Regular readers will know that I have spent quite a lot of time reading the…
Letter to Greg Mankiw
I am travelling today and so haven’t much time. Given that I am in the letter writing mood at present I decided to write to another of the New York Times columnists Greg Mankiw about a recent article he published. That has taken up my spare time today. So as not to disappoint I have made by letter available for all to read. I am sure Greg won’t mind. So read on …
I have been a letter writing mood the last few days. Yesterday I wrote a letter to our colleague Paul Krugman about some matters that concerned me in his recent portrayal of some work that I am associated with – the school of thought known as Modern Monetary Theory (MMT). I was initially going to take a pretty hard line and get straight to the point – you know the way we are trained in graduate school as economists to tear into arguments we don’t like – no holds barred, give no quarter.
You know how it is like. Especially, during seminars when a non-mainstream economist is presenting their work to us – we don’t hold back then do we – we seek not only to destroy the argument but also the reputation and self-confidence of the speaker. Almost anything goes when these pop sociology lefty types think they can do economics. You know all that though.
Anyway, I was thinking that it would save me time just to go to the jugular in the way that the mainstream graduate schools train us – we all understand that approach. But because I was going to make it public and non-economists might have read it I didn’t want to generate too much negative angst from those who have different cultural expectations and think politeness is giving someone credit for not being truthful. I personally am not sure I should worry about the any middle class sensibilities, which often turn out to be “false politeness” anyway, especially when the views I was concerned about are being used, ultimately, to perpetuate policies which mean entrenched unemployment for millions.
But, just in case, and in the interests of cultural tolerance, I decided to take a softer approach in my letter to Paul Krugman.
Instead I opted to be more polite and to point out that when someone is writing for a newspaper such as the New York Times, which as you know is influential in forming public opinion, they have a duty of care to ensure they do not proliferate mis-representations for the purposes of advancing their own argument.
Especially when the writer is influential themselves and occupies a considerable position among so-called “progressives”. So when a leading academic writer represents a school of thought which challenges his/her world view – upon which they have probably been very well rewarded by way of speaking engagements, consultancies and/or Op-Ed columns – in a way that is untrue that is a concern.
In fact, this sort of poor scholarship abuses the position the person has because it holds the challenging school of thought out for ridicule. We have a polite word for saying things that are not true … we call that lying.
I am not able to assign intent – not being a psychologist – but we all know that we are meant to be trained to ensure that we do not deliberately set up false representations of theories that we may find challenging or threatening to our positions. We are trained instead to do our research thoroughly and to consider each idea on its merits. Anyway, my letter to Paul Krugman was just to point out that issue and tell him I thought he could do better.
I forgot to send the letter.
But the point is that when you write for the New York Times you should take care in what you say.
And on that, while I am in the letter writing mood … if I may … I saw something you also wrote in the New York Times on March 26, 2011. It might have been an article or a blog post but it was a written communication so who cares what I refer to it as. I don’t expect anyone will mind if I sometimes call it an article and other times refer to it as a post. What is at stake there?
Anyway, Greg, if I may intrude for a moment … I just want to make a few … small … well actually not so small … but you will understand … if I just take a little of your time … I know it is precious and you have important things to do … but I thought … ah … I might just point out … you know … nothing too important … well when it comes to it … quite important … things out that I thought … if I may … were not quite … well actually they were dead wrong … but excuse me please.
I refer to your Economic View column – It’s 2026, and the Debt Is Due which was purporting to be a speech written for the US President to be delivered in March 2026 where you consider the President would have “a heavy heart” and would be admitting that the US has a “crisis” on its hands which “is one of our own making. And it is one that leaves us with no good choices”.
I imagine the President would be reflecting back to about now and how he and his Administration handled the current crisis. There is a major crisis now which will reverberate via the children of the unemployed to 2026 and beyond. There are millions of American workers without jobs for no good reason other than the mainstream economics profession has somehow been used by politicians and lobbyists to support a policy situation whereby the government has failed to take its responsibilities seriously.
The US government is deliberately standing by – arguing about nothing important – and leaving millions without work and many of them falling further into poverty. It certainly doesn’t look like a great nation to anyone who understands these things.
And the current crisis that I imagine the President will be talking about in 2026 is definitely “one of our own making”. We listened to economists who preached the virtues of self-regulating markets and pressured governments into giving too much lead to the financial sector. The greed and corruption that is inherent in that sector once let of its leash created a product space that was impossible to risk-assess and ultimately doomed to collapse. As the collapse was building the mainstream economists sat around sipping coffee in their safe tenured jobs telling everyone that the “business cycle was dead”.
They wrote textbooks that they foisted onto their students (at exorbitant prices) which extolled the virtues of deregulation and claimed that the only real policy agenda – now that the macroeconomic questions were solved – you know inflation targeting with passive fiscal policy with unemployment being used to control inflation – was to further deregulate financial and labour markets. The upshot was that all corporate sector, particularly the financial sector pocketed increasingly larger proportions of national income at the expense of the workers and paid economists to make statements supporting this process. Many economists who made such statements under the guise of their academic affiliation never reported that they were actually being paid by companies etc who would benefit from the policy changes being advocated.
As an aside, Greg, I understand that you were asked to appear in the recent movie Inside Job but declined. I guessed you were probably too busy doing community work or spending time with your family to offer any insights.
Anyway, in your article, and excuse my intervention here … you say:
For many years, our nation’s government has lived beyond its means. We have promised ourselves both low taxes and a generous social safety net. But we have not faced the hard reality of budget arithmetic.
The seeds of this crisis were planted long ago, by previous generations. Our parents and grandparents had noble aims. They saw poverty among the elderly and created Social Security. They saw sickness and created Medicare and Medicaid. They saw Americans struggle to afford health insurance and embraced health care reform with subsidies for middle-class families.
I wondered about this Greg. Can I just offer a few small insights. Excuse me for taking that liberty.
A nation’s means is defined by the productive resources that they have at their disposable to put to work in creating real goods and services which people can enjoy. In addition, a nation can access foreigners to send them real resources which can also enhance welfare.
As long as these productive resources are being used in an environmentally sustainable way the best option for a nation is full employment. It maximises income. As economists we are always talking about optimal use of resources and efficiency. Your textbook is full of this stuff. It doesn’t take too much to know that if a nation sacrifices millions of dollars of potential income per day because it keeps millions of its citizens unemployed that it is not using its resources optimally. When you do the sums there is no greater inefficiency than mass unemployment.
For years, the US has had idle labour and capital resources because the national government declined to take responsibility for the spending gap and expanded their fiscal position sufficiently.
The government is overseeing a policy regime that entrenched unemployment and is deliberately forcing the US economy to forego billions in lost income earning opportunities which would have improved the lives of millions and allowed your cities to be more vibrant.
By 2026, the children of those unemployed will be adults and they will inherit the disadvantage.
So Greg, how is the US living beyond its means? Excuse my question.
I suppose you might be thinking that the budget deficits are a sign of spending more than you have in income. A layperson might term that “living beyond your means”. But that only really applies to a household or non-government entity doesn’t it Greg. They are financially constrained and cannot spend more than they earn indefinitely. Eventually they have to pay the piper.
But Greg, the US government is fully sovereign in the US dollar and it can buy at any time anything that is for sale in that currency. As long as there are real goods and services available and there are production opportunities government deficits are not pushing the economy beyond its capacity to produce.
I agree that you might think a government is living beyond the economy’s means – noting that it doesn’t make sense to consider the “means” of a government – if it keeps pushing deficits to the point that there are no idle resources and the economy responds to the increasing spending by inflating prices. That might be a sign that the deficits are too large. But while there is mass pools of idle labour the government has a responsibility to keep pushing higher deficits to ensure that labour is absorbed back into production.
In the speech, you characterise the President reflecting on the admirable safety nets that the US put in place many years ago. You write:
But this expansion in government did not come cheap. Government spending has taken up an increasing share of our national income.
Today, most of the large baby-boom generation is retired. They are no longer working and paying taxes, but they are eligible for the many government benefits we offer the elderly.
Our efforts to control health care costs have failed. We must now acknowledge that rising costs are driven largely by technological advances in saving lives. These advances are welcome, but they are expensive nonetheless.
At the outset, Greg, I note that these safetey nets – pension and health care – are at the lower end of generosity compared to other nations. I also note that many nations have comprehensive state-provided health care and pension systems that have been providing dignity to their citizens for years without major problems. But even in the US they provide some sense of security for your citizens which I think we can all applaud.
I also agree these systems are not “cheap”. The elderly like to eat and they deserve as part of their dignity to have a nice house/apartment and some spare change to enjoy the movies and surf the Internet. All the real resources – excuse me for the bold – my parents told me it was rude to put bold in letters but I just wanted to make sure we appreciated the point – that real resources carry an opportunity cost and can be allocated in one use at the expense of another use.
The same goes for health care. It is in our mutual advantage to keep people healthy and there is a very large public good component in public health. Your textbook tells us that a private market will under-allocate resources to public goods because the market fails to price the social benefits and costs. There are strong net social benefits in public health. So it is only efficient that the government ensure there are high levels of provision. Yes, that doesn’t come “cheap” because once again real resources have to be used.
I note that when there are lots of idle resources the opportunity costs are lower – even zero. I also note that as demography changes we free up resources that we were using to provide child care and primary education etc.
I also like your point about the rising costs being driven by “largely by technological advances in saving lives” – that is, a supply effect rather than a demand inflation. We should be profoundly proud that we can now help people live longer and happier lives Greg. As we get older we will appreciate that.
But the major point is that all these “costs” are just the real resources being used – the food the pensioners eat, the titanium that goes in the replacement hips etc. As long as there is enough of those things available there is no question the federal government in the US can afford to purchase them and make them available to advance public welfare.
The problem is that some people, even you, might not like the government doing that. But then you will vote as a citizen against it. Your opinion as an economist is irrelevant here – we have nothing to say when it comes to making political choices between competing ends. Society has to solve the political problem.
It might be that the health care, for example, will require spending that pushing total spending beyond the current inflation barrier. Then the government has to make political choices. Reduce spending elsewhere or cut back health care spending. Politics not economics.
But mostly I wondered why you didn’t acknowledge the problems America will get itself into as its society ages while at the same time it keeps unemployment so high and reduces the potential productivity growth path. What will matter in 2026 is how productive America is and how many people have productive skills to produce the real goods and services that will define our real standard of living. You will not achieve this desired state by 2026 if the US government doesn’t do something about the hideous unemployment problem it is currently facing.
Perhaps that is what you meant to say but didn’t quite get around to expressing it that way.
Your “speech” then made some interesting points about where the government gets its capacity to spend from. Excuse me for offering some additional points. It is not that you are wrong … perhaps dead wrong is better … but lets not labour the description.
If we had chosen to tax ourselves to pay for this spending, our current problems could have been avoided. But no one likes paying taxes. Taxes not only take money out of our pockets, but they also distort incentives and reduce economic growth. So, instead, we borrowed increasing amounts to pay for these programs.
Yet debt does not avoid hard choices. It only delays them. After last week’s events in the bond market, it is clear that further delay is no longer possible. The day of reckoning is here.
We both know Greg that the US government is fully sovereign in its own currency and as such is never revenue constrained. It is a monopoly issuer of the US currency. Your textbook has a chapter on monopolies so you understand fully what that means when applied to a national government.
So if the US government can spend whenever it chooses – and wisely would spend when there are real resources available (or it can make available) which it can utilise to advance public purpose – what is the purpose of taxation?
We know that governments tax to alter resource allocation – that is to deter people from doing certain things. These are political choices and not germane to our discussion here Greg.
Other than that taxation is used to regulate aggregate demand to ensure that there is ficscal space for the government to pursue its socio-economic program. Taxation Greg, creates unemployment (resources available in seek of work) which government spending then puts to good use – one way or another.
As you know Greg, when the non-government sector decides that it will cut its spending, output and employment falls if the government sector doesn’t pick up the slack. It is really simple “Budget arithmetic” to use your phrase. The only way the government can add to demand in net terms is to run deficits. Trying to tax people to cover the spending Greg may be appropriate at certain times but when there are lots of idle resources it is never appropriate. The economy needs a net spending injection. I am sure you teach that to students in first-year like all responsible teachers of macroeconomics should.
Then we come to debt. If the US government doesn’t need revenue to spend then we have to understand the role of debt issuance in a more sophisticated way. Quite clearly the government doesn’t need to issue debt to net spend. Even the textbooks like yours acknowledge that. I wrote a few blogs on this once which in the interests of keeping this letter short I might refer you too – perhaps to get some feedback from you … but only if you have time.
Please read the blogs – Deficit spending 101 – Part 1 – Deficit spending 101 – Part 2 – Deficit spending 101 – Part 3 – for a sequenced discussion on this.
In short, npw that the central bank in the US is paying interest on excess reserves held with it by the member banks there is no need for debt issuance at all. The central bank used this debt to manage the “cash system” – that is, as a liquidity management tool, to ensure that it could “hit” its target interest rate and ensure that the goings on in the interbank market each day didn’t compromise that monetary policy goal.
I have read your text book on this Greg and couldn’t find any mention of it. That is why I brought it up here. Perhaps you haven’t updated that chapter for some time – but then all this has been operational for a long time before you started writing those books so I wondered … perhaps … what was the issue.
To make sure I didn’t mis-read what you have read Greg, I consulted your textbook again – to check whether I recalled correctly that you consider the role of the central bank is to control the money supply and taught undergraduate students that story. I have spent a lot of time studying the way the monetary system operates and the way the central bank works within the system and I had not gleaned from the study that the “textbook” version was correct.
In your textbook – Principles of Economics (Chapter 27 First Edition) – you tell students that the central bank has “two related jobs”. The first is to “regulate the banks and ensure the health of the financial system” and the second “and more important job”.
To quote you some more:
… is to control the quantity of money that is made available to the economy, called the money supply. Decisions by policymakers concerning the money supply constitute monetary policy (emphasis in original).
You then outline how you think the central bank accomplishes this task?
You write that the:
Fed’s primary tool is open-market operations – the purchase and sale of U.S government bonds … If the FOMC decides to increase the money supply, the Fed creates dollars and uses them buy government bonds from the public in the nation’s bond markets. After the purchase, these dollars are in the hands of the public. Thus an open market purchase of bonds by the Fed increases the money supply. Conversely, if the FOMC decides to decrease the money supply, the Fed sells government bonds from its portfolio to the public in the nation’s bond markets. After the sale, the dollars it receives for the bonds are out of the hands of the public. Thus an open market sale of bonds by the Fed decreases the money supply.
Now forgive me for saying so but I think this description of the way the central bank interacts with the banking system and the wider economy is not entirely accurate. One might say … if they were being less polite … that it is totally false.
They might say that in reality, monetary policy is focused on determining the value of a short-term interest rate and that central banks cannot control the money supply. Those with a good knowledge of history would say that the ideas in your textbook are residual from the commodity money systems where the central bank could clearly control the stock of gold, for example. They would say that in a credit money system, this ability to control the stock of “money” is undermined by the demand for credit.
I guess you might have been trying to say that about the old system that died in 1971 when your then President decided enough was enough and introduced the fiat currency monetary system which remains with us today and has freed governments from all sorts of stupid constraints that prevented them from pursuing public purpose effectively.
But … being rather forward … I might suggest that the account of monetary policy in mainstream macroeconomics textbooks such as your own, which try to tell students that monetary policy describes the processes by which the central bank determines the total amount of money in existence or to alter that amount, is not accurate.
If you read up on Modern Monetary Theory (MMT), which I think would be of interest for you, you will learn that the central bank has very little capacity to control the monetary aggregates.
The theory of endogenous money is central to the horizontal analysis in MMT. i outline the difference between vertical and horizontal transactions in a macroeconomy in the suite of blogs I referred to above. It is very important to understand that distinction because it helps us understand the unique capabilities of government policy.
When we talk about endogenous money we are referring to the outcomes that are arrived at after market participants respond to their own market prospects and central bank policy settings and make decisions about the liquid assets they will hold (deposits) and new liquid assets they will seek (loans).
The essential idea is that the “money supply” in an “entrepreneurial economy” is demand-determined – as the demand for credit expands so does the money supply. As credit is repaid the money supply shrinks. These flows are going on all the time and the stock measure we choose to call the money supply, say M3 (Currency plus bank current deposits of the private non-bank sector plus all other bank deposits from the private non-bank sector) is just an arbitrary reflection of the credit circuit.
So the supply of money is determined endogenously by the level of GDP, which means it is a dynamic (rather than a static) concept.
We can conclude that central banks clearly do not determine the volume of deposits held each day. These arise from decisions by commercial banks to make loans. The central bank can determine the price of “money” by setting the interest rate on bank reserves. Further expanding the monetary base (bank reserves) as we have argued in recent blogs – Building bank reserves will not expand credit and Building bank reserves is not inflationary – does not lead to an expansion of credit.
But that was all about bond issuance and I just wondered why your textbook doesn’t cover all that especially when you feel as though you can write about concerns you have with debt in the New York Times.
I also would point out … modestly … that federal debt is really not very well understood. If all the government is doing is borrowing its own spending which would otherwise be sitting in reserve balances in the central banking system then what exactly is the problem. When it borrows it just recodes the accounting location of those balances and call them federal debt. When it pays the debt-holders their due the accounting entries reverse. Numbers in accounts buzzing around the place – what is the issue?
From reading your textbook and many others I guess you think that if the government doesn’t issue this debt then there will be inflation. But when you think about the process of debt-issuance – the buzzing around of numbers – you realise that it is the net spending of government that adds to demand and the monetary operation that may or may not accompany it (debt-issuance or not) does not change aggregate demand at all. I pointed this out to Paul Krugman in my letter – I guess you both are worrying about the same thing – but relax a little – there is no issue.
Later on in the “speech” you write that the President would say:
This morning, the Treasury Department released a detailed report about the nature of the problem. To put it most simply, the bond market no longer trusts us.
For years, the United States government borrowed on good terms. Investors both at home and abroad were confident that we would honor our debts. They were sure that when the time came, we would do the right thing and bring spending and taxes into line.
But over the last several years, as the ratio of our debt to gross domestic product reached ever-higher levels, investors started getting nervous. They demanded higher interest rates to compensate for the perceived risk. Higher interest rates increased the cost of servicing our debt, adding to the upward pressure on spending. We found ourselves in a vicious circle of rising budget deficits and falling investor confidence.
As economists often remind us, crises take longer to arrive than you think, but then they happen much faster than you could have imagined. Last week, when the Treasury tried to auction its most recent issue of government bonds, almost no one was buying. The private market will lend us no more. Our national credit card has been rejected.
Economists have had a very bad record of predicting crisis. In fact, none of the mainstream profession saw the current crisis coming. How do you explain that Greg?
But why would it matter if the bond market didn’t trust the US government? When a financially constrained individual wants to borrow from bank – they have to present themselves as credit-worthy – trust-worthy. But the shoe is on the other foot for the US government and all sovereign governments. The bond markets need the governments to be issuing debt not the other way around.
The US government could simply require the central bank to make the appropriate accounting adjustments to facilitate its spending. That is the power it has as a monopoly issuer of the currency.
Under the fiat monetary system, it is the central bank which sets the short term interest rate which then conditions the longer maturity rates which we call the term structure. I didn’t see much about that in your textbook Greg but then perhaps I missed it. It is very important though that students understand the freedom the central bank has in a non-convertible currency system.
So none of the above section in the “speech” you have written for the President in 2026 applies to the fiat monetary system. In that context, I tried to figure out why you put it in there and I came up with two theories.
I think maybe you are still stuck in the old days and maybe have been too busy to notice that the US no longer functions in a fixed exchange rate system with a convertible currency. President Nixon put that system to bed in 1971. I know you like history but things have moved on Greg … but excuse me for pointing that out.
Alternatively, you have some deeper insight and imagine that the US is going to go back to a fixed exchange rate system and offer gold convertibility to holders of the US dollar. I cannot imagine the US government being so stupid as to agree to that Greg, but perhaps you know better. In which case, you will join me in arguing against any such policy blunder.
The only other thing I noted in the “speech” that was of interest was that the “IMF headquarters had moved to Beijing by 2026”. I hope that turns out to be true for residents of Washington DC. It would reduce the city pollution levels I think. So a good move.
But if I may do a bit of editing to the rest of the “speech” I think the President might actually present the Horticulture Award for 2026 and I think you would be very proud to have once again captured that award for services to the gardeners of the World.
Given the current crisis has exposed all the mainstream theories to be inapplicable and worse – totally dangerous to the design of effective fiscal and monetary policy – eventually people are going to hand in all the mainstream economics textbooks to the local pulping depot for recycling into compost – assuming the ink is bio-degradable. Your textbook leads the way Greg so there will be hundreds of thousands offered up for composting. The world benefits in two ways: less mind pollution and more compost. Win-win. The President will speak glowingly of you in that context. You should be proud that you at least have made that contribution to humanity.
Anyway, that is enough for today.
ps all typos and grammatical errors in this letter are likely to be my own fault!
This Post Has 51 Comments
“Anyway, Greg, if I may intrude for a moment … I just want to make a few … small … well actually not so small … but you will understand … if I just take a little of your time … I know it is precious and you have important things to do … but I thought … ah … I might just point out … you know … nothing too important … well when it comes to it … quite important … things out that I thought … if I may … were not quite … well actually they were dead wrong … but excuse me please.”
I’m not liking the new approach Bill.
Nice! Everybody seems to be in the letter/speech writing business now. A letter “Unsustainable budget threatens nation” to the President by 10 Ex-Chairs of the President’s Council of Economic Advisers. The only problem I see: You Bill will be busy writing letters for the coming months given the extraordinary efforts by your colleagues to disseminate austerity-propaganda. PS: The real insult or may I say scandal in your letter is you’re quoting from the 1st edition of Greg’s textbook. Not only are you depriving Mankiw of hundreds of US$ by not upgrading each time he comes up with a new edition. You are also depriving the world of much needed compost.
Not at all Andy.
Looks like someone is demonstrating that they can read the comments to their own blogs and take note of what is said (something PK doesn’t seem to have mastered), and doing so while having a playful jibe at the same time.
Then again, I may be misunderstanding your desire for another dose of brimstone?
Compared to the disrespect these ideologues have shown Bill over the years I’d say he’s letting them off lightly.
Well done Bill.
Then again, I may be misunderstanding your desire for another dose of brimstone?
I think can understand where Bill is coming from, a man can reach a tipping point when he is totally fed up of listening to the same old power and control propaganda. Social niceties will fly out of the window, when you are constantly banging against an entrenched, ruthless establishment. I imagine Libyans, Tunisians et al would empathise.
I’m just curious on a technicality…..all along these were open letters or did Bill actually e-mail PK and GM? The open letter approach is good, just in case the e-mails get caught in their spam filters.
“Greg, if I may intrude for a moment … I just want to make a few … small … well actually not so small … but you will understand … if I just take a little of your time … I know it is precious and you have important things to do … but I thought … ah … I might just point out … you know … nothing too important … well when it comes to it … quite important … things out that I thought … if I may … were not quite … well actually they were dead wrong … but excuse me please.”
OK, Bill, that was a genuine LOL moment.
I think this is confirmation that Aussies have an irony dial that goes up to 11.
The minute I saw the article in the Times, I knew you would skewer it. Nice job.
Mordant sarcasm becomes you almost as well as moral outrage. Use both!
P.S. To get some hilarious prose out of Bill Mitchell ask him to be polite.
Frederick Mishkin – Money, Banking, and Finance.
Probably the most pathetic monetary text money can buy.
Does he qualify for a letter ?
That was fun! Thanks for saving my day Bill.
As an aside, in the schemas representing the vertical transactions between government and non-government sectors, why not put the government sector below the non-government sector?
That might make the pill easier to swallow, on a subconscious level, for people brain-washed by neo-liberal propaganda, while describing the exact same truth.
Wow, even I couldn’t read this to the end. I bet mainstreamers will eat it up though.
Seriously, could we go back to MMT?
LOL. fabulous bill! and after yesterday’s post, absolutely the funniest thing i’ve read in a long while.
That’s great for the 13 people who read Billy Blog.
Not sure how bloating an essay by 90% is helpful in making an argument.
Winterspeak put it best about this blog “Why all the other stuff?”.
I wrote a few blogs on this once which in the interests of keeping this letter short.
LOL, that was really funny.
I may concede that you can catch more flies with a sense of humor than with honey. Better target, better letter.
Mankiw is a fear monger.
“Taxation Greg, creates unemployment (resources available in seek of work) which government spending then puts to good use – one way or another.”
Does taxing assets create unemployment?
Interesting article here…
I’ll email him this…
Taxes have all the same effect on aggregate demand.
You have to pay them out of income or previous savings.
Once again, Bill,
The CB rate does not condition the LT rates and the term structure except when it willing and ready to buy alla vailable longer term bonds in secondary markets.
If the Government is obligated to issue long term notes in proportion to deficit. I can understand why with the current Central Bank set up the bond market determines the yield based on demand.
Surely Bill (and MMT) is coming from the perspective where the Government is not obligated to issue bonds 1 for 1 to deficit. In which case it can set whatever LT interest rate it desires. When talking amongst MMT circles is this not generally assumed?
I think this is an area where MMT needs to fine tune the message to external parties. It is a potential weakness in the communication strategy, full on MMT does require legislative and/or operational changes to central bank operations to be implemented. The casual response from the man on the street to MMTers is “Dream on”.
There are actually two distinct hats to MMT.
1) The lite version…. Non-prescriptive descriptive MMT that explains the current economic system and explains the optimum path forward within existing legislature.
2) Bill’s “Full Monty” MMT economy .. With Job guarantee, Nationalised Banks, regulated financial sector, no bond market and all the other trimmings.
I’ve found in external discussion, it’s usually better to start with MMT lite and take baby steps. The world is not quite ready for Bill’s “Full Monty”.
MamMoTh, yes, taxes do all this. But taxing assets brings down the prices of those assets. What is your estimate of the net effect?
“Taxes have all the same effect on aggregate demand.
You have to pay them out of income or previous savings.”
-my query was because I thought that the effect on aggregate demand would be extremely different if taxes were paid out of income or out of previous savings. If one person owned lots of assets and those assets were taxed then the result might be just to depress asset prices. Such a tax might even induce firms to spend in a disposible way on staff training, research etc rather than on pushing up the prices of pre-existing assets.
“Taxes have all the same effect on aggregate demand.
You have to pay them out of income or previous savings.”
-I could believe that depressing asset prices by an asset tax “might” mean that pension contributions would need to be higher or pensioners might get lower pensions and that that could reduce aggregate demand. However I’m extremely doubtful even about that. Lower asset prices lead to greater yields from assets and greater yields are what matters to joe average pensions. High (and so volatile) asset prices with low yields would seem to me to transfer wealth away from pensioners and to speculators who would plow their gains back into further inflating the prices of pre-existing assets. How could that create employment?
ROFL. You have to have been an academic to really get this. Great job, Bill, on many levels. 🙂
Sergei, I don’t know really. But you are right, taxing assets should lower their price.
So if you increase a tax on houses by 10%, house prices might drop by 10%, so taxation will remain the same.
But lower house prices means less houses will be built, hence unemployment, income falls, etc…
I think it’s pretty hard to assess the long term effect of any tax increase (or decrease). A few years ago we’ve introduced taxes on rents, because taxing those rich landlords would only be fair, and set the lowest income tax bracket at 0.
Of course, in the free rental market, after a couple of years new rental prices had increased by inflation + the new tax.
So low income tenants are nowadays paying more taxes than before, although it’s part of their rent, and progressives are starting to realize their idea wasn’t nearly as good as they thought.
(I should not say this, but that’s why I truly don’t believe in fiscal policy to control inflation.)
“But lower house prices means less houses will be built, hence unemployment, income falls, etc…”
Really?! I thought it is absolutely the opposite, ie. higher price means lower demand 🙂
Mammoth: “So if you increase a tax on houses by 10%, house prices might drop by 10%, so taxation will remain the same.
But lower house prices means less houses will be built, hence unemployment, income falls, etc…”
-Don’t you think such a scenario would reach stability when the availability of housing corresponded to what was actually wanted by people to live in rather than housing being a vehicle for speculation? Is employment based on a housing bubble ever possible to sustain however aggressively the gov tries to maintain the bubble?
Sergei: lower prices would mean higher demand, and lower supply. if you start from a shortage position, the shortage will be larger. ok, this is all a bit too much of a textbook explanation, i am not sure how close reality is… could be totally BS, is that what you mean? 😉
stone: i don’t think you will stabilize prices with such a tax. in the short term it will bring prices down but whatever was pushing prices up is still there, so prices will start rising again, unless you increase the tax, etc… of course i don’t think growth based on a housing bubble is a sensible growth strategy but notice that in most cases the wrong fiscal policy (tax deductions) has made things worse.
Mammoth,” whatever was pushing prices up is still there, so prices will start rising again” –
With rising asset prices isn’t momentum often a key factor. Once momentum is gone, the supposed rationalization for the bubble evaporates. In Ireland people presumably built houses and banks because they thought demand would push prices ever upwards. Now whatever was pushing prices up most certainly is not still there and I suspect however rich Irish people become in the (near) future, they will steer clear of speculating in Irish property- as in post-bubble Japan. But some other form of asset bubble is always forming somewhere whenever conditions are set.
The key question is what drives the momentum, and if a one time tax hike will affect it in the long run.
I don’t think so, a market collapse certainly will.
Mammoth, don’t you think that momentum is its own driver. I’m struggling to get my head around the idea that things wouldn’t be transformed if the tax burden was moved to being an asset tax. If tax was proportional to asset value then I find it hard to fathom that people would still bid up the prices of assets beyond the point where they no longer earned a meaningful yield and yet incurred more and more tax. Ultimately rational people want to ensure future capacity to consume. In a bubble free world they would seek assets that would earn them a yield when/if they no longer got paid a wage. In a bubblelicious world, people seek assets with rising prices in the hope that when/if they no longer get paid a wage, they can sell those assets either to buy assets that pay a yield or just to spend the money. The bubbles sometimes catch them out but many people manage to reap gains from bubbles and emerge unscathed. An asset tax bill with no yield to pay it from seems to me quite a dampener.
stone, you probably thought about it much more that I did. Without thinking too much, I’d say a single proportional tax will have little or no effect in the long term. Maybe a progressive tax would… I share your concern about bubbles, and how to prevent them. The problem is how to prevent all bubbles when there is too much money in a few hands. Taxes should have prevented this from happening in the first place.
I didn’t do well on the Saturday Quiz. Wonder how this article fragment should be answered”?
“The Japanese are in even worse straits than Americans, at least in some ways. Their government debt equals 220% of GDP. Savings rates are falling to zero. The annual government budget dwarfs tax receipts. The Japanese face a huge bill for rebuilding after the earthquake, the most expensive natural catastrophe in history. Where are they going to get the money?
There are two possibilities. The first is bad for Japan. The second is bad for the U.S.
Japan can print its way out of the problem. Some Japanese officials are all for it. Others aren’t. Japan paid for its military build-up in the 1930s with printed money. Eventually this led to runaway inflation and economic as well as military disaster.
There’s another option: Japan should dip into its “rainy day fund,” say economists Carmen and Vincent Reinhart. While the Japanese bought Japanese government debt, the Japanese government bought the debt of other governments, primarily the United States. Now that it has about a trillion dollars’ worth of Treasury debt, why not just sell some of it in order to rebuild the country?
You see the problem, don’t you? What happens to the price of U.S. government debt? It goes down, right? Then the U.S. has a hard time funding its deficits. But it can print money too.”
Printing Money to Save the World by Bill Bonner originally appeared in the Daily Reckoning.
sli: “Wonder how this article fragment should be answered”?
‘The Japanese face a huge bill for rebuilding after the earthquake, the most expensive natural catastrophe in history. Where are they going to get the money? . . .
‘Japan can print its way out of the problem. . . . Eventually this [military buildup] led to runaway inflation and economic as well as military disaster.”
Where are they going to get the money is the wrong question. They have a lot of work to do. They will do it. They are a patriotic and industrious people. They cannot print their way out of the problem.
To say that the Japanese face a huge bill for rebuilding sounds good, but what does it mean? For the most part, the Japanese will do the rebuilding, so collectively they may not face a huge bill at all. Will the Japanese people face real sacrifices? Probably, since so much of their efforts will go towards rebuilding, as opposed to producing other goods and services that they would have enjoyed.
A better analogy than the military buildup of the 1930s would be the rebuilding of Japan and Europe after WWII. That led to general prosperity.
Mammoth: “I’d say a single proportional tax will have little or no effect in the long term. Maybe a progressive tax would… I share your concern about bubbles, and how to prevent them. The problem is how to prevent all bubbles when there is too much money in a few hands. Taxes should have prevented this from happening in the first place.”
I think it is quite deceptive just how “progressive” a flat proportional (ie seemingly non-progressive) asset tax would be. Less well off people typically have zero assets and live hand to mouth. Someone like Warren Buffet with $50B in assets would pay $2.5B per year if there was a flat 5% asset tax. Contrast that with the current situation: “Mr Buffett said that he was taxed at 17.7 per cent on the $46 million he made last year, without trying to avoid paying higher taxes, while his secretary, who earned $60,000, was taxed at 30 per cent.”- I guess the current system is designed to give the maximum attainable ratio of asset price inflation to consumer price inflation so as to maximise “real GDP”.
stone, the problem you mention is very real, but I don’t think it’s because of progressive taxes not being effective but rather because of the many loopholes in place to legally avoid paying taxes the wealthier you are.
This is what happens with fiscal policy to regulate whatever, you end up with an increasingly complex system, often inconsistent, and with the opposite result of what you wanted to achieve.
I mostly agree with Mankiw about taxing only income. All kinds of income, and progressively if you want to limit wealth creation.
Letting it happen and then try to tax it away is nonsense in my opinion, and apparently it doesn’t work either.
Letting it happen and then try to tax it away is nonsense in my opinion
See Warren Mosler’s proposals about reforming the system to eliminate inefficiency and parasitism. I’ve had this discussion with him. First, best to is just get rid of the things that lead to economic rent, or highly regulate them. What’s left over, tax away. The idea is to use taxation to eradicate inefficiency and parasitism without harming the host, that is, the production, distribution, consumption cycle that constitutes the basis of the economy.
Mammoth “you end up with an increasingly complex system, often inconsistent, and with the opposite result of what you wanted to achieve.”-
-One tax, one rate- on any asset held anywhere by a citizen. If the tax is not up to date, then the asset is not legally owned and is confiscatable. That seems fairly simple to me???
stone, I don’t think taxation is ever simple. What is a taxable asset? Land? Houses? Paintings? Stamps? Who values the assets to determine how much taxes you have to pay? Who checks who owns what?
When assets are savings, I don’t see how it makes sense to tax past savings instead of having taxed the present income in the past… But it’s probably more complex than I think.
“What is a taxable asset?”
In one of the US state, all assets are up for bankruptcy other than one’s home and one’s bible. Of course, very wealthy people keep huge homes and rare bibles worth large sums at auction.
Mammoth “What is a taxable asset? Land? Houses? Paintings? Stamps? Who values the assets to determine how much taxes you have to pay? Who checks who owns what?” –
-I agree with Tom Hickey’s summary as all assets that would be up for bankruptcy plus your home and your bible. Cash, bonds, stocks etc (liquid assets) are trivial to value and the tax could be collected automatically just as stockbrokers sometimes charge a % charge on their customer’s accounts. Houses, commercial property, farmland, paintings and stamps have lots of precedence for being valued for tax purposes. Inheritance tax needs to be paid on these and in the past in the UK local tax was based on land (and building) value. I know someone (as a rock climber) who’s job is surveying commercial property for the inheritance tax collectors.
Mammoth “When assets are savings, I don’t see how it makes sense to tax past savings instead of having taxed the present income in the past… But it’s probably more complex than I think.”
-The key issue is that asset value can multiply without any “income”. The super rich typically have massively greater increases in wealth due to increases in asset value rather than due to income. The current tax free nature of such increases in wealth distorts capital allocation towards seeking asset bubbles.
stone: The key issue is that asset value can multiply without any “income”. The super rich typically have massively greater increases in wealth due to increases in asset value rather than due to income. The current tax free nature of such increases in wealth distorts capital allocation towards seeking asset bubbles.
This is economic rent and should be taxed away as unearned through productive contribution.
Tom Hickey “This is economic rent and should be taxed away as unearned through productive contribution.”
-To me a crucial aspect of a flat asset tax is that it makes no value judgments and is so simple, basic and free from political wriggle room. You are pointing out that a key part of what would be taxed away is what you regard as economic rent. However different people will have different value judgments as to what is or is not worthy. Those value judgments won’t need to come into play with a flat asset tax. All that would be up for discussion is whether it should be 1%, 3%, 5% or whatever as a % of all assets.
stone, I think trying to tax every kind of asset is total madness.
i am not sure about wealth. why should you be taxed on your home or your stocks before you sell them, that is, when you get income from them?
the problem with wealth is the ability people have to borrow on their estimated wealth. this fuels bubbles and is what should be prevented. i think warren suggested something about lending on income only which makes sense to me.
stone, the economy depends on real resource in the present and future. That is based on things like production, distribution, and consumption, and it is unwise to tax those things because all taxation and fees are negative reinforcements. The idea is to positively reinforce that which contributes to the real economy and to negatively reinforce negative externality, which economic rent is an aspect of, along with environmental degradation, all forms of cheating,etc. These are costs to the public that have no public benefit; therefore, gains from them should be taxed away in order to discourage them to the degree that they are permitted at all. Better just to eliminate them through law and regulation to the degree possible.
Tom Hickey “the economy depends on real resource in the present and future. That is based on things like production, distribution, and consumption, and it is unwise to tax those things because all taxation and fees are negative reinforcements”
Moving taxation to being an asset tax actually means that earnings from production, distribution, and consumption etc are now free from tax. Bidding up the price of farmland does very little to increase food production. Infact moving tax off employing farmworkers etc and onto the underlying base asset would ensure that productive use was made of that asset.
That is why a land/location value tax is needed, not a tax on houses. This will stimulate activity by making people use the land or sell it onto someone at will.