn’t already quite familiar with what MMT says. I know what it says. I’m just offering a different slant on it.
You got the message right on the split possibilities. That’s good. The government/non-government split may well be the most important one, but it’s not the only one.
But I’m not sure you’re getting what I’m driving at on currency issuance.
Again, consider the alternative architecture, not only with no bonds and not only with a combined central bank/fiscal treasury function, but with no commercial banking. There is one single banking entity that performs all required banking functions, and that bank is embedded in the institution of government. MMT must allow for this possibility. Let’s call the banking function the national bank.
So with regard to currency issuance, what you have is government deficit spending, resulting in non government deposits appearing in the national bank (there are no longer any banking system reserves required).
I go to the same national bank to get my consumer loan. I spend that money into broader circulation.
I’m in the same position relative to the national bank’s creation of money as is the government. It’s my spending that has been the reason for the creation of new money by the bank, the same as the government.
I have my credit limits.
The government may consider itself to have limits according to “real constraints”, or limits as dictated by Congress, or whatever. The point is that there is a process for dealing with the issue of limits, one way or another. In the case of government, somebody has to deal with the issue of translating real constraints to financial limits, at some point. (One of the unspoken debates within MMT is whether you attempt to deal with that issue now or later. The default MMT position is always later, it seems.)
Thus, there are limit processes for myself and the government. The two processes are quite different. But they operate in parallel. And apart from those limits, there is no barrier to operational money creation by the national bank – whether the ultimate cause for the new money is myself or the government. In that sense, I’m not subject to an operational constraint any more than the government.
Bank reserves are not ground zero for this type of analysis, because bank reserves are merely an artifact of a competitive private sector banking system. MMT thinking should hold up whether or not that’s in place.
Anon –
You say the starting point for MMT logic should be non-govt being constrained by credit risk vs govt constrained by real resource issues. I don’t find the contrast that compelling – and I’m still not sure why you think this is THE relevant contrast to draw. Govt carries the power to levy taxes (which ensures a demand for the currency, in addition to the legal obligation to accept it inherent in any fiat currency). What is the equivalent to this power in your non-govt analogy?
I appreciate your focus is on moving people away from focussing on the quantity of money; but otherwise, what is your agenda with respect to MMT?
If MMT has an agenda in the real world right now, I would imagine it’s something like liberating popular and policy-makers’ opinion from a fear of budget deficits in excess of 10% of GDP. If you broadly accept this agenda, I’m not sure why you are pushing a “different slant” on the existing way of setting out the MMT logic.
Finally – if you could also try a mite harder not to sound patronising in your comments, that would be splendid. We have plenty of that already from Ramanan.
Anon: Again, consider the alternative architecture, not only with no bonds and not only with a combined central bank/fiscal treasury function, but with no commercial banking. There is one single banking entity that performs all required banking functions, and that bank is embedded in the institution of government. MMT must allow for this possibility. Let’s call the banking function the national bank….
This is a proposal that is out there, being advanced by some people, as is a proposal for bank money only, excluding state money. MMT is presently dealing with the global monetary system that is in place, i.e., sovereign nations as monopoly providers of nonconvertible floating rate currency, and also with the various variations on that theme that are also in place. Should the US adopt a different system, like no bond and Treasury overdrafts, or a national banking system with a single bank, or abolish the Fed and move to commercial banking only, MMT will have to deal with that. After all, the EZ and euro already stretch the bounds of the present monetary regime, and MMT is dealing with that. So, I agree that MMT principles should be applicable to thought-experiments, and I suppose that MMT economists would also.
Economics deals with the factors of production, distribution and consumption of real resources. Money & banking, and finance in general are supposed to support those ends. So iit comes down to real resources, with money used as a way of exchanging them, keeping score, postponing resource use through savings, and drawing resource use forward through credit. State money also serves as the means for the state to allocate resources to itself without seizure, although some would claim that taxation of private property constitutes seizure.
There is obviously a difference between a system with state money and one without it. MMT claims that the latter is pretty much irrelevant since it has not be significant historically and is not likely to be in the future. So analyzing an economy with state money becomes the issue for Chartalists. Chartalists see state money as divided into two monetary regimes, convertible/fixe rates ones and nonconvertible/flexible rate ones. MMT calls the latter “modern.” So MMT is the analysis of the use of state money in a nonconvertible floating rate system. To do this is uses 1) a description of government operations involved in the creation and control of state money, and 2) stock-flow macro models to analyze the production, distribution and consumption of real resources based on reporting of financial transactions. Depending on the quality of the data, this more or less reveals what is happening in the real world and what can be expected based on trends, as well as what is likely to happen if certain policy options are implemented.
MMT aka Neo-Chartalism is about the employment of state money, and this is the focus of MMT. Indeed, MMT economists seem to take the vertical-horizontal relationship of government and nongovernment as foundational. If there were no nongovernment banking system, then that relationship would not pertain. But even with one, the money that is used is state money in the sense that it can be used as legal tender at government payment offices, even if it is borrowed from nongovernment. This means that commercial banks participate in the generation of state money along with government as currency issuer. That is a privilege that the state extends through bank charters, which can be revoked by the state. The state could operate with state money without extending such charters.
According to MMT, the real constraint on government is the availability of real resources, both for its use and the use of the population. Government has to control the monetary system in such a way that real resources remain available for use without generating price instability or social hardship. If it wants to stay in power in a democracy it has to ensure that the population is materially satisfied (economically “happy”) to the degree that they do not turn the government out. Thus, citizens become a real constraint on government, too.
Individuals and nongovernment institutions are revenue constrained. They have to tap income, sell assets, draw down savings, or borrow in order to purchase goods and services. The monetarily sovereign government is not revenue constrained because it funds itself with currency issuance. There are a lot of ways to slice a pie because a pie has no inherent structure. But institutions matter, and one cannot just slice up an economy randomly. There are significant structures to take into account. What MMT points out, which many people seem to have missed, even economists, is that the vertical-horizontal relationship creates a partition between government and nongovernment financially.
If I have stated this correctly, I am not sure what you are driving at when you say something like, “…In that sense, I’m not subject to an operational constraint any more than the government.” Your point may be simple but it is eluding me. Both the government and I are operationally constrained by the boundaries of the system, but I am constrained in a different way that the government is. You admit that the government and I operate in parallel. Agreed. The government exists for me as a citizen, not me for the government. Government is an institution created by the state for its administration. In a liberal democracy, the government is said to be “of the people, for the people and by the people.” That, of course, is not the only option. A nation is a system characterized by elements (individuals) and subsystems (institutions) standing in relation to each other and the whole (state, nation), and the whole to them. In a sense, what I do affects the whole system, but all individuals do not have the same impact. The state as an institution stands in the primary and hierarchically premier place with respect to the monetary system, and the people that control the levers of power have a greater impact. There is a “hierarchy of money,” with reserves/currency (state money) at the top of the hierarchy at present.
Other systems can be imagined that are different, in which case an observer would have to observe them, and someone conducting a thought-experiment likewise. Thought-experiment enables consideration of all kinds of possibilities. I get this, and it is both useful and fun to consider them. But I don’t get where you are going with your train of thought around it relative to MMT. BTW, I don’t take it that you are opposing MMT, but rather that you are tying to make point. I am just not getting your point.
Tom,
My single bank model does not exclude state money. State money is created in the same way it is now – by deficit spending. Bank reserves are redundant, but currency is issued by the envisaged single national bank as it is now – just without the commercial banking system as distribution agent.
There is also no damage done to the MMT concept of vertical/horizontal differentiation of money and financial assets. This merely requires a decomposition of the single government/bank entity I’ve described. If that entity has private sector assets, such as my bank loan, that qualifies for MMT horizontal treatment. To the degree that it’s deposits exceed its assets, the difference qualifies for MMT vertical treatment. This is merely a matter of keeping track of the split between the amount of liabilities that correspond to government deficits and the amount that corresponds to the regular private sector banking function. It’s messier, only because treasury, central bank, and commercial banking functions have all been combined into a single entity. BTW, I’ve not seen any MMT proposal suggest that architecture.
“BTW, I don’t take it that you are opposing MMT, but rather that you are trying to make point.”
That’s right. The point is the hierarchy for the logic of MMT and its description of the monetary system. I’m proposing a different hierarchy. It’s in my comments above.
Tom,
It should be clear from considering the operational nature of an integrated treasury/central bank/commercial banking entity that both the government and household customers of this entity can spend money into existence “from nothing” at the operational level.
If there was no limit on government spending, and if there was no limit on my spending from bank credit, there would be no constraint on either of us.
Clearly, I am limited – I have a credit limit.
Is the government limited? Yes – by real constraints. MMT admits that. And it is not particularly illuminating to suggest that the government is not financially constrained when real constraints must obviously be translated to financial constraints in order for them to have any meaning at all in terms of their effect on deficit spending boundaries.
So we both have limits, and they are financial limits.
The MMT focus should be about the difference between those limits.
Dear anon (at 2010/09/27 at 10:52)
You asserted:
I consider that is an incorrect statement. There is no intrinsic financial limits on a sovereign government. They are all political and/or real. There is a world of difference between these sorts of constraints and the financial constraints imposed on a non-government spending entity.
Trying to blur them semantically does not help anyone understand anything.
best wishes
bill
Currently, the Internet Tzars are trying to implement IP(v)6, which includes 128 bit addressing. From Wiki:
“The very large IPv6 address space supports a total of 2E128 (about 3.4×10E38) addresses-or approximately 5×10E28 (roughly 2E95) addresses for each of the roughly 6.8 billion (6.8×10E9) people alive in 2010. In another perspective, this is the same number of IP addresses per person as the number of atoms in a metric ton of carbon.”
Now when this is implemented, the global govt internet Tzars will probably think they are unconstrained in their ability to assign internet addresses….Anon may think otherwise.
Anon may think this because humanity can never manufacture NIC cards at a Flow measure that will ever be able to reach this total number. So Anon would say there is a constraint, the ‘real’ capability of the electronics industry to achieve a certain NIC card manufacturing Flow. But the internet Tzars who are running out of addresses would care less as their problem would be solved and manufacturing of NICs would never have to shut down due to lack of addresses.
Resp,
I’m just jumping into the ring with the big boys for a bit of comic relief.
In the left corner weighing in at 300lb and 6’7″ we have the all empowered state bank.
In the right corner at 300lb and 4’8″ we have a fully privatised banking system.
Interesting fight but they are good at different things and both have unique problems. E.g. Private banks will manage the day to administration of household loans more efficiently than a State bank. Private banks don’t manage aggregate risk very well.
We shouldn’t argue the extremes but look to create the ultimate fighting machine (A happy balance).
Why can’t we all just get along……:(
Anon:
there are limit processes for myself and the government.[…] And apart from those limits, there is no barrier to operational money creation
Since ‘barrier’ and ‘limit’ are synonyms, your statement seems inconsistent, prima facie at least. One might assume that what you wanted to say was :”apart from those limits (whatever those limits might be) there are no other limits to money creation”.
One would rather not assume though, but wait for an explanation of that odd statement.
Parenthetically, the mono-bank system you describe is not a theoretical construct but an actual system that was implemented and used in the USSR between 1933 and 1987, under the name of GOSBANK, without any complications of the interbank market whatsoever. Are you proposing the GOSBANK system as an MMT option ?
anon,
Thank you for explaining your thinking.
Matt,
I’m not very familiar with the technology of your analogy, but it seems to me the difference is that the internet Tzars have not assumed there are real constraints to their expansion process. As I understand it, MMT does assume real constraints are possible if not probable.
VJK,
It could be an option although I would not propose it as a selection. Your replacement sentence structure is quite OK.
Anon:
Thank you for the clarification.
Regarding the limits. In the hypothetical no-bond/merged CB+treasury universe, what number or a set of numbers would represent the government money creation limit ? If such set of numbers would exist in the NB universe, what specific tools and government structures would be used to control government money creation in a reliable and predictable way ?
VJK,
This may seem like a bit of a “cop out”, but I don’t think we know what the limit is, at least not in a very straightforward sense.
The murky area to me is that if we believe that there are real constraints to deficit spending, then those real constraints should affect decisions regarding a policy upper bound for deficit spending at some point – i.e. at the point that those constraints become “binding”. The aspect I then struggle with about MMT is that I wonder how such decisions flowing from the activation of real constraints actually enter into the process over time. Is this a sudden adjustment, or is there an element of anticipation, planning, or gradualism involved in starting to execute the idea of limits or upper bounds as the real constraint starts to bind?
So the idea of a “limit” is somewhat soft, compared to the harder limit of a maximum credit allowable for a household.
Still, this is the sense in which I’m suggesting there is a parallel.
VJK and anon, I think we have already passed a global limit for government money issuance. The governments may be operationally able to issue money in an unrestrained manner but the economy can only cope with a certain ratio of money in savings versus wages/consumption. Once the size of the real economy is dwarfed by the amount of money in savings, then capital allocation stops leading to the appropriate resource allocation that the real economy requires. The economy breaks down into a ponzi mess which is what is happening.
Anon:
Thank you for the thoughtful response.
Broadly, the considerations you have outlined are what bothers me too.
I don’t think we know what the limit is, at least not in a very straightforward sense.
Metaphorically speaking, it seems that the Mosler car may be set in motion without a speedometer and the brakes with both the engineer and the mechanic running alongside and trying both to design and mount missing pieces in vivo.
Vjk,
MMT Proselyte has already accused me of sounding patronising plus I have debated this many times with no empathy. Some commenters may accuse me of advocating the “twin deficits” doctrine. I must admit that I believe in it – though in a complicated dynamical way. However, see the blog post “twin deficits and other neoliberal myths” (don’t remember the exact title).
My views are quite opposite of MMT on this.
A nation has more fiscal capacity than what neoclassicals think but I think that there is one more constraint than the real constaint. That’s the balance of payments constraint.
Nations cannot ban imports because it goes against WTO rules. A good way to do a fiscsl expansion is to promote exports. Of course, it is silly to behave like China and peg your currency to a super overvalued number and transfer resources to the US. Some nations are lucky – the continue to attract foreign inflows to finance the trade deficit. However, this process is sustainable as long as the foreigners allow it to go on. The external world is a big constraint on fiscal policy.
Ramanan:
Thanks.
I think that there is one more constraint than the real constraint
How would you quantify “the real constraint” ? We’ll deal with CA/KA business later 😉
Vjk,
Neoclassicals think that fiscal policy is useful only temporarily and economies are mostly supply constrained. Money is neutral both in the short run and the long run in this picture and hence inflation is anywhere and everywhere a monetary phenomenon. They do not know how the money supply changes and conjecture things like the central bank printing money etc. Deficits are said to cause inflation because it is thought that the central bank monetizes some of the debt. This picture is wrong!
Moneterists won over Keynesians in the 70s because in that time wages increased – this caused firms to borrow more, causing the money supy to rise – because loans make deposits etc. Higher wage rates meant higher costs for firms and hence increase in prices. This caused workers to demand higher wages and it turned into a mess. Milton Friedman became popular while he convinced policy makers to reduce deficits and the money supply. The central banks increased rates to astronomic levels because direct control of money supply is impossible in practice. In reality they were just controlling interest rates and the high rates led to a recession and deflation. Hence we have the monetarist myth. They confused correlation to causation.
Inflation happens because of the societal struggle on the share of national income. It can also happen due to other supply factors such as food etc. One may say that inflation is due to rise of wage rates above productivty growth rates. Wages are downward sticky due to wage contracts and hence there is an upward bias on prices. Nobody likes high inflation and Milton Friedman conjectured the NAIRU. In reality its a chimera but there is some truth to it. When employment is near full empoyment – which is never the case – workers may have a higher bargaining power and this may lead to higher prices. However it is unscientific to conjecture that it will lead to accelerating inflation.
There are various ways to tackle this. For example fast wage increases can be discouraged by taxes. So there are a lot of complications there.
Also the basic rule has to be kept in mind – the Kaleckian thesis that when demand rises, firms do not increase prices as the neoclassicals say, they increase the quantity.
Didn’t answer your question. Its difficult to quantify really. Governments need to make sure that wages are in line with productivity growth for example. SIngapore does something like that. Don’t know the details. Many things can be achieved by having a proper scientific approach to policy. On the other hand, check Ben Bernanke’s speech recently at Princeton – he says that there is nothing wrong with the present economic theory and he calls it a science!!!
Ramanan: I’m eager to hear criticisms of MMT (not least because MMT appears in danger of suffering from epistemic closure) so can you expand on your BOP constraint please?
The way Bill, Mosler, JKG2 and Wray outline the real resource constraint, it’s related to aggregate capacity utilisation, irrespective of what the BOP says.
Anon – appreciate you trying at length to outline your govt/household parallel, but it seems that at least Tom H, Bill and I remain in the dark as to the relevance of your distinction. Do you have a blog where you set out clearly what you are all about, as I’m struggling to follow your myriad posts? Frankly the return on one’s effort expended to engage with your (admittedly intriguing) points makes me feel like you’re a troll, and you may well not be.
Anon: Yes, I get what you are saying, I understand because I thought of these things myself while trying to plumb the depths of MMT. I think some statements are so misleading that some other guys might call them “wrong.” 🙂 Bill, Tom etc are clearly right.
I write below at pedantic length to help interested others.
The single bank = Fed= Treas = government model, which is the essence of the current system makes it clear why “government and household customers of this entity can spend money into existence “from nothing” at the operational level.” or “households and others are effectively currency issuers when they borrow to spend” are not reasonable statements. What the reserve banking / discount rate picture collapsed into the single bank model boils down to is:
I, Anon, can give the government my IOU for $1 Million. IF I can persuade the gov to lend to me, they can give me their IOU for $1 Million – a government check for $1 Million. But the IF is a very big if, which has been elided. Only if you are a TBTF Bankster – pulling the strings of the government – to many intents and purposes, part of the government, can you do this.
There are semantic problems in your response, which at one point reasonably conflates the gov/treasury and the bank, and then invalidly separates them to seem to make the central bank the real government, and consider the gov/treasury as just another customer. This has it backwards. The central bank, and any bank, is inessential, dispensable, a recent innovation, and could be replaced by a cookie jar. The monetary/spending/taxing function of the treasury is not, and is indispensible to the concept of money.
Currency is (a type of) government credit. Government is the monopoly issuer. Individuals can create their own credit, unconstrainedly, to any sum, just as governments can. That is not the difference between individuals and governments. And individuals may be able to trade their own credit with governments for government credits. But there has to be an intentional government action for the trade to take place. They are always the currency issuer.
Unlike individuals, governments can issue credit not only in their name. They can write U-O-Me’s – IOUs in your name, payable to the government, without your intent or action. These are called taxes, and are what ultimately give government credit (unlike personal credit) intrinsic tradeable value for real world objects and services. The government can issue gov-credit and anon-credit, while anon can issue only anon-credit. My earlier comparison was a check-kiter, who is also a forger. Some guy who can make perfect, enforceable forgeries – checks from others to back up his kited checks, has the financial power of a government. So there is no meaningful way individuals are currency issuers. Neither individuals nor governments have intrinsic purely financial constraints. But because of government’s taxing / forging power – at any moment it can buy all the stuff in its legal reach – only governments are constrained only by real physical limits in the interaction of the financial world with the real one, in its capacity as a buyer confronting sellers.
The reason comparing silly rules like positive treasury balance, no monetization, head of the Fed must be a middle aged white male rather than a chimp (cf a Wray blogpost), etc to credit limits is simple. It’s comparing apples and oranges. Getting a bank loan of bank/government money in exchange for personal credit is borrowing. Government “borrowing” – issuing bonds to trade for currency is not borrowing. Government spending in return for private stuff is closer to private borrowing. Government “borrowing” in its own currency is constrained because it is a logical impossibility. You cannot borrow your own credit from someone else. Government “borrowing” is closer to making change – the Treasury trading its hundred dollar bills it created for a hundred of the one dollar bills the Fed created than it is to real borrowing. Mark Twain’s story “The Million Pound Note” or the Gregory Peck movie might be helpful to get in the right frame of mind. And just as the government could have “no bonds” policy, it could have a “no currency” policy, or put any crazy condition it wanted on its credit.
And so conclusions like “That difference is more constraining on governments than it is on households.” are not just wrong, but hardly intelligible.
@MMT Proselyte:
Anon is not being a troll. However, imho he is not being precise and careful enough and so is saying things which may be interpretable as true, but in the natural interpretation, are not. Like individuals being “currency issuers.” Exactly what they are not and can never be.
Some Guy,
Thanks for your comment.
I said earlier:
“my observation is that households and others are effectively currency issuers when they borrow to spend”
Not being quite sure that I said something like that, I looked for the reference based on your comment.
That what I said. And yet the single bank model actually highlights the fact that the issuing entity is effectively the government – so you are quite right to criticize such a statement on that basis.
So the question (for me as well) is what was I thinking in making such a statement?
I did say “effectively”. What I meant by it is that both the government and the household are using a banking function in such a way that it causes the bank to issue currency. If you separate the aspect of who is causing the currency to be issued from the aspect of whose credit is backing the currency issued, then my point may become a bit clearer. While the credit backing of the currency issuance is clearly the government, both the household and the government can cause the currency to be issued. The case of the household being the causal agent is the sense in which I used the word “effective”.
But you’re right to criticize, at least because it was a misleading statement (unintentionally), and there should be a better and more accurate way of expressing this thought.
anon, when you credit-spend and thus create “money” you actually issue not your money but other money which is government money. The step that is missing in your logic is that your bank converts your money into government money and settles your transactions for you when you pay for goods and services. But you still have to pay back your credit and it happens not with your money but other money, government money. This is what your bank will accept as repayment. That is precisely the reason why private sector is credit constrained but government is not. The banking and settlement system and central bank on top of it all constantly make sure that conversion rates are all par. Otherwise somebody is not viable and has no more credit.
If you can devise a case when private liabilities are worse more than government (so conversion is above par) then I would be happy to hear. As far as I can see the risk is only to the downside up.
“your logic”
Both households and government create bank money when they deficit spend.
Both are constrained and face financial limits.
Households are constrained by credit risk; governments are constrained by inflation risk.
As a result, there are financial limits to both.
I’m pretty interested reading this views of yours. I have a thought that what if the Federal Government borrows a large amount of funds. This may crowd out other potential borrowers and the interest rate might bid up by the deficit units. In other words, the fiscal budget deficit in large scale resulting in higher interest rates. Doesn’t it?
Dear IceBound (at 2012/11/04 at 7:42)
Short answer No! Long Task for you – start at the beginning of these blogs and read on – https://billmitchell.org/blog/?cat=11
best wishes
bill