I have received several E-mails over the last few weeks that suggest that the economics…
To challenge something you have to represent it correctly
I haven’t much time today. I note that the British Chancellor has made an emergency speech to the House of Commons last night (August 11, 2011) – Statement on the global economy. He claimed that the fiscal austerity had made the UK a “safe haven” for investors. The reason that demand for gilts is high at present is because the bond markets know the UK has no default risk. I also noted Paul Krugman’s wrote a blog in the New York Times yesterday (August 11, 2011) – Franc Thoughts on Long-Run Fiscal Issues – where he challenges Modern Monetary Theory (MMT) directly. To challenge something you have to represent it correctly.
Both inputs to public space were interesting and deserve a response but with time short I thought a few notes on the Paul Krugman blog would be useful.
He said:
Regular readers of comments will notice a continual stream of criticism from MMT (modern monetary theory) types, who insist that deficits are never a problem as long as you have your own currency. I really don’t want to get into that fight right now, because for the time being the MMT people and yours truly are on the same side of the policy debate. Right now it really doesn’t matter at all whether the United States issues zero-interest short-term debt or simply prints zero-interest dollar bills, and concern about crowding out is just bad economics.
But we won’t always be in a liquidity trap. Someday private demand will be high enough that the Fed will have good reason to raise interest rates above zero, to limit inflation. And when that happens, deficits – and the perceived willingness of the government to raise enough revenue to cover its spending – will matter.
First, I have never said that “deficits are never a problem as long as you have your own currency”. I have never heard Warren Mosler say that, nor Randy Wray, nor Stephanie Kelton, nor Pavlina Tcherneva, nor Scott Fullwiler nor others who have been working on developing MMT. I have never read anything to that end in anything the key proponents of MMT have written.
We always say that insolvency is never an issue for a sovereign nation which is one that issues its own currency, floats it on international markets and doesn’t borrow in a foreign currency.
But inflation may be a problem if the budget deficit is excessive in relation to the other spending aggregates (private domestic sector and external sector). There is only so much real productive capacity at any point in time which can absorb flows of nominal spending (aggregate demand) and respond to it in real terms (that is, by producing/supply of real goods and services.
Once that capacity is exhausted the only response from the supply side can be to increase prices. Inflation occurs in this situation if the flow of spending which is beyond that capacity continues. Remember that a once-off price rise is not inflation – it has to be a continuous increase in prices.
So at that point budget deficits – being a nominal flow of spending each period – matter for inflation. But at that point – full capacity utilisation – some of the key objectives of fiscal policy should have been reached – full employment and potential growth.
I appreciate that governments can become captured by lobby groups which then make it hard for them to tailor the nominal spending impulse to match the real capacity limits. But that is not a statement that budget deficits are damaging. Rather it reflects the poorly developed political processes that have hijacked our democracies.
Second, you will appreciate that if the budget deficit is calibrated correctly – which means that it matches the saving intentions of the foreign and private domestic sectors taken together – then it can be 10 per cent of GDP or 1 per cent of GDP forever without any risk of inflation.
It is only when the budget deficit accelerates and pushes total spending in the economy beyond the real capacity limits that they become problematic. So continuous budget deficits forever are fine if the circumstances are correct.
Third, you will also appreciate that there is nothing special in this regard about a net public injection of spending when compared to a deficit in the private domestic sector or an external surplus. These balances all add to aggregate demand.
So to say that budget deficits are dangerous with respect to inflation – under certain situations – is saying nothing more than any nominal spending growth that pushes aggregate demand beyond the real capacity limits is dangerous.
Would we say that the private sector has to present a coherent “Spending Stabilisation” plan in the long-run to avoid this danger? I don’t hear anyone talking about that. Which tells you that the emphasis on fiscal consolidation with Paul Krugman is really referring to reflects an ideological bias.
Further just as when private spending is too strong (if only) the government has the capacity to increase taxes to choke of some of the private purchasing power (among other restrictive policy tools) should they decide that at full capacity the public-private mix is appropriate they can also cut public spending.
Paul Krugman then provided an example – France in the period after the end of World War 1 which he says he studied during his PhD years. He says:
Like many nations, France came out of World War I with very large debts, peaking at 240 percent of GDP according to this recent IMF presentation (pdf, slide 17). And France was unable politically to raise enough taxes to cover the cost of servicing that debt. And investors lost confidence in the government’s solvency.
Various expedients were tried, including – late in the game – creation of monetary base, which was advocated by a finance minister on the (very MMT) grounds that the division of government liabilities between currency and short-term bills made no difference. But it turned out that it did: the franc plunged, and the price level soared.
Again, you have to be careful not to set up a straw person that you happily attack.
First, we know that the European nations were heavily indebted (and seriously damaged in real terms as a result of the war effort). We also know that at the start of the War in 1914 the US was indebted to Europe (heavily) but by the end of the war the situation was the opposite. The US provided billions of dollars in loands as well as selling massive quantities of military supplies to France and the other allies.
The British also lent the other allies considerable amounts during the war – resulting in it owing billions to the US but being owed billions by France (about $US3.5 billion) and other nations.
The foreign currency-denominated debts had to be paid back in hard currency and with trade in chaos after the war this clearly became a problem for the heavily indebted nations like France to deal with.
So France was carrying debt denominated in a foreign-currency – a very non-MMT prescription.
Paul Krugman also doesn’t relate the fact that when the Bolsheviks overthrew the Tsar they defaulted on 12 billion francs of debt which at the time was about 25 per cent of France’s total holdings of foreign debt.
Second, no MMT advocate that I deal with on a professional level would deny that under certain conditions – trade chaos, foreign defaults etc – that the currency can depreciate during a domestic expansion or a budget deficit. If the depreciation is sufficient then imported inflation might be an issue.
There is nothing in MMT that refutes that possibility. The historical cases of these events are limited and are usually associated with special events such as the immediate post-World War 1 chaos.
I haven’t enough time today to go further into the history but I think Paul Krugman is being a little disingenuous in presenting a selective treatment of it.
Recent Speech on Full Employment
I processed this presentation today which might be of interest. It runs for 20 minutes and is an edited version of a Keynote Address I gave on June 29, 2011 to the National Skills Conference in Melbourne, Australia.
The audience was made up of practitioners in the field of vocational training and policy development. I was asked to talk about the concept of full employment in Australia and while the setting is country-specific, the general principles are applicable to any nation.
The presentation comprises audio over a slide-show.
Conclusion
I didn’t have any time to write much today. But then that might be a relief.
Digression – Cadel Evans
Cadel Evans was honoured in Melbourne at lunch-time today with thousands lining the streets for his ride with 30 youngsters. It was called a Cadel-ebration
Here are the fans:
The Australian Prime Minister sent Cadel a message of congratulation and said, in part:
… And here back on Australian soil you have 22 million reasons for feeling back home because on this day all Australians are paying tribute to your efforts.
This created a research question. According to the ABS Population Clock – there were 22,676,656 Australians as at 13:35:04 (AEST).
So who are the 676,656 persons who didn’t like Cadel’s great sporting achievement?
Saturday Quiz
The Saturday Quiz will be available as usual sometime tomorrow.
That is enough for today!
“The British also lent the other allies considerable amounts during the war – resulting in it owing billions to the US but being owed billions by France (about $US3.5 billion) and other nations.”
Source ?
Also, I believe France didn’t default on these foreign currency debt. So whats the problem ?
“Source” in my previous comment as in source for the breakup of denomination of debt ? Plus the amount of “Reserve Assets” the official sector held.
Helluva ride Cadel!…… Are you sure he’s an Aussie and not Welsh?
Back to topic. I read Krugmans post and the robust rebuttals from the intelligentsia. Not me, because I’m one of those non academic MMT supporters who might have inadvertently suggested ‘Deficits don’t matter’. Sorry if I sent him the ammo guys.
Anyways, he got me thinking. If a country is at capacity with full employment, interest rates close to zero and had been running large deficits to support growth in domestic savings. Savings had reached say for argument 400% of GDP.
With a new Government not au fait with MMT. The tax code was changed so there was an incentive to spend more and save less. Instead of savings increasing they started reducing, at the same time a new regulation changes allowed banks to issue a boatload of debt and true to form they were starting to pump up a housing bubble.
If they raised interest rates to say 4%. So much demand would be created through interest payments on savings it would unleash a Tsunami of inflation. I can’t see how to halt the inflationary effects easily through what I’ve learned of MMT. Tax increases are really difficult to implement politically.
Is this a valid scenario/criticism of MMT, or have I created another silly straw man? Help please. Many people have criticized MMT as unfeasible politically. Is MMT an unexploded bomb in the hands of politicians?
The currency crop of politicians believe in confidence fairies, big bad bond markets and deficit monsters. They are about to collapse the economy of Europe and have half collapsed the economies of the US, UK and Japan. Only the remaining automatic stabilisers are keeping those economies afloat.
Exactly how much worse is a crop of politicians that half understand MMT going to be.
There are a lot of ifs in your post. The rules of Functional Finance are fairly simple.
MMT just builds on that foundation.
Apply those rules to your scenario and you’ll see what needs to be done.
So who are the 676,656 persons who didn’t like Cadel’s great sporting achievement?
Those who think he is as likely to have had recourse to illegal substances as the previous winners?
Dear Ramanan (2011/08/12 at 18:29)
You can find interesting accounts of this era in particular relating to the foreign debt in the book – Civilization Past and Present – by a stream of authors (across various editions – first edition was 1942) – including Palmira Brummett, Robert Edgar , Neil J. Hackett , George F. Jewsbury , Alastair M. Taylor , Nels M. Bailkey , Clyde J. Lewis , T. Walter Wallbank.
There is a Single Volume Edition in paperback – go to Section 6 or Volume II of the more extended edition.
Also the the Lords of Finance – by Liaquat Ahamed – is a more recent publication and has an excellent account of the period leading up to the Great Depression.
And you are correct – they didn’t default. The problem is whether budget deficits inevitably cause inflation outside of a “liquidity trap”. I say no. MMT says no. Paul Krugman says definitely.
best wishes
bill
bill
Ramanan,
The UK Treasury have been unable to ascertain who owes them what for the loans made during the First World War.
Technically the UK still owes the US for WWI loans ($4.4 billion nominal), but I can’t find them anywhere on the UK’s balance sheet.
http://news.bbc.co.uk/1/hi/magazine/4757181.stm
Andrew, When govt raises interest rates, those new rates only apply to newly issued debt. I.e. the interest on existing debt (your 400%) remains the same. Plus when rates rise, the market price for existing debt falls, which has a deflationary effect. Third, there is the question as to where the money for the new raised interest rate comes from. If it’s new money, it will have a stimulatory and/or inflationary effect. But if it comes out of taxes, then the effect is neutral. So overall, not much of a problem there.
Re MMT being “unfeasible politically”, it might well be, or aspects of it might be. But then getting Congress to give the US economy the stimulus it needs also seems to be politically unfeasible.
“And you are correct – they didn’t default. The problem is whether budget deficits inevitably cause inflation outside of a “liquidity trap”. I say no. MMT says no. Paul Krugman says definitely.”
Dear Bill,
Thanks for the references. Will check them.
Krugman may not be perfect but his argument is straightforward. Instead of raising funds in auctions of government securities and paying a higher premium to foreign creditors, the French government used its cheap line of credit at the Bank of France. Foreign creditors who weren’t satisfied made a capital flight and this lead to a huge depreciation of the Franc.
The depreciation of the Franc led to rising prices and perhaps a wage-price spiral (not uncommon) – judging by the price rise data in that period. Attempts by the government to increase the real output led to an even higher price rise due to the worsening of the wage-price spiral.
He is talking of an attempt by a government to increase output by fiscal expansion and how the attempt failed. IMO, the only way to disprove him is to provide a solution to what the French government could have done.
Neil Wilson,
“Technically the UK still owes the US for WWI loans ($4.4 billion nominal), but I can’t find them anywhere on the UK’s balance sheet.”
So does the UK fall in the “non-MMT prescription” list? Any list of nations for MMT-prescription ?
Ramanan,
It’s a bit facetious to pretend it is that black and white. The UK has huge US dollar export earnings.
Ramanan,
But was it the fact that they didn’t issue bonds that caused the problems or the fact that the deficit itself was too high? That is the key issue for MMT (beyond whether France was really a sovereign currency issuer–which I haven’t seen clearly confirmed either–and defaulting or not defaulting isn’t the point, since paying debt in foreign currency can certainly create large depreciations and inflation that paying debt in domestic currency would not).
Also, I’m trying to get clear on how they could have taken out credit at the central bank without the cb paying interest on the reserves or draining the balances–if they paid interest, then in Krugman’s own paradigm, that made bills and base perfect substitutes. Unfortunately, these details of monetary operations don’t show up in the history books much if at all.
“Instead of raising funds in auctions of government securities and paying a higher premium to foreign creditors, the French government used its cheap line of credit at the Bank of France. ”
“the only way to disprove him is to provide a solution to what the French government could have done.”
They should have followed the Functional Finance rules. Except that they hadn’t been invented at that point.
In which case you’d have permanent low interest rates and use the state’s confiscation and spending powers to remove money from the system ahead of inflation. You’d be concentrating on managing domestic consumption, not trying to attract foreign tourists or foreign ‘investment’. You’d have a mechanism to spread the pain of supply shocks – probably by using the Job Guarantee buffer to pick up people as firm fail. And you’d merge the central bank and treasury so that they didn’t intervene against your fiscal policy because they were in love with the Gold Standard.
You’d learn the lessons of 1920s France and Germany, 1990s Japan, the 1930s, the 1970s and 2008 and try and design policy accordingly. But you’d also be sufficiently modest to realise that you don’t know everything about how this system reacts and have backout plans in place, e.g. Taxation that can drain a spending impulse if it doesn’t work as expected.
In other words you’d engineer an operational system based on the theory.
Feel bad labouring the point but.
“2. By borrowing money when it wishes to raise the rate of interest and by lending money or repaying debt when it wishes to lower the rate of interest, the government shall maintain that rate of interest that induces the optimum amount of investment.”
But…What if the mechanism of borrowing money unleashes dysfunctional inflation in certain scenarios. Is this not a valid criticism of MMT. Have to peer up your own navel sometime if you wish to preach to others. Not that such niceties bother certain sectors of the political spectrum.
Bill:
Also at the end of WWI, there was a push to reestablish the gold standard (lets call it Austerity 1.0). There is the (in)famous example of England engineering a deflation shortly after the War, providing the returning troops massive unemployment (stiff upper lip and all that) to push sterling back up to prewar relation with gold.
France chose devaluation, choosing to sustain high inflation. Their exports soared and the accumulated huge FX reserves (currencies were still not convertible till the late 20’s). Later they converted their FX into gold and ended up with much higher gold reserves than England. I think it was a deliberate French strategy that succeeded. The Poincare stabilization was only possible because of their earlier policy of devaluation.
At any rate, they were committed to reestablishing the gold standard and finally did so. Another small point that Krugman apparently doesn’t feel is important to mention.
I am intrigued by staments such as, “Is MMT feasible politically”, and similar musings that occur from time to time. To me, this is like asking ” Is gravity feasible technically”? The answer to both is that one can choose to not believe in gravity ( or the society may not have reached an understanding) but such a society will never progress far in technical mastery of a variety of endeavors, flight, tall buildings, etc. Similarly, a society that remains ignorant of the laws of macroeconomics ( MMT) will forever wonder why unemployment is high, how do we create jobs while getting the budget under control, and all the other mysteries we read about every day in the press ( which Bill readily explains based on his understanding of the laws). There is no choice to “implement” MMT, the laws are ineffect, just as gravity exists and operates, whether the laws are understood or not. Budget cuts lead to recession, whether one understnds why or not. An understanding of the laws simply enables a society to implement policies which lead to the desired result, rather than bumbling around in the dark. Economically our societies are similar to pre-germ theory medicine. I liken the current debates to arguments about how much to bleed the patient to restore health. Some got better anyway, some did not, but no thanks to the treatment. Small intellectual solace in a bizarro world.
Best regards all.
Ramanan says:
The way you interpret PK, is that the inflationary effects of French policy were due to a sudden change from a conventional state of ‘borrow and spend’ with positive interest rates to a more MMT like state of spend at 0 intertest. Why else would the foreign creditors not have been happy? To me, it is this suddenness, and not the intrinsic (in)stability of either one or the other state that are at heart of your argument. But, to the extent that your interpretation is correct, PK uses it to prove the impossibility of a permanent ‘reserves only’, MMT world. That too, is a straw man line of argument.
I’ve been hearing a lot lately from the “MMT is not politically possible” crowd. To them, this: We already have what is politically possible. If “politically possible” is the criteria for action, there is nothing left for us to do.
Neil Wilson @ August 12, 2011 at 22:42:
Sorry don’t get you. The French Government tried to increase output by greatly relaxing fiscal policy and the fact that it used the lines of credit at the Banque de France unimpressed the foreigners, especially since it was done in secret.
“They should have followed the Functional Finance rules. Except that they hadn’t been invented at that point.”
Which rule ? The French government tried hard to improve output!
“In which case you’d have permanent low interest rates and use the state’s confiscation and spending powers to remove money from the system ahead of inflation.”
Remove money from which system ? Money doesn’t cause inflation.
“You’d be concentrating on managing domestic consumption, not trying to attract foreign tourists or foreign ‘investment’. ”
Yes, the French government tried to achieve higher demand! Sorry which investment ?
“You’d have a mechanism to spread the pain of supply shocks – probably by using the Job Guarantee buffer to pick up people as firm fail.”
Is it critical in functional finance to have a job guarantee scheme ?
“You’d learn the lessons of 1920s France and Germany, 1990s Japan, the 1930s, the 1970s and 2008 and try and design policy accordingly.”
In 1920s, how do you go future in time? Maybe there is something to learn from 2020 ?
Jim Thomson and Benedict@Large
I understand your frustration at people being bogged down in whether or not MMT is “politically feasible”. However, I actually think it’s a very important question to raise, and something that ought to be considered fully while trying to disseminate the theory – as we all know from day-to-day viewing of the mainstream media, and even from people like Paul Krugman, who’s considered to be a ‘far left’ economist, there’s a lot of misrepresentation out there. You can bet your life that anything that has to be explained for longer than ten seconds will cause the entire argument to be lost.
You have to remember, mainstream economic commentary, including the ‘Austrian School’ and the various neoliberals, have survived because the people behind these theories, as well as their supporters, have been able to come up with snappy imagery and rhetoric in order to make their message palatable, even if that means telling outright lies. If you hear or read interviews with the likes of Milton Friedman, Friedrich Hayek and fellow travellers like Keith Joseph, they regularly invoke words like ‘liberty’, ‘freedom’ and ‘self-interest’ with gay abandon, rhapsodising about the ‘magic’ of the ‘free market’, while simultaneously assuring all who will listen, that their pet theories are as certain as the laws of gravitation themselves. Further, the neoliberals have been able to intellectualise a kind of greed that one would formerly have associated with that of a toddler, and invoke ‘rugged individualism’ and ‘personal responsibility’, while denouncing any attempt to stymie or even disagree as being tantamount to ‘tyranny’ and ‘serfdom’. As a better writer than me remarked, they use words such as ‘freedom’ and ‘liberty’ as alibis. All they have to do is speak in the language of mystical optimism, and proclaim it as scientific certainty. It has been an incredible propaganda coup on their part, to endorse a form of economic tyranny, and enjoy the term ‘libertarians’. The mystical language they invoke is designed to appeal to people’s baser instincts – why would you care about the single mother with five kids? If she had exercised ‘personal responsibility’, she too could become the CEO of BP – right?
Coming from Ireland, I can only comment on the political class and the behaviour of the electorate here. If you were to attempt to propose MMT as a viable economic remedy in this country, for example, you would have to make the following proposals (among others, way outside my competence to prescribe!):
1. Leave the euro
You would really have to explain yourself before people instantly think of you as a eurosceptic nutter/Stalinist. There would be quite a cacophany of outrage and terror from the media in this country, as well as the big political parties who would denounce you for being ungrateful for EU structural funds (a stimulus package which offset similarly drastic cuts in Ireland in the 80s and 90s). There would also be a huge amount of white noise concerning the lack of ease of travel and having to go through the indignity of changing your currency every time you wanted to leave the country.
2. Tax
If my understanding of MMT is correct, tax revenue isn’t collected in the way depicted in Robin Hood, and that the Department of Finance doesn’t actually receive a vanload of money every week from all the various paypacks of employees throughout the country. Further, I believe that MMT teaches us that the idea that ‘tax money funds the health service/schools/etc.’ is erroneous, and that taxation is used as a method of taking the heat out of an overheated economy (forgive the base simplification, and please feel free to correct me). The problem here is twofold – firstly, there is a reasonable expectation on behalf of the taxpayer to have a stake in society, and their deductions on their electronic paycheques (which should provide a clue concerning the make-up of the ‘money’) give them this stake; one would have to make a compelling case for people to believe that they still have this stake in society, while realising that they don’t necessarily pay the wages of the council worker who sweeps the streets. Secondly, this element of MMT could be used cynically by the kind of politician who’ll keep demanding that taxes be brought down further and further, beyond the point where this is extremely dangerous indeed. In Ireland, there is a general allergy towards paying income tax, particularly since it was at Scandinavian levels during the 70s and 80s, only for it to have been ‘used’ for paying off the national debt, rather than providing Scandinavian public service levels. I think the taxation element of MMT would be very prolematic to explain properly to a public that has to endure the smokescreen of mainstream politicians and journalists.
3. The idea that deficits don’t matter when a nation has a fiat currency
One of the modern propaganda coups of the mainstream economists, together with their servants in the political and media classes, is, as Bill and others have been emphasising for a long time, the moral imperative to ‘balance one’s books’, and the equation of Government spending with that of a household. This is particularly galling from the previous consensus that it was alright for private individuals to have to rack up astonishing debt – for some reason, it’s considered alright for a graduate student to be forced into stifling debt, and yet the sky will fall in if a Government does the same thing for a millisecond. One would have to emphasise, in any political ‘selling’ of MMT, that public debt is always preferable to private debt, as well as the fact that the ‘deficit’ amount is not all money that is due for repayment at the same time! Basically, I think someone should come up with a snappier way of explaining ‘The Paradox Of Thrift’.
4. Public Spending
There is simply a feeling that I believe approaches utter contempt in mainstream circles, for the idea of public spending of any kind whatsoever. The donation of so much as a cent to a wheelchair-bound pensioner living on his/her own is seen as some intolerable burden on the ‘coping classes’, i.e., those of us who still have a job, but aren’t tax-avoiders. The challenge for MMTers is to turn this sentiment upside down in the minds of the public.
Overall, MMT has a huge mountain to climb, in terms of changing public attitudes. When you take the time to read about it, it seems like the greatest common sense – but you need to read it and let it sink in. I have no economics background, and I’ve been following this blog for just under a year now, and I feel I’ve finally come to grips with the most rudimentary parts of MMT. Contrast that with Joe Bloggs hearing some politician on the TV denouncing the idea of public sector workers not being drowned at sea as being ‘bad for the deficit’, or hearing some builder who’s managed to squeeze State money for the purposes of enriching himself through a ‘public-private partnership’ (I believe these are called ‘Public Finance Initiatives’ in Britain), talking about how wonderful it is that private sector input takes the strain off the taxpayer – it’s a simple message that gets through almost instantly. The fact that that message is utterly wrong, doesn’t make it any less effective.
So even though MMT may operate ‘like gravity’ as Jim above said, that doesn’t subtract from the seriousness of helping more people understand the theory. And it should be done before the Governments and central banks of the world descend any further into insanity.
SF:
“I’m trying to get clear on how they could have taken out credit at the central bank without the cb paying interest on the reserves or draining the balances-if they paid interest, then in Krugman’s own paradigm, that made bills and base perfect substitutes. Unfortunately, these details of monetary operations don’t show up in the history books much if at all”
That’s the problem with many of these historical comparisons.
@ Ramanan
You may be interested in reading what Keynes had to say at the time if you haven’t seen it yet.
Essays in persuasion by John Maynard Keynes, Section II, 3, “The French Franc,” p. 105-117. It’s available online at Google Books here.
(h/t Rob Parenteau for the reference)
The legal definition of “on all fours ” is legal precedent or case law that is precisely on point with respect to the case at hand. Applying this standard to economics, the French incident is a very special case, as Bill points out, and hardly a precedent under any ordinary circumstances. If this is the best that Prof. Krugman can come up with to raise the bogeyman of inflation now that he has apparently conceded insolvency (as has Greenspan explicitly), then MMT doesn’t have much to be concerned with. Yes, I suppose if the US goes through a devastating war, loses 4.3% of population with many more wounded, and borrows heavily externally, along with other contributing factors similar to France after WWI, there might be a valid comparison.
Right, Tom. And I might add to that even if all that happen it’s still not clear how a decision to “print money” rather than issue debt would cause this, which was Krugman’s point. Surely all the things you mention could cause it, but again that wasn’t the point Krugman was arguing. Without a proper description of how “printing money” occurred back then, I’ve seen no evidence that Krugman’s main argument has any validity whatsoever. And even once that occurs, and even if Krugman is right about how things happened then, since I actually DO know how “printing money” would work in the US now I see no reason to believe that example would be relevant–which again, was his main point.
Scott,
“Also, I’m trying to get clear on how they could have taken out credit at the central bank without the cb paying interest on the reserves or draining the balances-if they paid interest, then in Krugman’s own paradigm, that made bills and base perfect substitutes. Unfortunately, these details of monetary operations don’t show up in the history books much if at all.”
Firstly Krugman is making a general point – the point being the effort of the government to create higher output led to a complete failure. If one is paying attention to his understanding of “monetary operation”, then his message is lost.
The idea that “as long as the central bank is targeting an interest rate, debt monetization is impossible” is not the best way to put it.
When crisis situation arises, the government may force the central bank to be not adamant about this. The central bank may issue short-term bills to banks (which is equivalent to paying interest on reserves). However foreign creditors who hold long term bonds may not see the bonds paying a premium and are unimpressed by this fact.
France used an overdraft financial system most likely. If the Bank of France buys government securities, it does not lead to an increase in reserves because the adjustment happens via reduction in banks’ indebtedness to the Bank of France. This gives enough opportunity for the government to have its account at the Bank of France in an overdraft position (or have the Bank purchase Government bonds directly) for an extended period instead of it behaving in a systematic manner in which foreigners make a decent participation at auctions.
Not only does it matter (or mattered) for the Bank of France and the government to finance its deficit, but also the composition of holding between domestic and foreign creditors… maybe that was the technical point in Krugman’s article – which aimed to say something more general).
Oliver,
See Krugman is not the best monetary economist but he does get balance of payments accounting right, if that impresses you.
Why can’t you have a general approach instead of nitpicking ?
“The way you interpret PK, is that the inflationary effects of French policy were due to a sudden change from a conventional state of ‘borrow and spend’ with positive interest rates to a more MMT like state of spend at 0 intertest.”
Maybe. Not sure interest rates were 0. It matters for the government and central bankers to worry about the external situation (unlike the MMT world) and it also matters how the deficit is financed. The situation highlighted by Krugman shows how a government’s stance of not taking such factors into account can lead to problems.
Sorry fiscal policy has its limits.
Tom,
Google Books has no preview for the book. Could preview only a page at Amazon. But what does Keynes say, do you know ?
@ Ciaran
Excellent comments and suggestions.
As Keynes said in his book “The General Theory of Employment,Interest and Money” 1936 ; “The difficulty lies, not in the new ideas, but in escaping from the old ones, which ramify, for those brought up as most of us have been, into every corner of our minds.”
The biggest problem lies with the way conventional (non-MMT) economics has been “ramified ” into every corner of our minds, in particular the minds of influential “economists”. Paul Krugman is not , by any means , the worst of the influential economists in the world.
John Maynard Keyne’s challenge to the orthodoxy of the 1930’s was fought tooth and nail by the old guard of that era but his insights prevailed (at least for a generation) because his theory made more sense of the problems of unemployment at that time.
This time around the austerity policies of governments “ramified” by neoliberal economic theories will fail and a greater role for fiscal policies will eventually be necessary. Sadly many will suffer in the meantime.
Ramanan,
I completely disagree with your interpretation. Krugman is trying to argue that deficit finance through “printing money” is inflationary when you’re not in a “liquidity trap.” I already went through the logic of his argument in detail at Cullen’s site. Any other alternative interpretation would have to ignore about 75% of his post. And to just argue that deficits were “ineffective,” which in this case mostly means too large with a very big number of contingencies related speicifiically to the particular historical episode in question is not persuasive whatsoever as an argument against MMT–it’s quite likely we would agree, after all.
This looks good … at least from a historical perspective, not necessarily a conceptual perspective
The Gold Standard Illusion: France, the Bank of France, and the International Gold Standard, 1914-1939 [Hardcover] – Kenneth Mouré
http://www.amazon.co.uk/Gold-Standard-Illusion-International-1914-1939/dp/0199249040
One more thing independent of this .. the French may have had a somewhat different historic setups such as government owned post offices accepting deposits .. government itself a bank (?) “comptes cheques postaux” ??
Sorry Ramanan, not trying to nitpick, only trying to pinpoint. I think PeterD and PeterC at Pragcap and Heteconomist respectively have shown where the fundamental difference lies. I\’d boil it down to the question of whether there can be a \’wrong\’ policy rate.
What interests me beyond that question, is whether there might be room for both standpoints being \’right\’, i.e. approximations of the world through which economic realities of a modern society can be satisfactorily managed. I picture an economy to be a interplay of many moving parts, and it seems to me, as long as not too many of the joints in between the parts have been arbitrarily fixed, the whole system should remain controllable as a whole. This still leaves room for interpretation as to which parts should be managed more rigidly and which should be left to float freely. And I suspect the answer hinges, among many things, on a: the state of the economy as such, i.e. desparate times call for more radical measures, and b: what we consider to be a good outcome. And even if there is a consensus on these questions, I fear there will always be a trade-off between systems that can cope with exogenous changes more flexibly and those that can be brought nearer to \’sweet-spot\’ more precisely and consistently. In other words, it’s complicated :-).
In any case, I trust a nobel economist knows a thing or two about the economy that I don\’t… And I know that you do too.
Hope that made at least of sense
Regards
Ramanan,
“When crisis situation arises, the government may force the central bank to be not adamant about this. The central bank may issue short-term bills to banks (which is equivalent to paying interest on reserves). However foreign creditors who hold long term bonds may not see the bonds paying a premium and are unimpressed by this fact. ”
Then don’t issue long-term bonds.
“France used an overdraft financial system most likely. ”
Probably true. All of them are, technically.
“If the Bank of France buys government securities, it does not lead to an increase in reserves because the adjustment happens via reduction in banks’ indebtedness to the Bank of France.”
This is a reduction in reserve balances, or an offset to the increase created by the deficit. OK so far.
“This gives enough opportunity for the government to have its account at the Bank of France in an overdraft position (or have the Bank purchase Government bonds directly) for an extended period instead of it behaving in a systematic manner in which foreigners make a decent participation at auctions. ”
OK still, except that foreigners don’t matter unless you’re trying to issue in another currency.
“Not only does it matter (or mattered) for the Bank of France and the government to finance its deficit, but also the composition of holding between domestic and foreign creditors… maybe that was the technical point in Krugman’s article – which aimed to say something more general).”
This last paragraph doesn’t follow at all from the others, at least as written, unless you’re referring to the foreign creditors owed in foreign currencies. Could you elaborate? Also, again, there are several key differences from the MMT proposals-France had foreign denominated debt, which it did not default on apparently but in a time of falling fx (given previously overvalued, according to what I’m reading) would raise the size of the deficit in domestic currency necessary to service. It also had a significant % of its anticipated revenues in German reparations that never arrived. And so on, including all the particularities mentioned by Bill and others here. Sounds to me like the deficit was just too big to avoid inflation-needed a smaller one given the circumstances in play. Overall, I still don’t see what “printing money” had to do with anything here, or if they even did that in the sense that Krugman understands it. And it certainly doesn’t apply to the US regardless.
“Why can’t you have a general approach instead of nitpicking ?”
This is not merely an academic exercise. It is about US policy and therefore politics. Krugman has a bully pulpit, and if he had it right, it would make a big difference. That is what a lot of this is about.
Scott,
“Then don’t issue long-term bonds.”
Not sure of that one. I find it weird that there is a denial amongst MMTers of the fact a nation cannot be indebted in its own currency. In fact, the French episode show how that is not true. More than anything its a simple matter of double-entry book-keeping.
“Probably true. All of them are, technically.”
Yes true all economies are a mix. Providing overdrafts to banks does not make them an overdraft financial system. The item “claims on banks” is always high – unlike the US, where even though banks make use of daylight overdrafts and the discount window sometimes, they are not hugely indebted to the central bank from a balance sheet viewpoint.
So you see the item “Lending to euro area credit institutions related to monetary policy operations denominated in euro” at EUR 406,239 million (in 2006, before the crisis) which is not the case for the United States.
Ref: http://www.ecb.int/press/pr/wfs/2006/html/fs060110.en.html
Why did I bring that in ? Its because rates wouldn’t fall immediately to zero in case the government takes huge overdrafts at the central bank or if the central bank purchases GSecs directly from the government.
“OK still, except that foreigners don’t matter unless you’re trying to issue in another currency.”
That’s what Krugman is indirectly is pointing. Foreigner creditors have to be attracted to lend because they are creditors and not “creditors” if you know what I mean.
“Overall, I still don’t see what “printing money” had to do with anything here, or if they even did that in the sense that Krugman understands it. And it certainly doesn’t apply to the US regardless.”
There are two things about that Krugman nytimes blog post.
1. Krugman is pointing to a situation where fiscal policy did not do the trick.
2. Krugman describing what went on and struggling a bit.
Now, Krugman is not the best monetary economist, so he is bound to struggle in describing what went on. So, its not difficult to point out errors in his description. However, point 1 still remains to be addressed. And as per my comments on this some while ago … its a great example of why the external sector is a huge constraint.
German reparations may not have arrived but even in peactime economies, residents can make huge capital losses on their assets abroad.
The Gold Standard Illusion
http://depositfiles.com/es/files/axdlhlpt4
The Lords of Finance
http://www.filesonic.com/file/55551824/The+Lords+of+Finance.pdf
Oliver,
Don’t see any disagreement with your comment @ Sunday, August 14, 2011 at 1:58 and in fact agree strongly with some.
Will check Pragcap and Heteconomist about the “wrong” policy rate.
Further to my comments, here’s from James Tobin article “Agenda For International Coordination Of Macroeconomic Policies”
Of course, one can criticize James Tobin himself, but he is exactly right in above quote, IMO
@ Ramanan
That’s strange. The link above takes me to a preview in which the whole text of “The French Franc” is available. I don’t know why you aren’t coming up with it.
Here’s the nut of it:
“The level of the French franc is going to be settled in the long run…by the proportion of his earned income which the French taxpayer will permit to be taken from him to pay the claims of the French rentier…You can increase the burdens on the taxpayer, or you can diminish the claims of the rentier. If you choose the first alternative, taxation will absorb nearly a quarter of the national income of France…I should judge from recent indications that the French public will certainly refuse to submit to the imposition of a burden of additional taxation to satisfy the claims of the rentier at their present level…your next business is to consider coolly how best to reduce the claims of the rentier…Successive Finance Minister have, in fact, done their utmost to find an escape through the Exit I indicate. They have inflated magnificently, and they have brought down the gold value of the franc…Your present difficulties are due, not to the inflation of the notes or to the fall of the exchange…but to the failure of these factors to diminish proportionately the internal purchasing power of the rentier’s money claims…Thus the Inflation of the currency has produced its full effect on the exchanges, and consequently on the prices of imported commodities, but has largely failed to do so on the prices of home produce…if internal prices had risen as fast as the exchange has fallen, the real burden of the national debt service would be reduced by at least a third…The metallic reserve of the Bank of France is worth (at the present exchange) nearly 40 percent of the note issue…As the internal price level gradually rises…your budget receipts will grow month by month until they balance expenses.”
“Nonzero current accounts must be financed by equivalent capital movements, in part induced by appropriate structure of interest rates.”
Looks to me like that says that CAD = KAS as an accounting identity, so to run a CAD of any particular amount, then interests rates have to be high enough to attract the same amount of capital to balance the equation. The US has a huge and growing CAD and has no trouble attracting capital at historically low rates. If net exporters to the US choose not to save in USD, buy US exports, or invest in the US, then they risk their US export market shrinking if no one else picks up the capital tab. Where does this conflict with what MMT economists say about this? I guess I don’t see your point here.
Dear Ramanan (at various times).
You quote Tobin:
Which I would say means that foreigners will be willing to export their real resources in return for less real resources from elsewhere because they want to accumulate financial assets denominated in the currency of the current account deficit nations. The willingness of the deficit nations to enjoy those deficits is what finances the foreign desire to accumulate assets in their currency. That puts the Tobin quote in a different light. It is a matter of accounting though that the balance of payments balances.
Second, it is a trivial observation and hardly contrary to MMT to say that a rapidly depreciating exchange rate will introduce inflationary pressures in to the local economy commensurate with the penetration of imports and the weighting of imports in the CPI. So what! It is a finite process because in a flexible exchange rate system the trade imbalances resolve – perhaps to the detriment of the local economy. The government can always moderate the impact of the adjustment process by ensuring the real terms of trade losses that are implied are shared across all distributional claimants.
Third, it is a trivial observation and hardly contrary to MMT to say that if the supply of a currency into the foreign exchange markets exceeds the demand for that currency then the exchange rate depreciates when it is floating. There is no robust causation that has ever been proven to systematically link this situation with continuous budget deficits. Australia, for example saw record low exchange rates against the USD during a period of record budget surpluses.
The external economy does not reduce the capacity of the government to use fiscal policy to create full employment. Changes in the currency parity certainly can alter the composition of domestic demand and output – and in some instances those shifts might reduce the material standard of living of local residents but that doesn’t limit or constraint locally-targetted fiscal policy initiatives.
Paul Krugman’s 1920s French example does not negate that MMT insight nor does any example or argument that you have put up over the last few years. These so-called MMT rebuttals are just statements of the obvious and do not go to the heart of the matter.
best wishes
bill
Dear Bill,
“It is a matter of accounting though that the balance of payments balances.”
Not really a matter of accounting. Tobin is saying that foreigners have to be attracted by hook or crook across the term structure.
“Second, it is a trivial observation and hardly contrary to MMT to say that a rapidly depreciating exchange rate will introduce inflationary pressures in to the local economy commensurate with the penetration of imports and the weighting of imports in the CPI. So what! ”
Yes trivial in one sense! But is a part of a whole story. The examples like this show how difficult the external sector dynamics makes policy makers’ life difficult.
“It is a finite process because in a flexible exchange rate system the trade imbalances resolve – perhaps to the detriment of the local economy.”
So they thought in fixed exchange rate regimes! The point is that such belief is equivalent to believing the invisible hand. Trade balances are partially resolved by demand restraint and is not automatic. In fact the above example shows how it unwinds in a disorderly manner.
“…but that doesn’t limit or constraint locally-targetted fiscal policy initiatives.”
but the Krugman precisely shows that is not the case.
“…and do not go to the heart of the matter.”
IMO, the example went directly into the heart of the matter and hence you see the divorce between the central bank and the government in most nations. Don’t want to argue forever but it seems it has taken a Krugman to say this one a post directly (which he has said in his academic work as well). But arguing relentlessly has been good for me and thanks for engaging.
Tom,
Thanks for the quote.
Yes it happens – I try to find a lot of stuff from Google Books but some books which show preview in my computer do not do so in another computer/location.
Krugman replies…
http://krugman.blogs.nytimes.com/2011/08/15/mmt-again/
Thinks you all sound like Galt in Atlas Shrugs…