I am still catching up after being away in the UK last week. I will…
What is the balanced-budget multiplier?
I have been working today on the modern monetary theory text-book that Randy Wray and I are planning to complete in the coming year (earlier than later hopefully). It just happens that I was up to a section on what economists call the balanced-budget multiplier which is a way to provide stimulus without running a deficit when I read an article in the New York Times (December 25, 2010) by Robert Shiller – Stimulus, Without More Debt. I also received a number of E-mails asking me to explain the NYT article in lay-person’s language. So a serendipitous coming together of what I have been working on and some requirement for explanation and MMT interpretation. So what is the balanced-budget multiplier?
In the New York Times article, Yale academic Robert Shiller introduced the notion of a balanced budget multiplier which he says will allow the US government to provide more stimulus but “does not require deficit spending”. The logic of this is:
With the unemployment rate at 9.8 percent, more … [stimulus] … will certainly be needed, yet further deficit spending may not be a politically viable option. Instead, we are likely to see a big fight over raising the national debt ceiling, and a push to reverse the stimulus we already have. In that context, here’s some good news extracted from economic theory: We don’t need to go deeper into debt to stimulate the economy more.
Most people associate a fiscal stimulus with an expansion of the deficit. But there is a curiosity in macroeconomics that a “Keynesian economic stimulus does not require deficit spending”.
Shiller says that “(u)nder certain idealized assumptions, a concept known as the “balanced-budget multiplier theorem” states that national income is raised, dollar for dollar, with any increase in government expenditure on goods and services that is matched by a tax increase”.
The history of the concept is interesting but beyond this blog. Shiller notes that during the Great Depression, Keynes and his group developed the national income generation model of macroeconomics and it became standard doctrine to assume that the spending multiplier (discussed in detail below) was above 1.
This meant that when governments increased net spending the ultimate rise in total income would be more than the initial increase in net public spending:
… because the income generated by deficit spending also induces second and third rounds of expenditure. If the government buys more goods and services and there is no tax increase, people will spend much of the income that they earned from these sales, which in turn will generate more income for others, who will spend much of it too, and so on.
However, the worries about increasing public debt ratios have never been far below the surface and Keynesian economists in the 1940s started to consider the impact of deficit spending on public debt. Remember, this was an era where governments operated in a convertible currency system with fixed exchange rates and so were financially constrained.
So unlike now (since 1971) where a sovereign government is never revenue constrained because it is the monopoly issuer of the currency and floats that non-convertible currency on international markets governments had to “finance” their net spending by issuing debt. Now, the act of debt-issuance to match deficit spending is totally unnecessary and voluntary. It is an artefact of a monetary system that most countries abandoned in 1971.
But back in the 1940s, economists were worried that the accumulated debt from the Great Depression then the prosecution of the Second World War might be so large that it might constrain the capacity of governments to ramp up their deficits again (because the withdrawal of the war-time stimulus might provoke a return to recession).
Note: no such worry should exist now. A sovereign government can spend what it likes as long as their are goods and services available for sale it its currency regardless of the public debt ratio. The latter is irrelevant in a modern monetary system for determining (or influencing) in a technical sense – government spending.
All the fears we hear now (which were valid during the 1940s) are simply the echoes of ignorance or conservative ideologies and have no substance in economic/financial theory or practice.
As Shiller notes of the 1940s “this worry was unfounded. The Depression did not return after the war”. But the fears spawned the development of the insight that became known as the balanced budget multiplier.
So what is the balanced-budget multiplier? Several people have written to me asking me to explain this. Serendipitously, I have been working on a section of our textbook which spans this topic this week and so with the stars aligning a corresponding blog seemed appropriate.
Shiller offers this explanation of the balanced budget multiplier:
The reasoning is very simple: On average, people’s pretax incomes rise because of the business directly generated by the new government expenditures. If the income increase is equal to the tax increase, people have the same disposable income before and after. So there is no reason for people, taken as a group, to change their economic behavior. But the national income has increased by the amount of government expenditure, and job opportunities have increased in proportion.
I doubt that will resonate very well with many people. So more explanation is obviously required.
But first we need to develop some conceptual apparatus in the form of a simple macroeconomic model to first understand what national income determination is all about, then to refresh our memories on how the normal spending multiplier works before we can hope to understand the concept of a balanced budget multiplier.
Jargon aka terminology
All disciplines invent their own language as a way of making it harder to understand so that they can parade in the public sphere with a semblance of authority even if no such authority is justified by the actual substance of the ideas.
Here is some terminology (jargon) that is used in the specification of macroeconomic models. All models have a number of equations which are relationships between variables. Each equation has some variables, some coefficients (or parameters). Usually a variable is written on the left-hand side of the equals sign (=) and is then expressed in terms of some other variables on the right-hand side of the equals sign.
So y = 2x is an equation which says that variable y is equal to 2 times variable x. So if x = 1, then y = 2 as a result of this equation.
The rule is that what is on the left-side of the equals sign has to be the same in magnitude as what is on the right-side (that is, an equation has equal left and right sides). You solve an equation by substituting values for the unknowns.
In the above example the 2 is called a coefficient which is an estimate of the way in which y is related to x. A coefficient can also be called a parameter – which is a given in a model and might be estimated using econometric analysis (regression) or assumed by intuition).
In the specific context, a variable is some measured economic aggregate (like consumption, output etc) which is denoted by some symbol that hopefully makes sense. The correspondence between the short-hand symbol and the variable is not always intuitive but convention rules.
So Y is often used to denote GDP or National Income (but it can also be used to denote total output). C is usually used to denote final household consumption and I total private investment. X is typically used to denote exports and M imports although in some cases M is used to denote the stock of Money. I always use M for imports.
There are two types of equations that are used in macroeconomic models: (a) identities which are true by definition – that is, as a matter of accounting – they are indisputable; and (b) behavioural equations which depict relations between variables that model behaviour – for example, consumption behaviour.
An example of an identity is the national income equation depicting aggregate demand and output:
Y ≡ C + I + G + X – M
Note that in strict terms we write an equation that is an identity using the identity sign (three parallel horizontal lines) instead of the equals sign (two parallel horizontal lines). For the rest of this blog I will just use the equals sign irrespective but you should be aware that some of the equations are identities and are thus accounting statements.
A behavioural equation captures our hypotheses about how some variable is determined. So these equations represent our conjecture (or theory) about how the economy works and obviously different theories will have different behavioural equations in their system of equations (which is what a model is).
An example of a behavioural equation is the consumption function:
C = C0 + cYd
which says that final household consumption (C) is equal to some constant (C0) plus some proportion (c) of final disposable income (Yd). The constant component (C0) is the consumption that occurs if there is no income and might be construed as dis-saving.
In macroeconomics, some behavioural coefficients are considered important and are given special attention. So the coefficient c in the consumption function is called the marginal propensity to consume (MPC) and denotes the extra consumption per dollar of extra disposable income. So if c = 0.8 we know that for every extra dollar of disposable income that the economy produces 80 cents will be consumed.
The MPC is intrinsically related to the marginal propensity to save (MPS) which is the amount of every extra dollar generated that is saved (after households decide on their consumption). So the MPS = 1 – MPC by definition.
The importance of MPC is that is one of the key determinants of the expenditure multiplier (more about which later). Please read my blog – Spending multipliers – for more discussion on this point.
The other piece of jargon that we encounter is the difference between exogenous (pre-determined or given) variables and endogenous variables (which are determined by the solution to the system of equations).
An exogenous variable is known in advance of “solving” the system of equation. We take its value as given or pre-determined. We might say that government spending (G) is equal to $100 billion which means that its value is known and not determined by the values that the other variables take or are solved to.
But in a system of equations, the values of some variables are unknown and are only revealed when we “solve” the model for unknowns.
So if we have these two equations which comprises a “system”:
(1) y = 2x
(2) x = 4
Then x is a pre-determined variable (with the value 4) and is thus exogenous. You do not know the value of y in advance and you have to solve the equations to reveal its value – so it is endogenous. It is determined by the solution to the system.
To solve this system we substitute the value of x in Equation (2) into Equation (1) so we get:
y = 2 times 4
y = 8
So the solution of a system merely involves substituting all the known values of the coefficients (in this case the 2 on the x) and the exogenous variables (in this case x = 4) into the equations that depict the endogenous variables (which in this case is only Equation (1) but there will typically be multiple endogenous variable equations).
In real modelling it becomes very complicated as to which variables can be considered endogenous and which are truly exogenous. At the extreme, everything might be considered endogenous and then things get mathematically complex and there is a whole body of theory in econometrics relating to the identification problem, which is well beyond this blog.
A simple macroeconomic model
In macroeconomics we know that expenditure equals income (output). This fundamental relationship is covered in the national accounting framework.
The national income identity which relates income (Y) to expenditure (E) is written:
(1) GDP ≡ Y ≡ E ≡ C + I + G + (X – M)
where C is final household consumption, I is private capital formation (investment), G is government spending, X is total export spending and M is total import spending. The right-hand side of the identity is total expenditure in a given period (a flow).
Another accounting statement is the relationship between disposable income (Yd) and total income (Y):
(2) Yd ≡ Y – T
where T is total tax revenue net of transfers (pensions etc). This is the government’s share of national income. So Y is pre-tax income and Yd is after tax income.
Our simple behavioural equations are:
(3) Consumption function C = C0 + cYd
Consumption is the determined by some fixed amount independent on income plus the MPC (c) times disposable income. The MPC lies between 0 and 1. The higher the MPC the higher is the proportion of new income generated that is consumed. So if c = 0.8 then there will be an extra 80 cents in consumption for every extra dollar generated.
Clearly the MPC = 1 – MPS. So if c = 0.8 then 20 cents in every extra dollar generated after tax is saved.
(4) Investment function I = I
While in the real world investment is likely to depend on interest rates, expected income and other variables in this simple model we assume it to be fixed in each period – that is, it is considered exogenous.
(5) Export function X = X
While in the real world exports are depend on local and external influences in this simple model we assume them to be fixed in each period – that is, they are considered exogenous.
(6) Import function M = mY
Imports are considered proportional to total income where the proportion (m) is the marginal propensity to import. In the real world, imports will be influenced by other factors including the real exchange rate. If m = 0.20 then imports will increase imports by 20 cents for every real GDP dollar produced.
The behavioural policy equations are:
(7) Government spending G = G
So we assume government spending is fixed in each period.
(8) Tax rule T = tY
Tax revenue is a simple function of total income where t is the marginal (and average) tax rate. We could make the rule more complex by adding in, for example, lump-sum taxes and other taxes independent of income.
So if t = 0.2 then Yd = (1 – t)Y = 0.8Y.
The system of equations (1) to (8) define our macroeconomic system or model. You will note that the system reduces very quickly to the following model (because several of the variables are given in this simple model). We will also assume that C0 = 0 for further simplicity.
Y = C + I + G + (X – M)
C = cYd
T = tY
M = mY
In mathematics if you have a system of equations, to get a solution you need to have as many equations as there are unknowns. We have four variables which are unknown here Y, C, T and M and four equations so we should be able to find a solution. In fact we can simplify the model even further by substituting (“putting”) the equations for C, T and M into the national income equation as follows:
Y = cYd + I + G + X – mY
We also know that Yd = Y – T = Y – tY, so our simple model reduces to a single equation with one unknown (Y) which will allow us to solve for Y and then subsequently we will know what C, T and M are.
Y = c(Y-tY) + I + G + X – mY
We simplify this further by collecting all the Y terms on the left hand side:
Y – c(1 – t)Y + mY = I + G + X
Note: all the exogenous variables in our model are on the right-hand side.
This simplifies further (non-mathematicians please bear with me – it is just a matter of understanding a few simple rules of algebra, applying them and re-arranging terms):
(9) Y[1 – c(1 – t) + m] = I + G + X
Therefore our model solves for total output and income (Y) as:
(10) 
We could simplify this further by denoting the exogenous right-hand expenditures are A (autonomous spending) such that:
(11) 
So a change in A will generate a change in Y according to the this formula:
(12) ΔY = kΔA
where k = 1/(1 – c*(1-t) + m) and is the expression for the expenditure multiplier.
A model solution
Assume that c = 0.8; m = 0.2; t = 0.15. This will give a multiplier value of approximately 1.9. It is in fact equal to 1.92307692.
This means that if A changes by 1 (that is, there is an extra dollar of spending) then national income will rise by $1.92. National income would fall by $1.92 if A fell by 1.
Clearly A could rise if investment and/or government spending and/or exports increased. A can increase even if private investment falls as long as government spending and/or exports rises by more than the fall in investment. You can tell a myriad of different stories about the way the government sector, the private domestic sector and the external sector is performing and how these sectors impact on aggregate demand (spending) and hence national income (GDP).
With these behavioural coefficient values, and if we know that I = 100; G = 100 and X = 150 then we can solve for national income as follows:
Y = kA
Y = 1.92307692(350)
Y = 673
C = c(1-t)Y = 0.8(1-0.15)673 = 458
S = (1-t)Y – C = 0.85(673)-458 = 114
T = tY = 0.15(673) = 101
M = mY = 0.2(673) = 135
We can then deduce the following balances:
Government budget balance = (G – T) = (100-101) = -1 (that is, a small budget surplus)
Private domestic balance = (I – S) = (100-114) = -14 (that is, a surplus because saving is higher than investment spending)
External balance = (X – M) = (150 – 135) = 15 (that is, a trade surplus)
We know that the balances have to sum to zero which they do (when arranged in the correct way).
An increase in government spending
Assume that the government wants to increase national income because it considers that employment is too low and unemployment is too high. It can use its fiscal capacity to stimulate aggregate demand (by increasing G).
If it increases G by $50 – so G now rises to $150 then what is the impact on the system?
In this case A increases by 50 and is multiplied throughout the economy 1.92 times so that the total increase in national income is 769.
Consumption rises to 523; Imports rise to 154; Saving rises to 131; Taxes rise to 115.
In terms of the balances, the budget is now in deficit of 35; the private domestic sector saving overall increases to 31 and net exports records a small deficit (because imports have risen with the rising income).
So an expansion in government spending which pushes the budget into deficit (even though tax revenue also rises) stimulates national income and promotes increases in both consumption and saving.
Why does the multiplier work in this way?
Remember the basic macroeconomic rule – aggregate demand drives output with generates incomes (via payments to the productive inputs).
What is spent will generate income in that period which is available for use. The uses are further consumption; paying taxes and/or buying imports. We consider imports as a separate category (even though they reflect consumption, investment and government spending decisions) because they constitute spending which does not recycle back into the production process. They are thus considered to be “leakages” from the expenditure system.
So if for every dollar produced and paid out as income, if the economy imports around 20 cents in the dollar, then only 80 cents is available within the system for spending in subsequent periods excluding taxation considerations.
However there are two other “leakages” which arise from domestic sources – saving and taxation. Take taxation first. When income is produced, the households end up with less than they are paid out in gross terms because the government levies a tax. So the income concept available for subsequent spending is called disposable income (Yd). So taxation (T) is a “leakage” from the expenditure system in the same way as imports are.
Finally consider saving. Consumers make decisions to spend a proportion of their disposable income. The amount of each dollar they spent at the margin (that is, how much of every extra dollar to they consume) is determined by the marginal propensity to consume. Saving will be the residual after the spending (and tax) decisions are made. Saving (S) is thus a “leakage” from the expenditure system.
Economists also define expenditure “injections” as autonomous spending which in our model comprises the sum of investment (I), government spending (G) and exports (X). The injections are seen as coming from “outside” the output-income generating process (they are exogenous or autonomous expenditure variables).
For GDP (Y) to be stable injections have to equal leakages (this can be converted into growth terms to the same effect). The national accounting statements that we have discussed previous such that the government deficit (surplus) equals $-for-$ the non-government surplus (deficit) and those that decompose the non-government sector in the external and private domestic sectors are derived from these relationships.
So in our simple model the uses of national income are:
C + S + T + M = 458 + 114 + 101 + 135
And the sources of spending are:
C + I + G + X = 458 + 100 + 100 + 150
The total leakages are:
S + T + M = 114 + 101 + 135 = 350
The total injections are:
I + G + X = 100 + 100 + 150 = 350
National income is in equilibrium (that is, will not change) once the leakages equal the injections. Income changes bring that equality into force because the leakages are sensitive to income changes.
So imagine there is a certain level of income being produced – its value is immaterial. Imagine that the central bank sees no inflation risk and so interest rates are stable as are exchange rates (these simplifications are to to eliminate unnecessary complexity).
The question then is: what would happen if government increased spending by $50? This is the terrain of the expenditure multiplier. If aggregate demand increases drive higher output and income increases then the question is by how much?
The spending multiplier is defined as the change in real income that results from a dollar change in exogenous aggregate demand (so one of G, I or X). We could complicate this by having autonomous consumption (C0) as well but the principle is not altered.
Firms initially react to the $50 order from government at the beginning of the process of change. They increase output (assuming no change in inventories) and generate an extra $50 in income as a consequence – so Y increases initially by the full injection of new government spending ($50).
The government taxes this income increase at 15 cents in the dollar (t = 0.15 in our example) and so disposable income only rises by $42.50.
There is a saying that one person’s income is another person’s expenditure and so the more the latter spends the more the former will receive and spend in turn – repeating the process.
Households spend 80 cents of every disposable dollar they receive which means that consumption rises by $34 in response to the rise in production/income. Households also save $8.50 of the initial increase in disposable income as a residual.
Imports also rise by $10 given that every dollar of GDP leads to a 20 cents increase imports (by assumption here) and this spending is lost from the spending stream in the next period.
So the initial rise in government spending has induced new consumption spending of $42.50 which then triggers further production increases.
At the end of the first period (before the induced consumption spending starts to take effect), the total leakages (S + T + M) equal 26 (that is, 8.50 + 7.50 + 10) and they are well below the initial injection of 50. So the system is not yet at rest because the leakages have not yet matched the initial injection.
This is where the multiplier begins. The workers who earned that initial increase in income increase their consumption by $42.50 and the production system responds. So consumption spending in the next period rises by 0.8(1-0.15)42.50 = $29.90. Firms react and generate and extra $29.90 of extra output and income to meet the increase in aggregate demand.
And so the process continues with each period seeing a smaller and smaller induced spending effect (via consumption) because the leakages are draining the spending that gets recycled into increased production.
Eventually the process stops and income reaches its new “equilibrium” level in response to the step-increase of $50 in government spending. At that point the leakages will have risen in total (accumulated over the period of adjustment) to match the initial 50 injection in government spending.
The new national income is $769 a rise of $96 after the government increased its spending by $50. The extra $46 in income came about by the successive induced consumption increases as the multiplier played out.
Please read my blog – Spending multipliers – for more discussion on this point.
The balanced budget multiplier
Now we can see how the balanced budget multiplier works and is different to the normal expenditure multiplier.
What we will see is that Shiller is making very large assumptions about the external sector. But to see that we need to go back to our simple macroeconomic model.
There is also a complexity that I will abstract from which is whether the budget neutrality is to be achieved at the time of the spending (so initially) or at the end of the multiplier process. The latter is much harder to explain in a blog and so I will assume that the government decides to initiate a budget neutral spending increase which is in the spirit of Shiller’s proposal.
The other complexity is how the tax increase is accomplished. Clearly we could increase the tax rate such that at the current level of income the tax revenue rises by the amount of extra government spending. Or we could simply impose a lump-sum tax of $50 and leave the income tax component alone. The final result is dependent of which choice is made. In this example we assume a lump-sum tax equal to the rise in government spending is imposed – it keeps the model and the explanation simpler and is the way most of the old text-books used to explain it anyway. If there is sufficient interest I can write the model out where I change the tax rate to accomplish the same end.
So if we go back to our example where the government increases its spending by $50 but taxes are simultaneously increased by $50 so that the deficit is unchanged and there is no debt-issuance required (even under the voluntary practices that are used in today’s modern monetary system).
What is the net impact of national income of the increase in government spending and the matching increase in tax revenue? The balanced budget multiplier theorem tells us that the impact is not neutral. In fact, national income rises by exactly as much as the increase in government spending.
Clearly this has to work via the separate impacts that the increase in government spending and the increase in taxes have on aggregate demand. Remember aggregate demand (spending) equals income (changes equal changes).
The initial rise in aggregate demand (and income) attributable to the increase in government spending is ΔG = 50. If there was no tax rise, then this increase in income would induce further consumption spending and the expenditure multiplier (k) would determined the final increase in output (income).
But the initial rise in taxes ($50) causes consumption to fall because disposable income falls. Note we are assuming a lump-sum tax is imposed and the tax rate (t) is unchanged. Therefore the spending multiplier derived above is unchanged.
The drop in consumption is the drop in disposable income ΔT times the marginal propensity to consume (c). Thus the fall in consumption is given as:
(13) ΔC = -cΔT
Given that c = 0.8 and ΔT = 50 the initial fall in consumption is $40.
The tax multiplier is thus given as:
(14) ΔY = -kcΔT
So the fall in consumption (cΔT) which results from the fall in disposable income initially multiplies through the expenditure system via the spending multiplier k = 1/(1 – c(1-t) + m).
In our example, other things equal this would lead to a fall in income (Y) of 1.92(40) = $77
However, aggregate demand is also stimulated by the change in government spending. The rise in income attributable to this is given by Equation (12) so:
ΔY = kΔG = 1.92(50) = $96.2
The total change in national income is thus the sum of the tax multiplier impact and the government spending multiplier impact, which is just the net change in aggregate demand multiplied by k:
ΔY = kΔG -kcΔT
And because ΔG = ΔT this becomes:
ΔY = k(1-c)ΔG = 1.92(1-0.8)(50) = $19.2
Puzzled? Recall that Shiller said that “(u)nder certain idealized assumptions, a concept known as the “balanced-budget multiplier theorem” states that national income is raised, dollar for dollar, with any increase in government expenditure on goods and services that is matched by a tax increase”.
That is, Shiller is claiming that the balanced-budget multiplier is unity (= 1). In our example, it is positive but certainly not equal to 1. For a rise in government spending of $50 the final rise in national income is only $19.2.
What gives?
The reason is simple. Shiller must have dug out an old 1950s or 1960s American macroeconomics text-book which derived all the main macroeconomic results as if the economy was closed. In those days, the external sector and trade were often examined in the closing chapters. This was justified by the fact that the US economy was a large and fairly closed economy.
This has always been a problem for Australian students and students of other small open economies that were forced to use American textbooks. Most of the analytical results that were derived from the US textbooks were of limited relevance to the Australian setting.
The balanced-budget multiplier is a classic example. If we consider a closed economy with only lump-sum taxes we would get a simple multiplier of 1/(1 – c).
Then the tax multiplier is -c/(1 – c) and the balanced-budget multiplier is equal to 1 as shown in the following:
In our example, the closed economy expenditure multiplier with no income tax would be 1/(1 – c) = 5 and the tax multiplier would be -c/(1 – c) = 0.8/0.2 = 4.
So if we plugged in our example to this model we would get:
ΔY = 1/(1-c)ΔG -c/(1-c)ΔT = 5(50)-4(50) = 50
So the rise in income is exactly equal to the initial government spending increase, which is Shiller’s case.
But once you open the economy and have income-sensitive tax revenue then the leakages are much higher and this reduces the overall impact of the spending increase on aggregate demand and while the multiplier remains positive it is much lower than 1.
I could show more cases to demonstrate this but the algebra can get tricky and I would lose more than I would keep.
Idealised assumptions?
So Shiller completely ignores the fact that the US is an open economy with positive marginal tax rates. It is questionable whether you would get very much bang for the spending increase.
Shiller does qualify his proposal by saying that the “balanced-budget theorem is only as good as its assumptions”. But his concerns are do to with the possible prescence of Ricardian agents.
Shiller say that:
Other possible repercussions could make its multiplier something other than 1.0. The number could be less, for example, if people cut consumption because of psychological reactions to higher taxes. Alternatively, it could be greater if income-earning people who are taxed more cut their consumption less than newly employed people increase their spending. We can’t be sure what will happen.
I dismissed the Ricardian arguments in this blog – Pushing the fantasy barrow. They are nonsensical – rely on assumptions that are never found in reality and have no empirical support.
Shiller’s heart is in the right place. He says:
But the balanced-budget multiplier is simpler to judge: If the government spends the money directly on goods and services, that activity goes directly into national income. And with a balanced budget, there is no clear reason to expect further repercussions. People have jobs again: end of story.s
What kind of jobs? Building highways and improving our schools are just two examples …
There is no doubt that the US government could significantly reduce the entrenched unemployment it has created by its policy failures to date (not net spending enough) by significantly increasing the budget deficit.
Worrying about the balanced-budget theory, which was apposite in a past monetary system, is not something it should be doing. The US government has no spending constraint and its public debt ratio is irrelevant when it comes to having the capacity to introduce a large-scale job creation program.
The welfare improvements that such a program would bring would be huge.
Yes, critics will say that the debt ratio is a political problem even if it is not a financial one. I agree. The polity is failing the American people as polities are failing citizens all around the world. A polity in the grip of neo-liberalism will always produce these poor outcomes for the majority while transferring assets and real income to the elites including the politicians that are captured by the elites.
Shiller recognises this when he says:
AT present, however, political problems could make it hard to use the balanced-budget multiplier to reduce unemployment. People are bound to notice that the benefits of the plan go disproportionately to the minority who are unemployed, while most of the costs are borne by the majority who are working. There is also exaggerated sensitivity to “earmarks,” government expenditures that benefit one group more than another.
Another problem is that pursuing balanced-budget stimulus requires raising taxes. And, as we all know, today’s voters are extremely sensitive to the very words “tax increase.”
When you live in a country that rejects small relief to the most disadvantaged citizens then you are living in a failed state. Again the polity has failed to provide sufficient leadership and the education system has been poisoned by conservative (free market) look-after no-one but myself thinking.
In these situations, as the oppression of unemployment worsens and the gap between the haves and have-nots widens revolutions occur. In the meantime, crime rates rise, property and life is increasingly threatened and an increasing number of citizens have a very low quality of life.
It is all unnecessary and the capacity is within the government’s grasp to remedy it. There is just a failure of leadership.
Conclusion
The balanced budget multiplier was a cute construct in its day. But in an open economy where the government is fully sovereign it is an irrelevant idea to resurrect.
Sorry to those who hate algebra for all the algebra and I hope you appreciated the message nonetheless.
That is enough for today!
I find this passage of Shiller’s staggering:
Unlike the costs of the crisis, of course, which were distributed perfectly equally …
Faaark.
Wonderful stuff Bill. Exquisite detail.
The UK Office of Budget Responsibility has fiscal multipliers that are very low – suggesting for example that the rise in Value Added Tax (a sales tax) is 0.35 (http://budgetresponsibility.independent.gov.uk/d/junebudget_annexc.pdf pp 95)
This all comes from “Fiscal Multipliers, Antonio Spilimbergo, Steve Symansky, Martin Schindler (IMF Staff Position Note), May 2009” and a few other references.
It seems to me that there is a multiplier for every occasion and you can always find one that fits your particular prejudice. So if you want to raise taxes and cut public spending, the multiplier is suddenly very low indeed.
Perhaps its just another failure of intuition over reality, but I would have thought that the leakages on an increase in aggregate demand are likely to be a lot higher than leakages on cuts in aggregate demand. Perhaps it’s just me, but I’m always a lot more likely to increase savings if I can and reluctant to decrease them unless I have to.
Is there any easy way to differentiate what the multiplier quoted is and what it means? Or is this yet another case of obfuscation via scholarly reference.
Billy,
I never before had anyone lay out model-building for me. I get it. Thank you. I appreciate the effort and the patience.
See if I have these right:
1. The (G-T) surplus is negative, because it accrues to the public sector, thus is a private-sector loss.
2. The (I-S) surplus is negative, because though it stays in the private sector, it comes out of circulation and thus is a loss.
3. The (X-M) surplus is positive, because it accrues to the private sector.
4. The “correct way” to arrange the balances is to distinguish private from public.
“That is enough for today.”
Art
Shiller says:
“On average, people’s pre-tax incomes rise because of the business directly generated by the new government expenditures. If the income increase is equal to the tax increase, people have the same disposable income before and after.”
Surely this is intended to mean that the taxes paid out of the new income generated by the additional government expenditure count as part of the overall “tax increase”. After all, those taxes need to be taken into account in order to have a coherent legitimacy to the idea of a “balanced budget”.
If so, your lump sum tax assumption would overstate the amount of additional tax necessary to balance the budget, wouldn’t it?
That’s appears to me to be the primary reason why the multiplier as you calculate it is less than one – because of the additional tax increase that is embedded (and itself multiplied) within the sequence of government generated multiplied income.
If one solved for the primary tax increase as the difference between the government expenditure injection and the additional tax multiplied out from that injection, wouldn’t the multiplier then be 1, as posited by Shiller?
And wouldn’t the import leakage issue be moot to the argument in that case?
Non sequitur: In describing the sequence of events, R. Shiller sort of points out that the government spends first, and then collects the taxes.
“with any increase in government expenditure on goods and services that is matched by a tax increase”. >>> spending comes first.
(emphasis added)
Great – thats a Keynesian demand-led dynamics as I want to see it. Not due to foreigners net saving desires (which is a part of the story) – they just find themselves with windfall gains.
A huge fiscal expansion of the US will lead to a catastrophic deterioration of the current balance of payments and the net external position. And this bleeding or “small deficits” causes a hemorrhage in the circular flow of national income. Part of the damage has already been done with the patient rescued by fiscal policy and whats been called “automatic stabilizers” here but there is no mechanism for debt ratios to stabilize unless something is done about net exports. Else both the public debt and the negative international investment position of the United States is headed toward unchartered territory which can be continued only if the nation is immortal and Santa Claus doesn’t promise that.
Of course the above situation is not what will actually happen in reality because fiscal restraint prevents that – at the cost of the unemployment situation not improving for a long time.
The causality story is not complete. An increase in investment – perhaps due to increased animal spirits of entrepreneurs – also causes deterioration of the current balance of payments. All injections can cause the leakages.
Keynesian strategy cannot save the US – I think Michal Kalecki would have said something right about the “deterioration” (without the quotes) of the balance of payments. Good project for myself.
is not even wrong (a phrase used by Wolfgang Pauli once). The debt ratio can go as high as the foreigners allow. Money is debt. If the US external debt is 25% of GDP (which is nearly what it is now according to Z.1), the US net financial assets is minus 25% of GDP. The MMT stand is that it is “not debt”. More or less.
Lets see this more closely. For a closed economy, the public debt is the mirror of the private sector wealth as Nicholas Kaldor put it in the Scourge Of Monetarism. This is due to “cancellations” of claims on each other by the private sector. For a nation as whole, the “cancellation” is between citizens’ claims on each other (directly as households and through institutions such as corporations, banks, the monetary authority and the federal government) and one is left with the claims on foreigners which can be negative.
Lots of assertions there – but how much can the negative International Investment Position go – 200%, 500% ?
Of course you’re right that it isn’t economically ideal, but what if economically ideal isn’t relevant, but politically feasible is. Economists aren’t relevant if their policies have no chance of becoming the law of the land. We are living in a world where many still feels money should be backed by something and the printing press is to be avoided because of inflation. Politicians are fond of being re-elected, and if one went up in front of the C-SPAN cameras and said the national debt is too small, you can expect the next airplane fare they will purchase will not include a return segment.
“Government deficit (surplus) equals $-for-$ the non-government surplus (deficit).”
On a separate note- I haven’t read anywhere how savings is defined. It seems to have various meanings. Are we calling treasury bills/notes savings? Is it financial assets that are being held however briefly? When I buy a stock is that consumption or savings?
How is borrowing defined? Does it include equity capitalisation? I wish you had a glossary for those of us who weren’t formally trained in these dark arts.
“(3) Consumption function C = X0 + cYd”
“C0 = 0 for further simplicity.”
did you mean to write the consumption function with C instead of zero? also you skip equation 9.
otherwise this was a great post.
@ramanan
you unfairly jump on bill about your long standing issue with the current account deficit in this model. he assumes that exports are constant but imports are proportional to income. in that type of situation of course a cad will be produced. this doesn’t necessarily say anything about real world international dynamics.
Ramanan, as I recall, Bill and Warren have both said that the trade deficit can increase to the degree that foreigners desire to save in the nations currency or acquire assets in that country. This will be different for different nations. When the desire to save in that currency diminishes, or there is less demand for the country’s goods or assets, then the game changes and the country has to get used to less imports. Where’s the problem?
Nathun,
You have raised a superb point.
This is precisely what is happening in the world right now. Its like a gigantic chess game. Yes exports also increase usually and is dependent on demand in the rest of the world (amongst other things like price/nonprice competitiveness)
But the rest of the world has a control on its demand because the government has a tremendous control on demand. One nation will do fiscal expansion provided others do. We are stuck in a situation which is far from optimal, if I may use the word.
A proposal to take concerted action and run international trade on fresh principles is what is needed. Due to business cycle fluctuations it is not straightforward. And thats not MMT.
On the other hand, I don’t require Bill to take time and reply to me and hence usually I do not usually address him when I write a comment. Physically (as opposed to the e-world) I am surrounded by people who cant even get “loans make deposits” and “government deficit is net private saving” right so this is the place to hang out and have challenging discussions. I should say that my repeated writings have really helped me understand many things.
Tom,
My post was precisely on this issue – causalities. I have talked about import invoicing of imports. Again we are back to assuming imports getting invoiced in local currency! With some commentators, I have made progress on getting this thing clear at least but I have a long way to go! (.. and its not my theory – its PKE, Kaldorian dynamics).
In the above I highlight, imports are proportional to demand. In the first approximation, exports are exogenous and the assumption can be modified later. The point raised by Nathan Tankus – see my reply
“Whats the problem?” A fiscal expansion leads to a rising (negative) international investment position even though it increases national income. You cant come back with an example saying the budget was in surplus and the current balance of payments was deteriorating etc – but all injections lead to leakages and one needs a very careful study of this.
“When the desire to save in that currency diminishes, or there is less demand for the country’s goods or assets, then the game changes and the country has to get used to less imports.”
The way such sentences are written makes it really difficult to debate. I mean not because of lack of competence on the part of the arguer but because of the construction of the sentence. Do not behave as if the exchange rate do not matter for a country. Also such a statement avoids answering how high can the external debt go. What are you pretending here – the price of commodities do not depend on the exchange rate – and every nation is self dependent ?
Lenin was supposed to have told John Maynard Keynes once that there is no surer way of overturning a nation than degrade her currency. Of course you can come and say that the exchange rate dynamics is complex and its a one time depreciation etc. You may also say that the discussion is “political”.
Do not try to avoid the empirical fact that external trade determines the fate of nations. Do not assume that politicians are so silly. Of course they may have silly economic advisors but when the election time is approaching, its easy to ignore the silly advisors and go into an expansionary phase.
The struggle which central bankers and the people at the ministry of finance have with the currency markets have is a complex one – do not simply blame it on the arrangements such as currency boards. And you know what – Argentina has run a current account surplus in every quarter from around and after the time of its crisis to the last quarter i.e from 2001. This time it weakened though the “consensus” was deficit. How come this is not mentioned anywhere in the places we exchange comments and ideas ?
Of course I am not advocating pegging exchanges here but its not so simple! All nations except the US have foreign reserves in the central bank’s balance sheet.
Bill,
This is a great post, I would add a simple diagram showing the injection of additional spending at the Firms sector, the increased flow towards the Households and then the draining from there in the form of increased taxes.
Ramanan,
Yes and No.
So you read Lenin? We need to start thinking dialectically in the Marxist sense. We have an apparent contradiction (a thesis and an anti-thesis)
1. US trade imbalance is good for the Americans as they consume more for cheap
2. US trade imbalance is bad for the Americans as they export jobs
So what is the synthesis (the new quality?)
Eventually the exchange rates will adjust or trade barriers will be erected (on both sides – just think about “rare earths”). If the Americans can quickly restore their productive capacities nothing serious will happen. But I bet they will not be able to restore anything as they have de-industrialised very thoroughly and this will coincide with passing the peak oil. The currency will lose its global reserve status despite the global military superiority.
So what? I thought you were not living in the US. Australia will be fine, mate, as we have kangaroos and coal. A lot of coal.
To me the only policy which would make sense for the US would be to use the fiscal capabilities rediscovered thanks to the MMT to invest massively in R&D and in energy-efficient technologies. Every president since Carter promised that and nothing happened.
The Chinese (and to some extent the decision makers from other BRIC countries as well, what includes India) have read the old books written by Kalecki very thoroughly. They not only use export as the lever to increase investment by the private sector but they also directly invest in R&D and in energy-efficient technologies.
Happy New Year…
Adam (ak),
Happy New Year to you too.
Yes I understand the apparent contradictions of forcing foreigners to not sell cheap. Other than throwing US citizens into unemployment (due to leakage of demand caused by the trade deficit – maybe should call it foreign surplus to keep the association : deficit = injection, surplus = leakage clearer), it creates deflationary pressures on the US economy as a whole. Its similar to the paradox – prices fall, things are better etc which they don’t. Inflation is needed to run an economy. Not to forget the higher indebtedness to foreigners caused by trade deficits.
Of course there are agreements on the leakage so the whole discussion is about the the strategy of a fiscal expansion to counter the leakage and the implications of this.
Plus remember we are discussing general trade deficits here – not a symbiosis between the United States and China – which Tim Geithner himself is determined to change. You think he is so silly ? I mean I brought in the US here, but in my comments I am talking of trade deficits in general – to get causalities right and then apply it to the US instead of the other way round.
The analogy of killing the golden goose is not right.
I don’t read Lenin, just saw someone mention it in an article.
In the scenario presented by you, you are assuming that the banking sector can meet any funding requirement in foreign currency when they expire. You are assuming that Australians would be happy to not interact with the rest of the world. “Capital flight” is difficult to explain if one assumes money is a “thing” and statements such as “no dollars leave the US” where one assumes dollar is a thing and thinks that the other person also assumes so, forgetting the fact that banks convert currencies. Capital controls is a complicated subject, but these measures are taken to maintain a relationship with the rest of the world. Am afraid, no nation can say we can survive ourselves – that’s equivalent to saying “I can live alone, I just need food”.
At any rate Australia has never been fine – it has had huge unemployment. That point is nothing new in this blog – but the situation will improve only if the external situation improves. There are points raised in this blog that the government is worried about the external situation because of leakages that may be caused due to fiscal expansion. That is an absolutely correct worry!
Ramanan,
We must resist any temptation to draw the conclusion ans seek for “the only truth” too early. I mentioned the dialectic method on a purpose.
1. Russia, Argentina and very recently Iceland all went through a dramatic exchange rate adjustment process driven by foreign capital flight. In fact the long-term consequences to the productive economies in these countries were moslty positive. The price was paid mostly by so-called “middle class” as their savings were wiped off. The unwinding of the carry trade in Australia may not be as dramatic as in Iceland but I still expect some people to be very unhappy.
2. It is the response of the Governments to these global macroeconomic processes what really matters. If the reaction is to invite the IMF and introduce an austerity program – bad luck to almost everyone. But the reaction can also be to jail the cleptocratic tycoons (or at least ignore them as Nestor Kirchner did) and then soldier on.
3. MMT (as I undrstand it) claims that the current post-Gold Standard Monetarist / Neo-Keynsesian / Neoclassical macroeconomic logic is flawed. MMT does not claim that the current macroeconomic logic does not exist, is not applied in the majority of countries or that there are no real capacity constraints. We have to clearly distinguish between the claims that the Government is not constrained in spending in the nominal terms if it chooses to do so and the claim that a puppet Government in a country “democratically” ruled by the banksters/tycoons/IMF/EU Commission is not constrained.
4. We have to separate the current IMF-like logic and the Abba Lerner’s Functional Finance / MMT logic in our thinking. If we say that the MMT logic is only applied initially what leads to thrashing the exchange rate as speculative foreign capital will be unhappy and will leave – and then we cannot apply the MMT logic during the cleanup phase – this is a major inconsistency in our reasoning.
Capital flight is a serious issue if the Governments have to borrow money from the “free” fiancial markets. Capital flight is a marginal issue if we operate within the MMT logic as exchange rates self-adjust over time so that the foreign trade is balanced. Yes this may mean speculative capital controls – implemented for example in China and Brasil. So why don’t we have them in Australia? To provide cheap financing of housing loans? This is an element of the “circular logic” of a heroin addict.
What is also important is that saving may be less profitable in the MMT world (saving propensity may decrease) so the size of the potentially inflationary overhang (stock) of private savings may stabilise. BTW the so-called inflationary overhang was a major problem in the communist countries so I agree that the “size does matter” if people choose to dis-save because of the initial inflationary impulse (for example caused by the cost-push inflation as in the 1970-ties in Western Europe / USA).
But forced saving rate in the Soviet bloc was very high (maybe as high as 30%).
5. The current global economic order underpinned by the American dollar as the reserve currency and massive military bullying leads to certain global pricing structure. Commodities and labour in the developing countries are still very cheap. Labour in the Western countries is expensive and the “capital” (money) can be created ex nihilo by the banking system – but only there.
There is certainly a kind of temporary symbiosis between the developing net exporters (who want to maximize I – Investment) and the “superimperialistic” (in the Michael Hudson’s sense) West – especially the US, where C – Consumption (and firms/banking sector profits) are maximized.
Is this global order sustainable especially in the context of the looming oil/other commodities shortages? Or isn’t it a kind of a global race to the cliff edge?
6. In the end a new global order will emerge and I would not be surprises if exchange rates of fiat currencies will be close to the equilibrium dictated by bidirectional flows in a well balanced global trade. No massive hoarding of dollars any more. Or we will have again a big war (to defend the current global order based on “Freedom” (absolute property rights) and “Democracy” (or rather cleptocracy)).
This is actually my main concern.
Dear Adam (ak),
how about you drawing the diagram? That would be nice.
Thanks, and
all the best for the New Year to all
Graham
Adam (ak),
Thanks for the longish reply.
Trying to find some writings of Michal Kalecki on foreign trade ? You have mentioned you know a lot about him as he is from the country you were stayed before. His books are really expensive.
The idea of exchange rates adjusting to balance trade doesn’t work in practice because we live in a “non-ergodic” world. Of course it has advantages over flexible rates. Nations have ended up in a rat race because they have understood that foreign trade is critical in growth. Those who are slow have ended being behind because the international organizations such as the IMF and the WTO etc have imposed the free trade doctrine on nations and its difficult for structurally weak nations – it ruins their fate.
There are some comments on the Triffin dilemma etc but not sure what the commentators exactly mean – the United States cannot run trade deficits forever at this big scale (some people think 3%, 5% are “low”).
The reason I have commented about the external sector so much is that there is this innuendo in MMT writing that it is not a problem. There is a post which says “export-led strategies will fail”. Exactly the opposite. Export led growth is the trick. In fact nations should be prevented from doing so by hook or crook rather than announcing that the strategy will fail.
Foreigners have been good to Australia and its the reason it has no capital controls. However, recently many nations have imposed the controls again!
What I am trying to say is that fiscal policy is useful as long as the external sector allows it to. Fiscal expansion leads to leakages as is true with other injections such as private sector debt. A long term solution of using fiscal policy without worrying about the external sector is not the solution.
There is an accounting identity which says that
NFA (citizens) = IIP
By citizens I mean the citizens in their capacity as households, production firms, banks. monetary authority and the government. If IIP (International Investment Position) is negative the nation as a whole owes foreigners. The fact that it may owe a lot of it in its own currency doesn’t mean it is “not debt”. Banks convert the currency.
More than arguing about anything on political issue, I am arguing about conceptual issues here.
There is no automatic mechanism for reaching trade balance – its upto all nations to come together and achieve it and do concerted fiscal expansion. That is the only way to resolve this crisis.
I have whining about this the whole year … should give it a break and try next year … Talk to you next year!
“Banks convert the currency.”
No they don’t. They simply change the names of the owners on pieces of paper. It’s just a trade – somebody else has to want the currency for something – and that has to be ultimately purchasing real things priced in that currency.
Surely it’s the real trades at the end of the sequence of paper exchanges that matter.
Neil,
The IMF uses the terminology “current account convertibility” and “capital account convertibility”
Write down the accounting entries when an import is made in foreign currency.
“Payment Systems: From the Salt Mines to the Board Room” by Dominique Rambure and Alec Nacamuli is an excellent text to work out the transactions which happen with banks in the international context – such as imports, foreign exchange transactions etc.
There are huge dangers in talking about indebtedness to foreigners in your own currency as “not debt”.
Think of yourself traveling in another country without cash and just a credit card in your local currency.
Ramanan,
It is not debt, any more than domestic users holding the currency is debt. For a discretionary import priced in the domestic currency, the foreigner has joined your currency zone and has exchanged real goods and services for the domestic currency. That makes them no different to any other private sector entity operating in that currency. The exchange issues then sit in another currency zone.
To use the currency is the same as any domestic user – they have to find goods and services they want in that currency, or exchange the currency via possibly a long sequence of exchanges with somebody who wants to hold the currency or buy goods and services denominated in that currency.
Think of yourself travelling in another country without cash and singing for your supper. As a foreigner you will survive perfectly well in that environment. It’s when you can’t get the right Mandolin strings in that country and need to send homw that the fun starts.
Neil,
Doesn’t really answer my question. How high can the external debt grow 200%, 500% ? (compared to gdp). One can come back saying debt ratios don’t matter which would imply that 200% is not a problem.
I have traveled to another country without cash. Used a credit card denominated in my own currency. I needed cash – purely because of my laziness – the canteen I wanted to have coffee nearby didn’t accept cards. Most of my purchases were on credit cards, though. For cash, I didn’t carry them. I used an ATM with my debit card and the bank handed foreign currency without me having a foreign currency account.
Do not assume mousetrapping – very dangerous assumption.
Whatever the foreigner does, he has the choice to convert it back to his currency. He can to it immediately or earn interest on the local liabilities for a while and then convert.
I do not know what your mean by other things exactly. Firstly, if one keeps assuming that imports are invoiced in the country making the import, then the arguments do not move anywhere – check up research on invoicing of imports. Amazing how this doesn’t move beyond this point. Even if imports are invoiced in the currency of the nation making the imports, foreigners can convert it back to their own, throwing the local banking requiring higher funding in foreign currency. Foreigners can earn interest by purchasing securities and then convert it later.
Nice way to avoid the question. International investment position – minus 200%, minus 500% ?
bill, (or anyone else who knows) how could i convert this model to excel and use solver to solve it? i’m in the process of attempting it but i feel as if i’m missing something.
” How high can the external debt grow 200%, 500% ? (compared to gdp)”
It’s not debt. It’s simply saving in the domestic currency. Just like any other saver. Therefore if it never gets spent the ratio is irrelevant. It can go as high as you like. The money is inert unless spent, and if it is spent then it comes back into the currency zone on the ‘export’ side of the equation.
“Even if imports are invoiced in the currency of the nation making the imports, foreigners can convert it back to their own, throwing the local banking requiring higher funding in foreign currency.”
They can only convert it back if the bank offers a price. And they’ll only offer a price if there is a counterparty somewhere. At the macro level all that happens is that the names on two bits of paper gets swapped. The money does not move around anywhere and at macro level it never really leaves the central bank.
In the words of the Right Honourable Reginald McKenna PC who was the UK chancellor during World War I (1915 to 1916)
“People often talk of money going abroad or foreign money coming here, but as a fact when gold is not in use money is incapable of migration. The title to money may change. An individual may sell his sterling to an American for dollars, but the American will then own the sterling in England and the Englishman dollars in the United States. If there is pressure to sell sterling the exchange value of the £ will be lowered and temporarily the burden of British payments in America will be increased. But the change of ownership does not remove the money, which necessarily remains and can only be expended where it was created. No exchange transaction, no purchase or sale of securities, no import of foreign goods or export of our own can take money out of the country or bring it here. Those who wish to be meticulous may say that British travellers sometimes carry currency notes and change them in foreign countries, but the total of such transactions is too trifling to be taken into account…”
(Post-war Banking Policy pp18)
Dear Nathan Tankus (at 2011/01/01 at 4:14)
You asked:
Answer: you send me an E-mail and ask me and I will send a spreadsheet model to you by return mail (maybe later today).
best wishes
bill
Ramanan, Neil has expressed the view I was putting forward, basically that the current account balance must equal the capital account balance as an accounting identity, and those exporting to a country have the choice whether than want to save in the currency, buy goods, invest, or sell the currency to someone else, who then has those same choices.
I am sorry, but I am not getting your point. But I appreciate your making it, and hopefully I’ll eventually see where you are coming from and where you are going. Right now, I am kind of stuck in the middle, trying to figure it out. Maybe I don’t understand enough of the intricacies of international trade and finance yet. So keep trying by all means. It’s an area I am interest in learning more about and I’m not about to do the work you are doing to discover.
Let me state what I do see at this point. Demand for imports has to be matched by equal demand for the currency, or exporters will not provide real resources. Reciprocally, the more a country imports, the more claims it creates against its own resources. So the issue is not so much financial as it is real.
Currency is just a pile of tokens used in playing the “free market, free trade, and free capital flow” game of property ownership and resource control that allocates resources to competing players (mostly) economically rather than chiefly politically or militarily. It’s a mixed bag in the US. Most Americans love cheap imports, hate job outsourcing, dislike foreign ownership of US assets, and fear the influence of foreign “creditors.” As Adam observed, this creates a dialectic driven by internal contradictions, and the US is having that dialogue politically right now and it’s turning uglier the longer high unemployment lasts and the greater uncertainties become about the future.
What is the limit on the capital account surplus/current account deficit? Basically, how much of a claim a country wants to create or can create on its resources (product and assets) in exchange for what it gets in return. It’s the real terms of trade that count, because the claims that a country creates are claims on real resources exchanged for real resources. Financial claims will one day be met as the currency is spent on goods or invested in assets in the currency zone, savings being for future consumption. (It is true, however, that a lot of dollars effectively stay abroad for various uses, but that is generally not the case for other currencies. But those dollars are still claims on the real resources of the US and can be used to purchase real resources at any time, if they can be laundered anyway. :))
On could argue that there is also the interest on the national debt to be considered, although this is only an operational issue for countries that aren’t monetarily sovereign and can’t service their current obligations from currency issuance. Of course, the overall constraint of inflation, i.e., availability of real product relative to nominal claims that result in effective demand, and interest adds to the deficit, so interest in not irrelevant.
As I understand it, this is the operational aspect of it. Am I missing something here?
There are admittedly other aspects such as result from political considerations and “perception.” How much is “too” much is often a matter of perception, as we are seeing in the matter of the national debt and budgetary deficit in the US. There is no empirical case being presented, just the assertion that “everyone knows” that the situation is “getting out of hand,” or is “unsustainable.” But as far as I can see, no one has made an empirical case for these claims. Is there an empirical cases for the CAD?
The US is currently running a CAD that many perceive as “too high” and “unsustainable.” But exporters dont’ seem to be concerned, the US have no difficulty clearing its securities auctions, and interest rates are historically low. It’s the bond vigilantes that are supposed to step in and demand higher yields when a country’s finances are “deteriorating,” and the trade balance is supposed to be one factor in this consideration. So far they have not revolted.
I think that the operative consideration here is political. The perception is that the US is exporting jobs, and the middle class is getting worked up over it. If unemployment doesn’t fall and wages don’t increase relative to productivity gains, then there will be an increasing political cost. However, in my view this is largely perception (really misperception), since it is in the US interest for the emerging world to grow, and the US can easily create jobs to replace the jobs lost, which, for the most part, have not been in critical areas. It’s a substitution problem that is not being addressed sufficiently and quickly enough, the president’s lip service notwithstanding.
Social unrest and the resulting political reaction can change that, since the current state of the middle class – the majority of voters – is unsustainable for a number of reasons, not just high unemployment. Basically, the American dream is fading and people are both shocked and pissed, and they looking not only for reasons but also for scapegoats. Free trade is coming under pressure (this started with NAFTA), and multinationals that outsource are being compared to immigrants taking US jobs. But at the same time, dollar stores featuring the cheapest of the cheap imports are competing heavily with Wal-Mart and other more established discounters. “Low price” is no longer low enough. The race is on to the bottom, even though at the macro level lower spending leads to lower incomes, playing into the hands of the neoliberals who want to bust wages to the floor.
Adam wrote: In the end a new global order will emerge and I would not be surprises if exchange rates of fiat currencies will be close to the equilibrium dictated by bidirectional flows in a well balanced global trade. No massive hoarding of dollars any more. Or we will have again a big war (to defend the current global order based on “Freedom” (absolute property rights) and “Democracy” (or rather kleptocracy).
I think that this is the trajectory. The world will likely have to pass through a crisis on the way to getting to a new order, and that could get weird, especially in light of the competition for resources, energy in particular. Anyone following the geopolitical scene knows how this is proceeding in Central Asia and the ME, with the Empire encircling Russia, China, and Iran militarily, and arming its client ME states. Imperial pretensions, vested interests, energy, and climate change are all going to make the transition to a globalized economy much more difficult and painful than it needs to be, and likely much more dangerous, too.
Thats in a chimerical world. Welcome to the real world and you have what Mexico faced in 2008 and Iceland too. You can come up with 10 reasons on how Iceland behaved according to your proposals, but thats real world. Mexico had troubles with 33% and had to be bailed out by the IMF and made to write to Dominque Strauss Kahn that they will put the public debt and the International Investment Position in a sustainable path by going into austerity (thus reducing imports) and take measures to improve exports.
Again an assumption that foreigners are moustrapped! Foreigners can simply make a capital flight, and their banks (the foreign ones) get the signal and refuse to renew currency swap contracts. The result is the local banks requiring funding in foreign currency.
Not that these events happen everyday. These events do not happen everyday because the policymakers do not behave in the way you want them to. They take measures to improve the exports situation. In the United States the opposite happened. People didn’t care – they thought foreigners money funds investments and causalities as such.
Imports are demand-led. A high propensity to import is due to the competitiveness of the local industry compared to the competitiveness of the rest of the world. Since imports depend on the propensity multiplied by demand, injections lead to higher imports. At any rate, you are still assuming invoicing in the currency of the nation which is importing.
Thats a bit of an exogenous money view. Have mentioned this before – but let me do it again. Let us say that the private sector imports stuff such as machines. The invoicing is in foreign currency. The importer doesn’t have foreign currency to begin with and he presents the invoice to his bank. The bank debits his account and the bank’s foreign correspondent bank debits the local (“respondent”) bank’s account. The local bank has to look for funding in foreign currency. Unlike the case of a loan making where the loan making bank has the backing of the central bank, its not true for the international case. The local bank may have to borrow in foreign currency, sell local currency to obtain foreign exchange or do a currency swap.
Banks have positions in foreign exchange and there is no guarantee how much ever good they are at risk management that they can continue funding in foreign markets.
At any rate check up what happened to Mexico in 2008.
Unfortunately neoclassicals/New Keynesians also do mythbursting regarding the accounting identity
For example check this blog post http://ajayshahblog.blogspot.com/2010/12/mythbusting-current-account-deficit.html
Plus where did I say that the accounting relation is not valid ? You are putting a behavioral hypothesis to it which is what my cribs are about.
Amusing how an accounting identity can make things go wrong and how people get it so wrong. Don’t forget, in the 2000s, people were worried about the trade deficit and neoclassicals were the ones who tried to say its not a problem! (In case you want categorize the worries as a neoclassical view)!
Do not bring in political considerations please. My aim is to talk conceptually. A rising current account deficit leads to an ever expanding external debt. Growth cannot stabilize it to a low ratio.
Its true that people are not worried about the US right now and exporters keep exporting. However, thats like saying that households kept borrowing without worries in 2006 and hence its not a problem. More importantly its not a problem because the US is restraining from the usage of fiscal policy and is taking measures to improve the net exports situation.
Again its not political at all. There are conceptual things here. Thats what I am stressing. One commenter – Beowulf – thinks it is political and hence imports situation should be improved. Thats not the point. Its both political and nonpolitical.
You have to understand that money is debt. Having liabilities in your own currency to foreigners is helpful because a depreciation of the currency doesn’t give rise to capital losses. However you have to make sure that the foreigners are invested that way.
In developing nations there are spectacular outflow of funds from the equity markets. Do not think of this as liabilities to foreigners remaining in your own currency (Neil seems to think that way). With banks’ funding needs expiring every now and then, the combination of outflow and expiry puts pressure on the banking system. Having the government not issuing debt in foreign currency is not a sufficient condition.
Keep in mind the empirical observation – exporting nations do well. Now of course one may argue that fiscal policy can do wonders for weak expoters – true but a long term strategy to expand fiscally doesn’t work because the increased demand increases current account deficits and in fact governments take the opposite action than what you want them to do.
This subject is fraught with causalities. The underlying principle should give you the guidance Money is Debt. Combine all the sectors in an economy and you have NFA (citizens) = International Investment Position. The other principle is the Post Keynesian description of processes as demand-led
You cannot claim the world is so silly. The IMF publishes a yearly report on various institutional setups Check this Google Books link.
Annual Report on Exchange Arrangements and Exchange Restrictions 2008
It has so many details about arrangements and capital controls. Why capital controls ? Because sudden flows lead to pressure on the banking system in foreign markets.
Most important point – the IMF imposed the free markets doctrine on developing nations – it ruined their fates instead of making them grow. Its related to international trade and external debt and current account deficits. And right now it is affecting the United States!
(Have written a comment will appear in a while)
At the risk of sounding silly, thats an exogenous money view. Currency is not a “thing”. Currency notes however can be called “things”. More important are balance sheet entries. We can say that the balance sheet is written in this currency and another written in that currency.
There is a an anti-analogy going on here. Its because its view held by many, that reserves change in gold standard and since we live in a flexible system, reserves do not change and the money stock doesn’t change and so on. A nation’s producers imports stuff and the bank debits the importers account and could fund in the foreign currency by issuing bonds in that currency. The money stock did change. Its an anti-analogy and doesn’t work because the working of the gold standard was itself different.
The importer could have taken a loan and the money stock first rises and then falls after the invoice is presented. If the bank funds its nostro account by doing a currency swap, the foreign bank’s local currency account increases because swaps exchange principal in the beginning. The money supply has increased. Money is not a thing.
“What I am trying to say is that fiscal policy is useful as long as the external sector allows it to. Fiscal expansion leads to leakages as is true with other injections such as private sector debt. A long term solution of using fiscal policy without worrying about the external sector is not the solution”
what are we talking about here ramanan,
foreigners wont wish to hold dollar denominated assetts in dollar denominated bank accounts,
the leakages issue you raise is valid, but i would argue that a lack of government investment in the economy is one of a number of causes of de industrialisation. if the governmwnt doesnt spend enough to generate private sector savings, then the private sector will find savings elsewhere, namely in cheaper labour markets perhaps. they may have done so anyway, but the lack of government investment doesnt help.
so if we dont want business’s going overseas, then the government ought to make sure they are kept occupied in the domestic economy in the domestic currency, employing domestic tax payers, rather than twiddling their thumbs dreaming of foreign shores.
furthermore i assume you are arguing that ” that a negative international investment position” means a country such as the US faces a threat to the value of its currency, and the desire of the external private sector to hold dollar balances in anything, and that expansionary fiscal policy exacerbates those leakages to the foreign private sector.
well,
tthe external demand for currency is driven by the internal demand for currency, so if you want to undermine the currency then run fiscal policy at a level well below the maximum required to foster the maximum productive capacity of the economy.
ultimately capital flows to areas of greatest productive or investment potential, thus driving the demand for dometic currency.
those leakages are occuring under dollar hegemony, and are ultimately held in dollar balances .
i dont see anybody putting ther hands up for running a trade surplus with the USA.
i mean whats the currency alternative at this stage, given this situation
and whats the external sector going to do, take their bat and ball and go home. well they will if congress decide to run the economy into the ground and not spend enough money. so the best way to avoid that is to run a much stronger fiscal policy thats directed towards local industry perhaps
OK, I was being flip calling currency “a pile of tokens.” I am quite aware that what changes is numbers on spreadsheets. My point was that the issue is about real resources rather than the units of account that keep track of international transactions. The reason I am not understanding you may be that you seem to be focused on the accounting, and you seem to see some financial problems with “debt,” which I am not seeing.
In a floating rate system, the relative value changes, affecting the value of what the “debt,” since the amount of real stuff to which it corresponds nominally changes with changes in the fx rate. Currency depreciation or devaluation is similar to domestic inflation in that purchasing power decreases and debt denominated in that unit of account is worth less in real terms, and vice versa with currency appreciation. But currency depreciation can also cause domestic inflation, since vital imports like energy and food increase in price, and foreigners can drive up asset prices which seem cheap to them.
But running a persistent CAD isn’t the only problem. If there is a capital influx, inflation can be the result, as emerging nations, which are largely export-driven, are now finding. These are the vagaries of a floating rate system, just as the convertible fixed rate system has its own vagaries that countries had to deal with, albeit somewhat differently. Floating rates move up and down, sometimes with great volatility, and that this can result in problems for some countries. Those dependent on vital imports like energy and food, or have accumulated foreign denominated debt see one side of it, while countries experiencing an influx of hot money see the other side. The former may have to import less discretionary goods, pay more for some vital imports like oil, perhaps leading to cost-push inflation, etc. The latter may see asset prices way up, only to crash when hot money moves on the next great thing. That’s what free trade and free capital flow entails.
Floating rates work seem to work reasonably well, frequent imbalances and distortions notwithstanding. For example, the Asian countries learned from the Asian currency crisis and protected themselves by accumulating foreign reserves and staying away from foreign debt. Similarly, China learned from the US suckering Japan into raising its exchange rate to much too soon. They are determined not to repeat that mistake.
Yet, even though China is a leading exporter and has accumulated a lot other nations’ debt, it is still having its own internal problem, due in part to its export-driven economy. Japan is an exporter also, and it is stuck in deflation. Germany is a net exporter, too, and adherence to an austere domestic policy is likely going to sink the euro by exacerbating asymmetry. So there are problems that arise from exports, too, or at least, exports aren’t the solution to all problems.
But where things get interesting is at the margin, and I assume that this is the reason for the question about how much of a CAD is “too much.” It’s probably hard to say with any degree of accuracy based on historical examples, since conditions are so divergent, even to the type of monetary system in play. But to me, the question is not what the answer to that question may be, but rather how such a question is to be approached, e.g., what it would take to answer it and what the justification would look like. I am not clear on this from what’s been said so far. I am building basically from scratch here, and maybe I am a slow learner.
“In these situations, as the oppression of unemployment worsens and the gap between the haves and have-nots widens revolutions occur”
yes bill
the consequences of the boston tea party were far more than an extremely weak brew meandering through boston harbour
and here we are again
here’s a prediction,
tax revolts are on the way, in the US
and along with it a threat to the whole union.
this time it will be the political system being thrown overboard 😉
Tom,
Because a negative net asset position is as much debt as any other debt. Of course one can say many things such as governments do not default and that the debt is never repaid and things as such. While I do not have issues with the two arguments, consider this – the corporate sector is indebted to the banking sector forever and even that debt is never repaid.
Let us say that the GDP of a nation is presently equivalent to γ1T where γ is the currency symbol. And that the net asset position of the international investment position is γ300B. Consider two scenarios:
a. Foreigners hold all the γ300B as private sector securities
b. Foreigners hold all the γ300B in the form of government securities.
In the real world, the situation is a combination of (a) and (b). Apart from the different yields of these two cases, is there a difference ? If there is no difference, in case (a) you would say that the nation owes γ300B to foreigners but in case (b), you don’t ?
The answer is that in both cases you owe γ300B to foreigners. If you say that currency can be created etc and all those arguments, you are effectively saying that foreigners do not mind the net asset position going anywhere. I understand this is circular – you may say that in my argument I am already assuming debt is debt and in yours debt is not debt 🙂
Also if “debt is not debt” as Neil seems to believe, why do currencies devalue ? But we know they do. However, you cannot say that you are not worried about the value of the currency or that its “political”. Also you have to look at capital flows, convertibility etc properly.
Exports do not cause inflation. It is true that if there are shortages, there is inflation and some nations at some times ban exports of some commodities. Neither does capital inflow cause inflation. This happened neither in the gold standard nor in the present setup. In the gold standard it was said that capital inflow caused reserves to go up and hence increase in the money supply and hence inflation. In the present system, let us say there are equity inflows, independent of imports/exports. This raises the money supply temporarily and when the weekly report about the money supply comes out, people start worrying.
China may have its problems, though I do not know why you blame it on exports. Do the exports create a shortage ? China keeps its demand low and hence keeps people in poverty thats its problem. Increase in demand may cause net exports to do down and perhaps stay negative.
By itself a CAD can be “high” for a few years. However this causes a deterioration of the net asset position and the simplest solution is restrict demand. On top of that the IMF has bullied nations into the free trade doctrine! Even the US with an IIP of minus 25% is worried!
Neoclassicals argue that trade imbalances resolve by the free market mechanism and PKEists argue that they do not – in either fixed of flexible exchange rates. Neoclassicals have theories that capital inflows fund the difference between saving and investment and crazy theories such as that (Roubini etc). However a description with the innuendo “not a problem” doesn’t help. There is a problem there. The institutional setups, exchange rate regimes, capital controls are not due to silliness.
mahaish,
Yes of course, when did I argue that governments shouldn’t do that ??
Of course, they will restrict demand if the situation arises! The solution then is to create a coordinated effort where growing nations can perhaps enjoy some imports and countries such as Germany are asked to increase demand and China is asked to not intervene in currency markets. The only solution is to take discretionary steps to run the world economy with a completely different set of principles regarding international trade. Trade imbalances do not resolve automatically. Governments can then do what you wish them to.
“Ramanan: why do currencies devalue ? ”
Why, it’s the supply and demand of course. For example in the case of China and the US, central bank of china keeps it’s enhance rate artificially low by creating new RMB and buying up USD until FX rate is there where it wants it to be (low). Chinese exporter gets these new RMB assets and U.S. governments bonds are purchased with USD:s. So in the end, Chinese exports were subsided and China has growing stockpile of us bonds on it’s account at FED. These are equivalent to cash that get some interest payments from tax payers.
Opposite happens when China wants to purchase some real goods or services. USD is sold to purchase RMB:s and exchange rates move accordingly.
“CAD can be “high” for a few years. However this causes a deterioration of the net asset position ”
Okay. Now explain to me why this is so bad?
Puzzle,
I have been writing on this for long and have to go through the exercise again 🙂
A growing debt matters to a nation as a whole just like it matters to any entity – a growing debt generates a growing debt service burden. You you can say “the government can dash-dash-dash” and I say “no the government do not and cannot dash-dash-dash”. Thats the debate.
Yes I understand the supply-demand of course.
Then it’s same kind of question can “national debt” be unsustainable to sovereign currency issuer. Government bonds yield very little compared to inflation, maybe they can even go to the negative. So interest burden is not very high. What you call debt I like to call assets. National debt is the amount of financial assets released by government. External debt is the amount of assets owned by foreigners.
Puzzle,
Yep I know. Lets take a closed economy. The public debt is a mirror of the private sector wealth. Neoclassicals and New Keynesians look at the intertemporal budget constraint and say that the government needs to aim to achieve a primary surplus in order to achieve debt sustainability. However, PKEists have shown that no discretionary measures need be taken to achieve sustainability. Then there is this term (r-g) in the debt sustainability equation, however that doesn’t present a problem. Even if r>g, no discretionary measures are needed to be taken – it is sustainable. The government can take a draft at the central bank in case the “markets” feels that either the debt is sustainable or is too high. Plus the increases in income and wealth due to government deficits automatically finances the government deficits.
Now, for the open economy, its how you interpret the similar constraint on external debt is important. Either the markets thinks the debt is too high or unsustainable. Both are important. One can argue that the debt is sustainable but it may be the case that the debt sustains at high levels. So there is a binding constraint – except that we do not know what that is and can change from time to time. For example Australia has a high negative net asset position (around minus 56%). However one can make a case that Australia’s growth depends on its exports and its growth is a balance of payments constrained growth.
To not go there, nations export and keep demand low. Keeping demand low helps prevent leakages but at the cost of having a bad employment situation.
Ramanan: While I do not have issues with the two arguments, consider this – the corporate sector is indebted to the banking sector forever and even that debt is never repaid.
This is actually true in a financialized economy and it is not only industrial capital that is in hock to the rentiers but also the populace for housing, vehicles, durables, ordinary expenditure using plastic, as well as insurance. According to Michael Hudson, the game is to convert as much income and return on capital into rent as possible and to keep it rolling over. If the rentiers dont’ get too greedy and loan imprudently, this can go on “forever.” The developed world has been doing this with the developing world “forever,” too.
The things I said above that you contest aren’t my conclusions. These are things I read from the knowledgeable people that study these matters, like Michael Hudson and China-watcher Michael Pettis. I don’t have the data, nor do I have the time and expertise to deal with it personally. But I assume that they are not spinning this out of their heads. I have your word against theirs. How do I decide?
I do know from people that trade fx that currencies are far more complicated than modeling allows for. I know people that have constructed models that worked great for awhile and then they ended up putting all their gains back in when the model broke down. (It doesn’t’ take long with high leverage.) So am suspicious when someone says that they know how these markets work if they aren’t very wealthy from successful trading over a significant period.
When you speak of debt, the issues that debt involves are cashflow, liquidity and solvency. How do you see this operating in currency relative to trade balance, GDP and other relevant factors?
Here’s the point I am interested in. A lot of people say things like, “The deficit (budgetary or trade) seem to high,” or, “The debt/GDP ratio seems too high.” The point of scientific enquiry is that things are not always as they seem. What is the empirical evidence for an amount or a ration being “too high”? Can this be determined. How? What is the justification for the answer, i.e., criteria.?
Ramanan, I am not trying to be persnickety here. These are things I would really like to understand. As I have said before, I am suspicious about claims that all is well with trade and currencies owing to floating rates, as long as countries don’t do stupid things. While I don’t know that much about it yet, my tentative conclusion is that the issue is complicated and needs explication. I don’t know of anywhere this is set forth clearly in a simple enough way for a non-economist or sophisticated trader to grasp. Moreover, I don’t know enough yet to be able to distinguish a good argument from a bad one. Hopefully, through discussion like this, I will get a better grasp on it.
Ramanan: The solution then is to create a coordinated effort where growing nations can perhaps enjoy some imports and countries such as Germany are asked to increase demand and China is asked to not intervene in currency markets.
This has been going on for some time to no avail.
The only solution is to take discretionary steps to run the world economy with a completely different set of principles regarding international trade.
Let’s make that the only sane solution. Markets always resolve imbalances eventually, if politics doesn’t intervene beforehand. In the past, this has involved crises when markets fail to clear smoothly, and wars when major interests collide. I doubt that the neoliberal paradigm will be changed before it seriously breaks down.
Tom,
Yes I understand your points. In the middle of how economies work, there are these pests how keep claiming things. However, governments do have control but these people keep making noises, unfortunately. They prevent governments to achieve their objectives by repeatedly saying this is “high”, that is high etc. In the middle of this, there are buyers of government debt who receive no signals of any weakening and continue buying the debt. This is not surprising as we know that government deficits is equal to the net acquisition of financial assets (DEF=NAFA) and that there is no problem in financing.
However, in the case of the external sector, what I am saying is that there is something involved. In the middle of people making several claims, there are signals which causes issues. These signals are supply and demand signals. And I agree whatever “models” fx traders may have, they don’t work simply because one has one idea of the future. However, import shocks are bound to create funding pressures on banks and it shows up somewhere.
Just one example – although I fully understand that it is a different institutional setup than we are talking. Italy’s is included in the weak Euro Zone nations’ list because its public debt is 117% or so. However its external debt is around 17%. So it is in a much better position than other Euro zone nations which have issues have high negative net asset positions and is under less difficulties. Again, its a different setup, no choice of devaluation etc, but making a case for economists’ views versus market signals.
If one has the attitude that trade imbalances have to be resolved than its easier to convince that even flexible exchange rate regimes do not do the trick. However, if someone starts talking in the tone with the innuendo that “its not a problem”, its a hard battle.
Ramanan,
To what extent do we analyse the effects of foreign capital flight and exchange rate gyrations within the MMT framework and to what extent do we talk about the current “Dollar Standard” framework? To me bullying the governments into underwrite foreign liabilities of failing banking sector is a political not purely economic issue. I am not sure whether your critique fully applies to the MMT world.
If I learn that a Hellfire from the Predator drone flying nearby is pointed at me or that I will be extradited to Guantanamo Bay, Cuba for having unprotected consensual sex with one lady in Poland in 2001 I will also publicly admit that Monetarism is 100% true. I am not a hero.
But what if the Government of a highly indebted middle sized country just refused to cooperate with the IMF and tried to fix the productive economy instead? The system may recover as shown in Argentina. So maybe there is a grain of truth in MMT in regards to foreign debt and foreign trade imbalance.
I think that if there is a verifiable threat that the Government will behave in that way and functioning capital controls in place, the so called “financial markets” will not allow for an accumulation of foreign debt (by running a Current Account deficit) for too long and we will have a fully floating exchange rate. We may not need to fret about solving the foreign debt problem because we may not have that problem in the first place. Yes the mercantilist export-driven growth strategies will not work in the MMT world too but apparently there is an alternative.
Adam (ak),
Not sure about your para on Cuba etc .. but anyways …
Argentina has been running a current account surplus almost always since 2001 and it has been successful due to that.
As to your point about bullying, not sure which statement of mine, you referred to but here is what I have to say. You can’t change a movie. Governments by themselves try to rescue the banking system by borrowing in foreign currency. Now you cannot change this fact. Now the question is suppose governments do not do that – is it a problem ? And I say, yes – for the simple reason that you cannot beat national accounting – money is debt. If the national accounts and the BoP/IIP statistics tells you that your net asset position is negative, you are indebted to the rest of the world. Simple!
In 2008, Mexico had a crash in its currency and had to go to the IMF for help. It had a floating exchange rate.
Also, flexible exchange rates do not resolve trade imbalances – the assumption that it does so is equivalent to believing the existence of an invisible hand. Its true they adjust but not sufficiently and in a timely manner.
Talking of export-led growth, fate of nations have been decided by foreign trade. The US which was acting as the “importer of the last resort” was the biggest creditor of the rest of the world and over time became the biggest debtor. See any connection to the issues in the policy makers minds ?
There are many parts to this story. First you assume imports are invoiced in the importer’s nation’s currency. Then you assume there cannot be capital flight. And what about capital controls ? Capital controls have advantages and disadvantages – nobody has been successful in implementing them in a proper way.
Ramanan,
I simply don’t think that it makes sense to analyse the impact of a single policy advocated by MMT (that is government spending filling the gap in aggregate demand) within the current institutional framework “all things equal”. Of course if you sell too many bonds and let the markets dictate the interest rates you may get to the point when the whole GDP has to be given back to the bondholders. The same applies to the consequences of a collapse of a banking sector caused by the foreign capital flight – if the Government has to rescue the banks because of the external and internal pressure, we know perfectly well what will happen next and what conditions the IMF will impose on them.
In my opinion we need to analyse the impact of all the alternative policies (including the abolition of bonds, possibly nationalisation of banks and capital controls / taxation policy to curb speculation) implemented together – whether that system can be stable or not. Will a fiscal stimulus leak overseas then or not? Will the currency exchange rate adjust in time to stimulate export and rebalance trade or will it happen too late? Will an inflationary overhang of savings keep forming like in the Soviet Bloc countries or will the saving propensity reduce over time if high interests are not paid on bonds? So far I saw a very few arguments against the possibility that a pure-MMT driven system implemented in a single country can be stable. The straight transition from the current system may lead to a major instability but what is more likely to happen is that the current system may collapse first under its own weight before the MMT is seriously considered.
Is analysing the possible consequences of running the Current Account deficits in the context of MMT a waste of time because we don’t live within that framework? I can tell you one thing. Until December 1989 the eternal friendship with the USSR was engraved in the Constitution of People’s Republic of Poland. Currently they have a public debt cap equal to 60% of GDP written there but there is no USSR. I just wonder what will be in the next edition of the Polish Constitution in 20 years time.
There is a conversation going on now at History of Economics on Are there ‘Grand Challenges’ in history (of economics). My suggestion there is understanding crisis in a historical perspective in order to determine the causes of instability so that they might eventually be reduced and corrected. It seems to me that what Ramanan is pressing is a key part of that inquiry, especially in the emerging vast and highly interactive open global economy, where virtually everyone on the planet is affected by trade almost day to day, e.g., through commodity price fluctuations that everyone sees, and fx rates, capital flows, trade balances, and so forth, with which most people are not concerned directly, but which the effects of which they experience suddenly as crisis.
I think R is correct to focus on causality. What are the causes of currency and trade crises, what conditions lead to them, and how can they be prevented or at least minimized.
I have suggested approaching these questions by looking at the global economy as a closed one and asking what it would take to operate smoothly as an interactive system with lots of moving parts and different interests (motivators). For example, Minsky and the subsequent Minskians have done a lot of good work on financial instability within a national system. Is there anything like that internationally?
On one hand, there are the free marketers that believe the invisible hand will take care of everything, and they have the upper hand at the moment. On the other, there those who think that an overarching order needs to be imposed with meta-national control levers in the hands of technocrats. It seems to me that the former is historically discredited or at least irrelevant because its modeling assumptions are unrealistic and impractical to achieve. The second is scary because it aggregates virtually all power in the hands of whom, chosen by whom? It is turning out, for example, that the Fed is the lender of last resort to the world. While the New World Order may be a far-fetched conspiracy theory, there is a disturbing element of truth to it, e.g., in the push for cb “independence” and the EZ/EMU as a trial balloon, which, to be frank, scares me.
So I think that R has hit on a matter of importance, of which there two aspects. The first is the causes of systemic imbalances and breakdowns in open systems, and the second is what MMT has to offer in correcting for these tendencies. What relevant work has been done on this already. What needs to be done? Where are the most promising places to look for light.
Ramanan’s approach is to focus on NIIP/GDP as the canary in the coalmine. But I think this is flawed:
1. NIIP is highly volatile as a function of FX rates, markets, and nominal GDP growth. The UK moved from -25% to -7% within a 2-year period over 2006-2008 (it has widened since). Far more volatile than simple govt debt/GDP ratios. As such it’s an inadequate metric on its own to flag potential concerns
2. Presumably the currency situation we should all fear is a sudden stop or massive capital flight, as opposed to a gradual weakening of the FX rate to a level which sees more balanced trade values. I don’t think there are historical precedents for this, nor do I see how the transmission mechanism could work, for monetarily sovereign governments. Isn’t some tipping point required, in the form of a peg to be attacked, for speculative pressure to mount?
3. R seems (I think) to be saying that budget deficits drive CADs. Maybe this could happen in theory if the private sector insisted on spending all its income, but doesn’t the data now indicate that, rather, in the US & UK at least, the BD is merely balancing the ‘structural’ CAD and mainly accommodating a large private sector desire to run a surplus? Evidence that the BDs are being sized at levels above the ‘structural’ CAD as well as above the private sector ex ante desire to save, would be much appreciated.
As ever, Ramanan prefers quantity to clarity and as such his messages remain somewhat delphic to some of us. I would welcome it if he could direct us to somewhere he has taken the time to spell out his thesis clearly.
Best
MMTP
MMTP,
You make some of the same good points Bill has been making for months now in response to this …
Its true that the net international investment position is volatile and this is due to the volatility of asset prices. However, run current account deficits and it trends toward a bigger negative number and is volatile around that point. Volatility alone cannot bring back the net IIP position to positive. Its easy to see this, trade deficits are financed by issuing securities to foreigners or by sale of existing assets to foreigners and is likely to deteriorate the net IIP position. Its still possible that even after running a trade deficit, the net IIP improves, due to revaluation effects but this cannot happen forever. The volatility argument can also be used in an opposite way – since it is volatile, it can go even more negative due to volatility etc.
Depreciation of the exchange rates does not resolve trade imbalances. A nation has to take discretionary measures to achieve competitiveness in international trade. There are two things – price competitiveness and non-price competitiveness. Do not assume an automatic mechanism. Of course, given a non-price competitiveness, one can try to figure out the value of the exchange rate which can be hoped to do the trick. However, the exchange rate is under the control of the markets.
One cannot take the moral refuge by arguing ” Mr X is arguing that budget deficits cause trade deficits”. There are many causalities involved. If the rest of the world incomes increase due to an increase in demand not necessarily due to relaxation of fiscal policy (i.e., by increased private sector deficit for example), budget deficits may not “cause” trade deficits. Trade balance can improve even though there is a budget deficit. It is crucial to get causalities right before attempting to take someone to task.
To me the whole thing looks backward. One starts with debt is not debt and argues that since debt is not debt, indebtedness to foreigners is not debt etc. Then there is the question “where do the dollars come from”. It is true that the government is the monetary authority but banks create and destroy money every day. It is also true that the government doesn’t promise to convert currency. However, banks do it for you.
References are many, and a lot has been written in the PKE literature. Unfortunately it is not straightforward. There are zillions of causality issues involved here. Plus if one continues to treat money as an asset without a liability, it is difficult to see things clearly. However there are some guiding principles which can be kept in mind. Money is credit, hence a net asset position is not “not debt”. Issuing liabilities in your own currency just means that you do not suffer capital losses if there is a devaluation. It also means interest payments are protected. It is easier for the government to roll over the debt etc. More importantly, the causality associated by the act of importing itself. How much ever the world “desires to net save” in the Japanese Yen, they like their own products and will purchase them. They are also competitive and do well in exports. Imports arise due to the volitional decision of citizens to choose a foreign product over a domestic one. Now I understand that MMTers also make the last point, but … some other day on that.
Ramanan,
“Depreciation of the exchange rates does not resolve trade imbalances.”
But how does this statement apply to Argentina which was your example of a country running a CA surplus during the recovery after de-pegging from the USD?
link_http://www.indexmundi.com/argentina/current_account_balance.html
“Money is credit, hence a net asset position is not “not debt”. ”
I would not use that statement to deduce anything as fiat currency issued without a public debt offset may only be a nominal liability of the central bank. I don’t subscribe to believing that all “money is credit”. Money are claims on goods and services which can only be resolved by the market system at the market prices. Foreign net financial asset position may only be reduced by purchasing goods and services supplied by the country which has issued these assets (by running a trade surplus – reversing the trade deficit process which led to accumulating the assets by the foreign entities). I am not convinced how a possibility of running a trade surplus in the future could do any harm to the American economy. They may simply not sell these goods and services they don’t want to sell like aircraft carriers to China.
What can pose a serious problem is the rapid change in the pricing structure of the commodities on the international markets and the withdrawal of cheap import. The process of re-tuning the economy and restoration of productive capacities after decades of de-industrialisation may also take decades (what we can currently see in Russia).
I would say that the real problem for the US and the real reason why more aggressive fiscal intervention is rejected is that they don’t want to upset the global pricing structure if the global economy leaves the Dollar Standard. The Americans are currently still able to get a plenty of free lunches. For example they sell rather poor quality operating system software for a high price and keep buying advanced computers manufactured in China or various commodities at dirt-cheap prices.
The Dollar Standard is also an attribute and ultimate symbol of power of the American Empire… again this is a political, not economic issue.
“Depreciation of the exchange rates does not resolve trade imbalances. ”
You do go on about this much as our friend Vincent goes on about Hyperinflation. Yet when challenged there is little proof.
One of the core points of MMT is that the floating exchange rate is key to monetary sovereignty and the policy recommendations flow from that. If this is flawed then there is a serious problem with the entire thesis.
I think there is an underlying assumption that causes a lack of clarity and that is the one underlying GDP. GDP is always cast in the domestic currency, yet the transactions that comprise GDP didn’t necessarily occur in the domestic currency. So you have
GDP – all transactions that occur within a national border regardless of ownership or currency – cast in the domestic currency.
GNP – all transactions that occur in the world owned by the nation in question regardless of currency – cast in the domestic currency.
To that there should be added a third
– all transactions that occur in the world in a particular currency regardless of ownership or where in the world they occur.
In other words you recast the financial map according to the amount of transactions in a particular currency
Nice strategy. Put someone in one camp. Then thrash some other point of the camp and claim something.
Whats the claim ? Flexible exchange rates resolve trade imbalances ? I thought the whole world runs unbalanced trade.
Regarding proof – I think I have written about Mexico’s case in 2008 many times here. I am sure I can find more.
There was a comment I dropped where I quoted some cases about currency runs in flexible exchange rate regimes. Now, I do not know in detail about the situations because its requires a lot of hard work. On the other hand, if you want to make a claim such as “there can be no currency runs”, please go ahead and make it instead of avoiding it and posing it as a question.
More importantly, policy makers are not so overconfident like you. They control demand in line with exports growth and hence you do not see such things happening everyday.
Plus a question for you – “Who’s taller – the State or the International Money Markets” ?
Adam: not sure why Argentina is an example. Is its trade balance balanced over the last ten years ? Careful with what I am saying here. Depreciation does bring about an increase in exports and reduction in imports. The question is how much depreciation can lead to a trade balance and whether the “market” knows the point. It may be the case that the depreciation is too high. In that case, you have to try to put more efforts into exports. In fact the US is precisely doing that.
I will try to not write more. My first comment was directed to one point on this post. The remaining all were defenses with commentators. Already being tagged a hyperinflationista!
Also Adam (ak), the view that exchange rates will cure trade balances is a chimerical view based on how the world operates. It offers no free will to economic actors on their decisions. Read the “Economic Report Of The President 2010” – page 133 “Steps To Encourage Exports” and you see discretionary steps on achieving this.
Old story again but this time with a new twist added. Like MMTP, I would also prefer this story to be less verbose as a non-English speaker it takes me much longer to keep up with this pace of comments. However sometimes I am also thankful for comments being sooo verbose as I get to learn a lot. Ramanan, you are like a next generation “google” providing links before people even get to formulate a search query. Maybe you should check with them after you patent your algo 🙂
So if I read it right the argument now goes along the following lines: (i) imports are invoiced in foreign currency and local banks avoid going to (ii) spot market and also avoid taking (iii) direct fx-risk and therefore (iv) fund in foreign currency so that when fx-rate depreciates because (v) foreigners refuse to roll-over then (vi) government takes over foreign liabilities of banks and (vii) is forced to go to IMF and then goes the rest of the standard IMF happy-end line.
Ramanan, is it a proper interpretation of your argument?
Ramanan: Imports arise due to the volitional decision of citizens to choose a foreign product over a domestic one.
This comment is not germane to the causality question that R is interested in but it’s significant in my view.
The question is why residents are so prone to imports. In the US some of it is better quality (often German or Japanese made products) and some, less expensive (generally Chinese).
My point is that what is underpriced is over-consumed, and vice versa.
It is my (anecdotal) observation that cheap imports are over-consumed. I notice this in my own behavior. I will buy a cheap tool that might (or might not) use because it is so cheap that I “cannot afford” not to have it on hand. Similarly luxury imports are price rationed, but with the huge distribution to the top, that’s still a large dollar figure, Moreover, there’s the bling effect operative, too. Current US culture tends to be ostentatious. The added value of a lot of what is bought is vanity-based.
What I am suggesting is that the foreign market is a complex one. In the US at present, I would submit that it is very inefficient (wasteful). It is also supporting the decline in the real wage and the ability of capital to suppress wages. Most Americans don’t get that their behavior involves self-sabotage, and it’s not just imports.
“So if I read it right the argument now goes along the following lines: (i) imports are invoiced in foreign currency and local banks avoid going to (ii) spot market and also avoid taking (iii) direct fx-risk and therefore (iv) fund in foreign currency so that when fx-rate depreciates because (v) foreigners refuse to roll-over then (vi) government takes over foreign liabilities of banks and (vii) is forced to go to IMF and then goes the rest of the standard IMF happy-end line”
Which is a similar line of argument to that which results in hyper inflation. A lot of ifs and buts all of which need to line up before you get a disaster. Take any one out and everything is fine.
The counter argument is simple. If the exporter wants to sell in the country and make a profit then they’ll find a way to make the exchange happen – and that generally means accepting the local scrip (ie very few imports are priced in foreign currencies). The exporter then ends up with a lot of foreign currency.
The exporter government then provides a way for the exporter to get the domestic currency in return for this foreign scrip. And they do this by offering a guaranteed and beneficial exchange rate for all foreign currency.
Which is the system the Chinese use.
Beyond that you really need to ensure that you avoid importing in a foreign currency unless you’ve previously funded it by exporting in a foreign currency. Which all just boils down to the ‘avoid state backed debt in a foreign currency’ which always seems to me to be a recommendation coming from MMT.
So I just don’t see a problem here that isn’t already dealt with by the standard recommendations.
“The question is why residents are so prone to imports.”
I would submit that it is because they are unnecessarily offering long bonds at a higher interest rate than the monetary policy rate. That then stops the exchange rate from descending to its unmanipulated clearance rate.
So there is a huge and needless government subsidy (in the form of interest on bonds) on the currency exchange rate, which increases imports and reduces exports while crushing local production. And that happens in all western countries running a CAD.
Governments appear to be terrified of inducing stagflation because they don’t really know how to deal with it.
Sergei,
That example was just one description. The government need not issue debt in foreign currency. However that is equivalent to saying “ruin the banks”! The purpose is not to spend it – governments spend in the local currency, but relieve the banking system of the funding pressures.
On the other hand, doesn’t mean that if governments do not do that, there is no problem.
Also I have been trying to build a story of how nations run into problems and have become enslaved to the currency markets. Some commentators are already pained by my comments, but most of the times, I am just defending my position.
Also I am trying to illustrate the problems by giving facts first. But the claim is of course that it doesn’t matter which currency imports are invoiced but very few nations have that advantage. Perhaps this strategy is the best way get the point across.
My whole point on the debate is imports are benefits only if the government runs a fiscal policy to counteract the leakage created by imports and this strategy won’t work because the currency market will ruin your game plan. Organizations such as the IMF/WTO have put restrictions on import restrictions and exporting is the way to counter the demand leakage.
Tom,
What you say is true provided you compare two producers selling almost equal things.
The case of China is an extreme example, where they have a massively devalued currency due to peg. (Analysts keep talking of it being devalued by 20% or so .. doesn’t seem right. Just an opinion -not claiming anything – any attempt to find the fundamental value of a currency is doomed to be a failure)
Because of this, China has a huge advantage. Of course price competitiveness matters but nonprice competitiveness too. In fact PKEist have written about the two and place the latter as more important. So the question then is what determines imports/exports ?
Nicholas Kaldor wrote this in The role of increasing returns, technical progress and cumulative causation in the theory of international trade and economic growth.
Exchange rates move and this puts some pressure on the competitiveness. However do not leave the game to the exchange rate.
There you go .. hyperinflation again!
Unfortunately such an action which in some sense is restricting “current account convertibility” is not allowed by the IMF.
We interrupt regularly scheduled programming on channel Ramanan, in order to bring you this special message…
🙂
Bill,
Further to my earlier comment, I am struggling to understand and agree with your conclusion about the balanced budget multiplier. My own conclusion is quite different, and should you have time to read this, I’d appreciate your guidance as to where my analysis goes wrong.
You say the reason that the net multiplier isn’t 1 is because the economy isn’t closed. However, your reduced form example where you force out a net multiplier of 1 assumes that the economy is both closed and income tax free. The inference that this result is due specifically to the economy’s closure isn’t entirely obvious, given the presence of constraining assumptions for both income taxes and imports.
Moreover, I believe that the requirement for such a balanced budget multiplier of 1 is not that the economy should be closed, but that there should be no income taxes. And assuming no income taxes, I think it should then be the case that the multiplier is 1, whether or not the economy is closed.
Your reduced form example includes the expressions 1/ (1 -c) and c/ (1 -c) for the expenditure multiplier and lump sum tax multiplier respectively, in the case of no income taxes and no imports. These net to 1 for a balanced budget multiplier, as you show.
I think it works this way because there are no income taxes – not because there are no imports.
Here is how I arrive at that conclusion.
I believe the following expressions apply in the case where there are no income taxes, but where imports are admitted:
1/ (1 – c + m) is the standard expenditure multiplier, with imports, in the case where there are no income taxes.
(c – m)/ (1 – c + m) would be the corresponding tax multiplier, again in the case where there are imports but no income taxes.
(For purposes of illustration, consider the converse example of a lump sum tax reduction. The numerator in the tax multiplier is (c -m) now, because the first round of induced consumption generates domestic income that is itself reduced from the level of consumption by the amount of first round import leakage.)
Using the values provided in your example:
c = .8
m = .2
t = 0
Then:
The expenditure multiplier with imports = 1/ (1 – c + m) = 1/ .4 = 2.5
The tax multiplier with imports = (c – m)/ (1 – c + m) = .6/ .4 = 1.5
And the net multiplier = 2.5 – 1.5 = 1
Also, parallel to the algebra in the your case of no income taxes and no imports,
1/ (1 – c + m) – ((c – m)/ (1 – c + m)) = (1 – (c – m))/ (1 – c +m) = 1
Thus, as with your reduced form case of no taxes and no imports, my case of no taxes with imports results in a net balanced budget multiplier of 1.
Therefore, I conclude it must be the assumption of no income taxes – not zero imports – that is critical to the preservation of the intended balanced budget multiplier effect.
Somewhat separate from the analysis relating specifically to the import question, and as noted in my earlier comment, I believe your initial example generates a multiplier of less than one because the income tax induced by the expenditure injection, in combination with the lump sum tax increase, effectively generates a marginal budget surplus – when the combination of the two taxes is considered as the effective total response to the expenditure injection. Given the logical expectation of an induced income tax effect, there should be a corresponding expectation of an induced marginal tax surplus effect. Reading Shiller’s column as a layperson might, I find it difficult to believe he intends to allow passively for an expected surplus, when the core issue is that of a “balanced budget multiplier”. A marginal tax surplus is contractionary, with the combined multiplier being less than one in this case.
Instead, I would have assumed that the additional taxes expected to be generated from the income created by the expenditure injection itself would be included as part of the intended and projected total tax increase. That would allow for a corresponding reduction in the lump sum tax calculation required for balance. I think such an allowance is implicit in Shiller’s approach to the idea of balance. If that’s done, the net multiplier is then expected to be one – or as close to one as can be assumed in the process of estimating the expected income tax effect to be induced by the expenditure.
That final point said, perhaps you did address it in whole or in part, when you stated:
“There is also a complexity that I will abstract from which is whether the budget neutrality is to be achieved at the time of the spending (so initially) or at the end of the multiplier process. The latter is much harder to explain in a blog and so I will assume that the government decides to initiate a budget neutral spending increase which is in the spirit of Shiller’s proposal.”
Still, I see no reason not to accommodate the expectation of induced income taxes in setting the lump sum tax amount, if balance is the true objective.
Ramanan: Exchange rates move and this puts some pressure on the competitiveness. However do not leave the game to the exchange rate.
That’s the point. The way to compete in a free market, free trade, free capital flow system is to reduce a country’s real wage to the global real wage. Socially and politically, that’s a problem for developed countries. We are seeing the the race to the bottom now in the US and it is creating political repercussions in addition to economic difficulties. US workers are starting to waking up to the agenda of multinationals, but too many haven’t gotten it yet owing to the propaganda and scapegoating.
Ramanan: “The US which was acting as the “importer of the last resort” was the biggest creditor of the rest of the world and over time became the biggest debtor.”
Over time? It happened in 6 years under Reagan.
I was rather alarmed at the time.
That’s a good post Bill,you realy got them going.
If never ending consumption increases is the answer wont we eventually consume more real resources than we can supply?
Perhaps the fantasy is that Gov will be able to control consumption below the ability to supply. I also believe in good men and unicorns.
Ramanan –
The mainstream account of budget deficits is heavily asymmetric, such as to make the dangers of a BD being too high seem much greater than the risks of it being too low, even if these ‘dangers’ are in many cases spurious (default, hyperinflation). MMT serves to skewer these bogeymen and replace them with the real issue – inflation. This can then be weighed against the costs of an excessive output gap, in a trade-off analysis.
Your caution that a persistent CAD or growing NIIP could lead to a currency crisis, feels like another bogeyman – not because it seems obviously nonsense, but because it’s unclear how such concerns would fit into a trade-off analysis. In other words, you don’t seem to offer any way to assess what size of CAD is a concern, or how urgently you should try and fix it – including by adjusting fiscal policy – lest the unpredictable FX market might eat you.
This compares closely to my mind to the regular references since 1987 to bond vigilantes, no matter what long yields were doing. The message from these references was always “keep reducing inflationary risks, and to hell with the size of the output gap”. I’m sure everyone would agree it’s a good idea to foster strong export sectors in the medium/long term. But aren’t you just saying “do anything necessary to reduce the CAD/NIIP, and to hell with what happens to GDP growth”?
Best
MMTP
Hyperinflationista tag again 😉
The central bank can unilaterally set the yield curve by offering to purchase and sell government bonds in the open market and bond vigilantes can’t do much. Unfortunately it cannot do so for currencies.
I have written in many places and many commentators have asked me to be clear etc at various points. I have written it in many places and have lost the links now. It is really difficult to write everything in one place.
Imagine two nations A and B of almost equal size and running low trade balances. Imagine the following cases. In the following relaxing fiscal policy would mean increase government expenditures and/or reducing tax rates and tightening is the opposite. The budget deficit is endogenous and will be the result of various things happening.
Case 1. Nation A relaxes fiscal policy.
In this case, A will have higher national income and as a result, the trade balance with deteriorate. This is because imports are dependent on income in A and exports dependent on income in B. Of course there are second-order effects i.e., income in B will move upward due to increased exports.
Case 2. Nation A relaxes fiscal policy and Nation A’s relaxation is higher.
Here, A will find itself with a better trade balance even though it relaxed fiscal policy because the income in B is higher and hence its imports and hence the exports of A.
Case 3. Nation A doesn’t do anything and B tightens fiscal policy.
In this case, A’s trade balance deteriorates because of less demand for its exports to B.
Case 4. Nation A tightens fiscal policy and B tightens it higher.
Again A’s trade will deteriorate because of lower income in B.
Case 5. Coordinated fiscal expansion.
Both nation’s incomes increase and trades do not deteriorate. Both nations can “enjoy” imports.
That’s Post Keynesian demand-led trade dynamics in the short/medium run but put in crudely. Of course these things depend on the competitiveness which is encoded in income elasticity of imports but the dynamics is demand-led. Now one can argue that exchange rates may take care. Unfortunately they do not. In fact the nation with higher income may see appreciation due to foreigners interested in equity due to higher sales. Now you say the exchange rate movement is complex etc. However this Keynesian policy doesn’t work so well. The reason is that while the nation increasing demand via fiscal policy finds itself with higher national income initially, its indebtedness to the rest of the world also increases.
Now think of this in a global sense. If a nation relaxes fiscal policy in an uncoordinated way, its trade balance deteriorates. Hence the solution is to do a coordinated fiscal effort.
Now in this you may ask – whats the problem etc 🙂
In the real world, when nations find themselves with higher indebtedness to the rest of the world, they take action – the easiest way is a fiscal contraction. Please note nations do not behave the way you want them to. I am not claiming that the government should do that. What I am saying is that it’s the way they act and it creates unemployment. There are all kinds of misunderstandings that can be created. So hopefully that answers your question “do anything”.
The reason you don’t see currency falls everyday is due to the fact that the governments control demand this way. Of course there are other reasons in the policy maker’s minds but this is a big one. They have also figured that exporting helps in coming out of the situation.
Its like asking gimme records of people dying by driving at 400 kmph and leave the task for me to go through all public records to find it! That analogy is for a fiscal expansion to counter demand leakages caused through imports. As for a real world example about deterioration of IIP leading to an IMF bailout see my other comments above.
There is no need for “do anything necessary to reduce the CAD/NIIP, and to hell with what happens to GDP growth”. The solution however is international coordination of fiscal policies (Case 5)
Then in addition to the hyperinflationista tag, there is this analogy with neoclassicals. Unfortunately neoclassicals do not even understand what hemorrhage endemic trade deficits can bring. In fact during the 2000s, they were the ones arguing that since Current account balance is equal to capital account balance, imports are good and it leads to higher “investment”. They also mention the “global saving glut” – as if the US shouldn’t have done anything.
Simple plans of fiscal expansions do not help! Do not pretend that the currency markets are not a problem. Banning players won’t help – someone has to make the currency markets. Do not pretend that the State is taller than the currency markets.
“Unfortunately such an action which in some sense is restricting “current account convertibility” is not allowed by the IMF.”
To hell with the IMF. If rational economics theory says that’s what you need to do to keep your country on the rails, then that’s what you do.
R, What I’m seeing in your responses is that every time somebody puts out an obvious solution to your problem you dismiss it. That is exactly the same approach Vincent does when the solution to hyperinflation are presented. Hence why I keep raising it.
It’s a classic rabbit in headlight situation in psychology: “Why does your head hurt?”, “I keep banging it against the wall”, “Stop banging it against the wall”, “I can’t do that because [insert internalised ruleset here]”.
If you restrict imports in foreign currency to that already earned does that cure the problem?
If you put banks who go bust in a foreign currency go into administration, recover the domestic part of the bank, and carry on (as in Iceland) does that cure the problem?
Hyperinflation again 🙂
I have not read Vincent’s comments to say anything about them.
I am pointing out to the inherent confusions and self-inconsistencies.
For example your usage of protectionists measures such as going against the IMF is inconsistent with the stand that imports are benefits. I have nothing against selected protectionists measures in fact (if the phrase “protectionism” is correct and can mean different things to different people).
And the whole thing is nearly missing the understanding how the “free trade doctrine” has ruined nations instead of helping them. MMT fans can keep writing imports are benefits and overdoing things.
The strategy of letting the domestic banks go bankrupt and rescuing them in local currency doesn’t help. Your nation will be shut off from the rest of the world. It doesn’t get you to full employment as you are restricted fiscally and have the burden of servicing debt to foreigners.
The reasons there are confusions here is due to looking at money as an asset and not a liability. In fact nations do not want to go into higher negative net IIP. This can be seen by their recent behaviours on weakening their currencies to gain a bit of competitiveness in international trade.
The confusions arising here are reminiscent of debates involved in the money multiplier story. I tell someone that if the central bank starts controlling reserves and stops the usage of discount window, the interbank market rates will shoot up. The nonbeliever comes and tells me “give me an example of where the interbank rates shot up”. The reason interbank rates do not shoot up is that the central bank doesn’t behave like the Monetarist wants it to. The story is similar here – but harder to get across. Governments do not behave in the way you want them to. Even in money supply case, Monetarists thought its just a matter of political will and blamed it on incompetency of central bankers.
Neil,
A reference if you need from the Post Keynesian literature.
“Economic growth and the balance-of-payments constraint” by J. S. L. McCombie & A. P. Thirlwall
R,
Imports are a real benefit if they are paid for in the domestic scrip – because at that point the foreign exporters have joined your currency zone and the exchange issues are their problem. Which are then (where necessary) resolved by the foreign government buying the scrip in exchange for their local currency as China has done.
That’s why a policy should be to buy imports in your local scrip where ever possible.
Again though you have sidestepped answering the specific questions. So I’ll leave it there.
“Your nation will be shut off from the rest of the world”
Iceland hasn’t. Argentina hasn’t. Russia hasn’t. Germany hasn’t. Neither really has Zimbabwe.
Why? Because where there is chaos there is an opportunity for an extraordinary profit at the micro level and some smart person will find a way of making it work.
Icelandic frozen at sea fish makes great Fish and Chips. I’m certainly not going to stop buying that fish with Sterling just because Landisbanki went bust.
That Sterling can then be exchanged easily for dollars and there you have your oil. So that’s fish into oil sorted. At some point the Icelandic actor will need some Krona to pay taxes and local employees, so some oil will get sold and you’re off. Iceland could make it easier by offering scrip conversion direct from the government as they have in China.
Again I still see nothing you’ve put forward that isn’t dealt with in Bill’s open economy post: (https://billmitchell.org/blog/?p=5402).
Ramanan – appreciate the attempt to spell out your argument in a bit more detail, but don’t you agree that any policy recommendation to run a smaller BD needs to be expressed in terms of a trade-off?
International coordination on fiscal or FX policy would obviously be welcome, as would encouragement of export industries – so far, so uncontroversial. But you are going further than this, in saying that the US or UK should tolerate (even more) deficient demand today in order to address our trade imbalances.
If you present this exhortation without articulating how/when NIIP risks are to be balanced against deficient demand, I just don’t see how you expect to be taken seriously.
Best
MMTP
R, from your analysis it would seem that countries should retain the ability to adjust trade balances through price, i.e., tariffs. It might be asked why tariffs are now off the table but immigration is still tightly controlled in order to support the price of labor (a political necessity). What has happened, in effect, is that companies have gotten around the “tariff” on labor imposed through immigration policy through exporting jobs directly (outsourcing). Lots of talk now about re-instituting tariffs in order to smooth the transition to a global economy as a political necessity.
MMTP,
You have put me in a spotlight by asking that question ;-).
I should duck the situation by saying that I am merely presenting the irony of the situation rather than making any proposal. Of course what I said – coordinated fiscal policy and fresh principles on doing international trade – itself is a proposal but should be in that direction. Its not my own of course, and that is PKEish. However, that obsession will keep me occupied for quite some time. I understand however that governments are overdoing it (the austerity).
However, I am saying that fiscal policy is useful as long as the external sector allows it. Again not making any recommendation about budget deficits. I understand that tightening fiscal policy will put the domestic economy in recession and the dynamics in a closed economy.
I, however insist that the stand shouldn’t be taken as the US and the UK suffer deficient demand. No way! Increase demand but concentrate on improving the external situation as well. I won’t say “increase the fiscal stance and export-led strategies will fail”. This is because export-led strategies have actually succeeded.
Tim Geithner has tried to pursue the path of resolving the imbalances. He came up with a plan of putting ceilings on trade deficits/surpluses. Don’t know where it is headed.
Again, I am just presenting the irony of the situation. John Maynard Keynes once said
JMK got many things wrong but at the same time, said brilliant things.
Also, the IMF publishes a report every year on exchange rate arrangements and restrictions. These are in place precisely because there are risks.
Tom,
Not making any proposal which is in any practical form. Theory is different from practice. All I am saying is that nations have a balance of payments constraint and poorer nations need to be helped so that they can take measures on this.
R, what I have been saying is similar. In a closed global economy, what would make the system work?
Large elastic economics need to run persistent CAD’s for some time in order to create incomes in underdeveloped and emerging nations with inelastic economies that will lead to the increasing NAD needed there in order to generate increasing domestic consumption as an economic base. While the underdeveloped and emerging nations are the fragile ones at this point, developed nations have some fragility, too. Along with the income in developed nations has to be protected so that employment does not fall precipitously as the world adjusts.
In addition, overall coordination has be be exercised to promote sustainability on all levels. Steps also have to be taken to prevent extraction by special interests.
The invisible hand is not the exclusive coordination mechanism that is going to take us there. Human beings have to use their brains, too. I don’t see floating rates alone getting us through this wrenching adjustment called globalization. We also need some big ideas.
Dear Ramanan (at ) and others who have been lured into this dead-end
Ramanan asserts (for the nth time):
This is patently false. The correct statement is that fiscal policy is useful (and powerful) if it contributes to public purpose and is unconstrained by voluntary arrangements which restrict sovereignty. The external sector just influences the final composition of demand. The external sector can rebel or whatever, but a national sovereign government will always be able to purchase whatever is for sale in its own currency including any idle labour that has no non-government market bid. The external sector cannot stop or restrict that capacity. Sorry.
best wishes
bill
JKH,
To me the model of the balanced multiplier can be simplified if we assume that the economy is closed so that we don’t even need to get involved in calculations of the multiplier which involves marginal propensity to consume ratio, marginal tax ratio, etc.
The Government has to add to the aggregate demand extra spending Delta_G and subtract from the aggregate income Delta_T. This means that the disposable income Y-T remains exactly the same and that the Government net spending position (a flow) which is G-T also remains the same. But Y has increased by Delta_G and this is what we wanted.
How extra taxes are levied affects income redistribution and this is the real political problem. There can be some secondary effects related to different spending propensities of various social groups.
Bill @ Wednesday, January 5, 2011 at 8:02
You say “The external sector cannot stop or restrict that capacity. Sorry.”
Public purpose is a great cause. In spite of your assertions such “purchase whatever is available on sale in local currency”, poor nations remain poor. International trade decides the fate of nations.
What you are saying looks like a theory “when I leave my home reindeer start dancing there and whenever I open it, they go away”. Easy to assert, difficult to prove whether it actually happens.
Again the innuendo “trade deficits are not a problem”.
Get empirical. Sorry.
PS: The Iceland data during the time its exchange rate plumetted in 2008, suggests that the Central Bank of Iceland and the Government of Iceland combined was a net creditor in foreign currency! To pay off the coupons on foreign currency debt, the government could just take the dollars/euros from the central bank and credit international bank accounts.
Adam (ak),
Thanks for your interest. I’ll come back to your comment later. I’m still reviewing the methodology of the post.
This blog post contains some non-trivial arithmetic/numerical errors.
The section entitled “Why does the multiplier work in this way?” develops an erroneous numerical sequence for the example used. The math is wrong for several reasons, and I’ve corrected it by reworking the same example below.
The relevant sub-section starts out:
“Firms initially react to the $50 order from government at the beginning of the process of change.”
For reference, I’ve duplicated the key part of this sub-section, with my corrections, at the conclusion of my comment here.
Preliminary remarks:
First, it is important to note that the specific example used in this section DOES include an allowance for a 20 per cent marginal propensity to import. This should not be confused with the final part of the post, which develops an argument that purports to depend on the nature of the assumption about whether the economy is open or closed. That is an entirely separate issue from the nature of the error here.
The example used here is the generic one used in the main part of the post, where the income tax rate is 15 per cent, the marginal propensity to consume is 80 per cent, and the marginal propensity to import is 20 per cent.
It is also important to note that the example here assumes that there is an initial $ 50 expenditure by the government. This is an assumed “autonomous injection”. The way the example is developed, there is an implicit assumption, which really should be made explicit, that this order is entirely filled by domestic production – i.e. that the government does not import any product arising from this order. Otherwise, there would not be $ 50 of GDP and income associated with this expenditure, which is what is assumed very explicitly in the development of the multiplier math.
So it’s an assumption that means the initial $ 50 government SPENDING injection is also a $ 50 INCOME injection (i.e. income corresponding to GDP – as opposed to, say, global income, but not necessarily all GDP). I gather from memory that multiplier analysis typically glosses over this assumption, in general. If so, in my opinion, it is sloppy, since this really is a non-trivial and important assumption in the development of the logic for multiplier math, in general.
Hence, the autonomous injection of government spending is itself not directly subject to import leakage (although later induced rounds of spending are).
Finally, as preliminary, given the nature of the example as a government injection, there really is an opportunity here to blend the MMT perspective into the multiplier analysis. From a macro perspective, and based on the assumption just noted, the example of a $ 50 government injection immediately creates GDP, matching income, and net financial assets of $ 50. I will demonstrate below that the actual mathematical logic of the multiplier formula fits with such an analysis referencing NFA. In fact, the multiplier formula and its numerical decomposition are very much in synch with the idea that spending creates income as opposed to vice versa. The preliminary step in the multiplier math for this example is the creation of $ 50 of income from government spending. It is the subsequent step (which is the second step of the math sequence, but the first step of GDP and income multiplication) where non government spending starts from a base of $ 50, but proceeds to net out taxes, imports, and saving – i.e. the leakages. This occurs, at least logically, before spending on domestic consumption, which is what generates the next round of GDP and income. From this perspective, it is much better to consider the leakages as being allocations (e.g. income taxes, which reduce the initial NFA injection) or swaps (e.g. imports) of net financial assets, initially created from the government injection of $ 50. It is only the final residual of that $ 50 of NFA – i.e. what the private sector spends domestically – that ends up generating the first multiplied round of GDP and income.
This is all from the macro perspective of course, as micro allocations of the amounts in question are in a state of continuous flux in terms of sources and uses of funds, while adhering in total to required macro identities. The initial step in this sequence is the creation of $ 50 of GDP and income from government spending. That includes $ 50 of private sector income, which resides at the macro level as NFA. This NFA affects aggregate demand. Regardless of the micro composition, the macro dynamic in this particular government expenditure example is that the economy is multiplying the original GDP injection, on the strength of that initial NFA wealth effect (taking into account leakages, including taxes with partial NFA reversing effects), and its impact on aggregate demand.
Preliminaries over, here is my analysis of the multiplier example in question:
A government expenditure generates GDP and income of $ 50.
Disposable income is $ 42.50 (15 per cent income tax).
Consumption is $ 34 (80 per cent mpc).
Consumption includes imports of $ 10 (20 per cent marginal propensity to consume)
Consumption net of imports is $ 24.
Consumption net of imports creates the first round of multiplied GDP and income.
GDP and income increase by $ 24.
This $ 24 is the first round GDP/income multiplier effect arising from the original $ 50 government injection.
The $ 29.90 figure that appears in the post (instead of $ 24) is simply wrong. There are several different errors in the computation. Aside from failing to include the netting effect of imports on multiplied income, the factors used for sequential computation are simply not in synch with, and do not reflect, the mathematics that actually corresponds to the multiplier formula, and which are required for a correct summation to the correct multiplier result.
The second step in the multiplied income sequence:
GDP/income generated by the first multiplication step is $ 24.
Disposable income is $ 20.40 (15 per cent income tax).
Consumption is $ 16.32 (80 per cent mpc).
Consumption includes imports of $ 4.80 (20 per cent mpm)
Consumption net of imports is $ 11.52.
This $ 11.52 consumption net of imports creates the second round of multiplied GDP and income.
I.e. GDP and income increase by $ 11.52.
That is the second round GDP/income multiplier effect following from the original $ 50 government injection and the first round effect of $ 24.00.
Proceeding similarly, the full, multiplied GDP and income series is:
$ 50 (initial) + 24 + 11.52 + 5.53 + 2.65 + … = $ 96.15
The actual arithmetic multiplier quotient is 1/.52 = 1.92
The $ 96.15 total and 1.92 multiplier both match the corresponding numbers used in the post (96.12 in the post – a slight difference). The error isn’t in those numbers; it’s in the sequential decomposition of the multiplier,as per the example. The sequence of numbers that was calculated and used in the post is not correct, and does not sum to the correct total of 96.15.
………………………………
The erroneous section:
“So the initial rise in government spending has induced new consumption spending of $42.50 which then triggers further production increases.
At the end of the first period (before the induced consumption spending starts to take effect), the total leakages (S + T + M) equal 26 (that is, 8.50 + 7.50 + 10) and they are well below the initial injection of 50. So the system is not yet at rest because the leakages have not yet matched the initial injection.
This is where the multiplier begins. The workers who earned that initial increase in income increase their consumption by $42.50 and the production system responds. So consumption spending in the next period rises by 0.8(1-0.15)42.50 = $29.90. Firms react and generate and extra $29.90 of extra output and income to meet the increase in aggregate demand.”
……………………………
The erroneous section, corrected according to numbers and logical syntax, as per my comment (the wording is blended from the original text, which probably isn’t ideal, given the significant change in numbers that is involved here):
So the initial rise in government spending has induced new consumption spending of $ 50.00(1 – .15)0.8 = $34.00, which then triggers further production increases (after allowing for $ 10.00 of imports), resulting in a GDP/ income increase of $ 24.00.
At the end of the very first period (before the induced consumption spending starts to take effect), the total leakages (S + T + M) equal 26 (that is, 8.50 + 7.50 + 10) and they are well below the initial injection of 50. So the system is not yet at rest because the leakages have not yet matched the initial injection.
The workers who earned that initial increase in income have increased their consumption by $34.00 and the production system responds (after allowing for $ 10.00 of imports), resulting in a GDP/income increase of $ 24.00.
In the next period, consumption spending rises by $ 24.00(1 – .15)0.8 = $16.32. After allowing for further import leakage of $ 4.80, GDP and income increase again, this time by $ 11.52.
Etc.
JKH,
To me it looks that you’re using a different topology of the model.
In the Bill’s model M=mY is applied at the “commodity market” after the first round of paying wages-taxation-household savings
something like this:
link_http://www.readbangkokpost.com/businesswords/circularflowincome.png
(it is somehow assured that extra government spending ides not leak on import during the first round of the multiplier)
In your model the marginal propensity to import is satisfied out of the wages before the first round of paying taxes and savings
something like that:
link_http://upload.wikimedia.org/wikipedia/commons/thumb/a/a4/Circular_flow_of_income.jpg/220px-Circular_flow_of_income.jpg
Ramanan – appreciate you at least conceding that your comments here with respect to budget deficits are not intended as actionable policy prescriptions.
Poor nations remaining poor (ie which don’t see sharp GDP/capita growth) has nothing to do with Bill’s comment ‘ a national sovereign government will always be able to purchase whatever is available on sale in local currency ‘, which highlights more how actual GDP within a period can relate to potential GDP.
Yes of course existing industrialised countries’ development was historically helped by being able to run CASs, and yes CASs might help the US, the UK and poor countries today. But if you want these countries to reduce their CADs in the short term, it’s incumbent on you to highlight which countries you think will increase their CADs to offset this.
Your point ‘get empirical’, and your reindeer analogy, seem brazen in the extreme: you refuse to provide any evidence to indicate why the US or UK are about to see a currency crisis, putting your concern firmly in the ‘bogeyman’ category.
I hate to keep calling you Chicken Little, but you don’t leave one much choice 🙂
Best, MMTP
MMT Proselyte,
Bogeyman now 🙂
Since this point of mine is not understood, I will try to clarify. Nations are careful about their currencies and hence you do not see the crashes. I understand that there is a bit of circular logic here. The US has refrained from a fiscal expansion and its would like to see a controlled devaluation of the dollar than a sudden one. Of course, the irony of the situation is that the employment problem is not solved.
In fact I am actually not claiming a sharp fall. Its the commentators who have been adamant about doing so. On the other hand I have given an example cases where it has happened.
Again one cannot equate a fear of a moderate inflation to hyperinflation. Misses the point. Read my last para @ Tuesday, January 4, 2011 at 20:32.
Also, before accusing me of being a bogeyman, try to look at my other comments which are not on this topic. Probably Tom Hickey can certify to it that I am not a Monetarist.
Talking of poor nations, I just have one thing to say – the argument doesn’t even move beyond currency invoices of imports.
Also, imports are demand dependent and also depend on the volitional decision of citizens to purchase a foreign product or something else over the domestic ones. Since imports are proportional to income too (proof – this blog post), nations restrict demand to reduce imports (though the latter is not claimed in the blog post). Irony.
There is a difference in the central bank standing ready to purchase bonds in the open markets than governments trying to purchase labour. The former doesn’t increase government expenditures and the latter does. Not that increases in expenditures is an issue but the latter is just a statement without trying to look at the implications. Can purchase – in what quantity ? What’s the impact on the external situation ? Its a “questionable claim”
Neil,
Just seeing your comment. Why is there a pretense that Iceland isn’t facing problems ? I thought I should be using it against you, instead of the other way round. Argentina has been running a current account surplus almost every quarter since 2001. Germany doesn’t even need any discussion as it is strong in its exports. Russia offers a great example of how foreign “investment” cannot be mousetrapped. Not sure why Zimbabwe should be discussed here.
On the other hand, I managed to get you talking about importing in the local currency! Unfortunately money is still credit. Here is what the foreigners do. They export things to you. Their bank which has a correspondent account at a local bank gets credited in the local currency and the foreign bank credits the exporters local currency account. There is a currency swap which needs to be rolled over and the foreign bank uses the balances to retire the currency swap.
So really not sure if one can have no current account convertibility but can have capital account convertibility. Again before you tag me, just trying to prove that money is credit.
Not going to “allure” people more into this.
The balanced budget multiplier or the non-usefulness of it has nothing to do with the foreign sector *only* unlike claimed in the post. It doesn’t make sense because the budget deficit is endogenous. Bit surprising that the endogeneity is mentioned in one section and not in the summary. True, in the open economy case, its more involved, the fact is that its worth mentioning that it doesn’t in the closed case as well.
This was understood by Ott and Ott – Budget Balance and Equilibrium Income David J. Ott and Attiat F. Ott Source: The Journal of Finance, Vol. 20, No. 1 (Mar., 1965), pp. 71-77
They clearly understand that the government debt is a mirror of the private sector wealth and in fact have the “Definition of Net Financial Assets of the public” (equation 9) and “changes in net financial assets of the public”.
Footnote 4 says
And the authors do not use one-period multipliers as well! Of course the authors make some exogenous money assumptions such as IS/LM but that was 1965.
Ramanan – a bogeyman is something which people are afraid of but doesn’t actually exist – not you, but rather the dire consequences which you claim will result from a high NIIP.
I continue to struggle to make any sense of your elliptical writing style. Maybe it’s me or a language barrier, but you just don’t seem to have a consistent approach from one post to the next.
I had been hoping that clarification/substantiation of your point would illuminate me or the thread, but 10 posts later it’s clear we’re just wasting time. So sorry but let’s drop this.
Best, MMTP
MMTP,
Remember there was one MMT paper in 2006 on the Mexico Peso as if its current account doesn’t present any problem – with about minus 33% or so of net IIP, the currency plummeted in 2008. One can come up with various explanations such as “foreign currency debt of the government” but check data carefully and you see balance sheet consolidated with the central bank as a net creditor position.
It doesn’t really take time for the IIP position to go there. People start worrying about a current account deficit of 3% itself. So bogeyman tagging doesn’t help.
Its all about getting the causality right. Have you been able to convince many people that investment leads to saving rather than the other way round ?
Yes better to end here. Thanks a lot for engaging.
Dear Sir,
I would like to thank you for the nice post you shared. While I do follow and agree with its overall logic and arguments, I suspect that there might be a small parameter inconsistency in the numerical example you give about the balanced budget multiplier. Specifically, when comparing the expansionary impulse deriving from increased government expenditure against the contractionary impulse deriving from increased taxes, you set k=1.92. Crucially, such parameter value already includes the stabilizing effect of taxes, as it assumes t=0.15 (see equations 10-12). So, this value of k already dampens both expansionary and contractionary impulses, although to different extents. However, you then leave this value unchanged when presenting the case of a lump sum tax, which seems to cause an inconsistency.
More precisely, assuming a lump sum tax, I would argue that the expansionary impulse should be 125 while the contractionary impulse should be -100, so that their sum will generate an overall increase in aggregate income equal to 25. That is, ΔY=ΔG/2, under the parameter restrictions you use in your numerical example.
To see where my point comes from, one could turn to some simple algebra. In the following I will use the same parametric restrictions you used, namely C_0=0, c=0.8, and m=0.2. Equilibrium output in an open economy is:
Y = c(Y-T) + I + G + X – M
Y = cY- cT + I + G + X – mY
Y -cY +mY = – cT + I + G + X
Y(1-c+m) = – cT + I + G + X
Y = 1/(1-c+m) (- cT + I + G + X).
What happens in such an economy if G increases by ΔG and T increases by ΔT=ΔG? One can single out two opposing effects, namely:
– Expansionary effect: +ΔY=ΔG/(1-c+m)=50/0.4=125.
– Contractionary effect: -ΔY=-cΔT/(1-c+m)=(0.8*50)/0.4=100.
Then, the sum of the expansionary and contractionary effects will give an overall impulse to output equal to 125-100=25.
Why do these computations differ slightly from the ones presented in the post? Essentially because the multiplier they use is larger, since the denominator is not affected by taxation. As far as I can see, this is more consistent with the example of a balanced budget multiplier. In fact, if one inserts a role for a flat tax rate on income in the multiplier, the exogenous variation of T that is necessary to pay off the extra ΔG will indeed be ΔT<ΔG. That is because some of the extra tax revenue that is necessary to pay for the extra ΔG is already collected through the endogenous increase in y (and thus of ty) triggered by the expansionary impulse. In a nutshell, this is why the numerical answer discussed above differs from yours. In percentage terms, our answers differ by the amount (25-19.2)/19.2=30%, which is not so little after all.
Kind regards.
how can we use the cocept of leakages and injections to illustrate balance budget