As I noted yesterday, last evening I accepted an invitation to speak on a panel…
Not everybody can de-lever at the same time
The title reflects fact not opinion. However, most commentators still fail to grasp that reality. In the current economic climate it means one thing – imposing fiscal austerity in the hope that governments can reduce debt levels will fail and bring with it devastating consequences for the non-government sector. It is the latter sector that has reduce its debt exposure and under current institutional arrangements that means the government sector has to increase deficits (and debt) not other way round. The simple fact is that when private spending is subdued the government sector has to run commensurate deficits to support the process of private de-leveraging by sustaining growth. Those advocating fiscal austerity or those who claim that the amount of outstanding private debt is simply too large for the Government to replace with public debt fail to understand the basic tyranny of the sectoral balance arithmetic. Put simply, not everybody can de-lever at the same time.
On May 14, 2009, at the time of the 2009-10 Federal budget release, the Australian Broadcasting Commission ran this Opinion piece – Economists tackle the deficit and debt debate – which reported on an interview he had conducted with three economists – myself, Steve Keen (University of Western Sydney) and Stephen Kirchner (Centre of Independent Studies – a right-wing organisation based in Sydney).
I wrote about that discussion in this blog – The deficit and debt debate – and concluded that two out of the three economists interviewed did not understand how the modern monetary economy works.
If you are interested in the full exchange I recommend you go back to that blog. But for today there is only one aspect I am focusing on – the de-leveraging issue. The motivation is that two years after that exchange not a lot has been learned and in maintaining inconsistent positions, economists have been providing policy advice that, when adopted, has deepened rather than eased the crisis.
My position remains as it was – Not everybody can de-lever at the same time. Until that message is understood and reflected in public policy, the crisis will endure.
To put today’s blog in context, in the 2009 ABC Opinion piece, under the heading Stimulus stymied by debt the Reporter quoted Steve Keen as saying:
We have had far too much debt, more than the system can actually cope with, we therefore can’t get out of this the way we used to get out of it by re-encouraging private lending once more.
I agree that the volume of high risk private sector debt was a major part of this current crisis. But encouraging credit worthy businesses to borrow is still sound. Banks have no current constraints extending credit to these customers. The residual of so-called toxic debt is a separate issue and would be significantly attenuated if the debt holders were not unemployed.
The Reporter then quoted Keen’s view as saying “the amount of outstanding private debt is simply too large for the Government to replace with public debt.”
Those who understand Modern Monetary Theory (MMT) will realise that this comment misses the point.
The stimulus efforts in 2009 and 2010 had nothing to do with replacing private debt with public debt. Private debt was incurred to “finance” spending by revenue-constrained private sector agents (households and firms). The private debt build-up was matched $-for-$ with asset accumulation because all non-government transactions net to zero in an accounting sense.
Conversely, public debt doesn’t finance anything even if the institutional arrangements which see the national governments issue debt $-for-$ to match their net spending (deficits) seem to suggest they do. Currency-issuing governments are not intrinsically revenue-constrained and can spend when they like without prior recourse to revenue.
The implication of the Keen quote was that a national government could not overcome the real downturn in the private sector by expanding its budget deficit. Events since then have proven that viewpoint to be wrong.
The actual crisis being endured around the world is a real crisis where spending is below potential capacity output. That is exactly what a budget deficit aims to resolve. If the financial crisis (and the “toxic debt”) has impacted on spending so much that the spending gap is huge then that just means the deficit has to be that much larger.
When the non-government sector spends less than it earns and that gap widens we know that the government deficit has to rise for national income to grow.
The Reporter than coaxed Steve Keen into giving his solution to the debt problem which is “for the Government to get rid of the debt by causing higher inflation or by simply cancelling it and nationalising the banking system.” Keen is quoted as saying:
Ultimately, we’re going to see governments changing across either to abolishing debt, or to literally printing money rather than running out debt to finance their spending … We know this crisis was caused by too much debt, how on earth do we think that getting into more debt is going to solve the problem.
At that point you realise that basic concepts about the monetary system are not grasped.
Currency-issuing governments were not “running out debt to finance their spending” – the spending provided the private sector with the funds to buy the debt instruments not the other way around.
Further, governments do not spend by “literally printing money”. I covered this issue in my blog – Quantitative easing 101.
At the time, Steve Keen was running the line that governments would have to inflate away the nominal debt to reduce the real burden to maintain fiscal sustainability, a thoroughly orthodox line.
This viewpoint implies that if deficits are not matched by debt issuance then inflation results. So if the government wants to reduce its debt burden and run deficits it should “print money” (rather than issue debt), drive up inflation, and erode the real value of the private debt until it is worthless – thereby solving the problem.
You would read that narrative in a mainstream macroeconomics textbook written by luminaries such as Greg Mankiw or Olivier Blanchard or Robert Barro.
First, we need to understand the banking operations that occur when governments spend and issue debt within a fiat monetary system. That understanding allows us to appreciate what would happen if a sovereign, currency-issuing government (with a flexible exchange rate) ran a budget deficit without issuing debt?
In this situation, like all government spending, the Treasury would credit the reserve accounts held by the commercial bank at the central bank. The commercial bank in question would be where the target of the spending had an account. So the commercial bank’s assets rise and its liabilities also increase because a deposit would be made.
The transactions are clear: The commercial bank’s assets rise and its liabilities also increase because a new deposit has been made. Further, the target of the fiscal initiative enjoys increased assets (bank deposit) and net worth (a liability/equity entry on their balance sheet). Taxation does the opposite and so a deficit (spending greater than taxation) means that reserves increase and private net worth increases.
This means that there are likely to be excess reserves in the “cash system” which then raises issues for the central bank about its liquidity management. The aim of the central bank is to “hit” a target interest rate and so it has to ensure that competitive forces in the interbank market do not compromise that target.
When there are excess reserves there is downward pressure on the overnight interest rate (as banks scurry to seek interest-earning opportunities), the central bank then has to sell government bonds to the banks to soak the excess up and maintain liquidity at a level consistent with the target. Some central banks (and most in the current crisis) offer a return on overnight reserves which reduces the need to sell debt as a liquidity management operation.
What would happen if there were bond sales? All that happens is that the banks reserves are reduced by the bond sales but this does not reduce the deposits created by the net spending. So net worth is not altered. What is changed is the composition of the asset portfolio held in the non-government sector.
The only difference between the Treasury “borrowing from the central bank” and issuing debt to the private sector is that the central bank has to use different operations to pursue its policy interest rate target. If it debt is not issued to match the deficit then it has to either pay interest on excess reserves (which most central banks are doing now anyway) or let the target rate fall to zero (the Japan solution).
There is no difference to the impact of the deficits on net worth in the non-government sector. This doesn’t lead to the conclusion that deficits do not carry an inflation risk. All components of aggregate demand carry an inflation risk if they become excessive, which can only be defined in terms of the relation between spending and productive capacity.
Firms will respond to the spending stimulus by increasing output and employment. Once the economy reaches full employment then nominal demand will exceed the real capacity of the economy to absorb it and then inflation becomes a threat. No sensible government would push the deficit into this zone though. So at the point the deficit becomes inflationary you have already overcome the recession and created full employment!
So the monetary operations (debt-issuance or not) do not increase or decrease this risk. Budget deficits are good only when they close non-government spending gaps and underwrite employment. Outside of that there are problems.
The imperative to de-lever
The foregoing view – that there is too much debt and both the government and the non-government sector have to de-lever to restore growth – still resonates in the current period and is driving the fiscal austerity ambitions of most political leaders.
Somehow we are to believe that we have a sovereign debt crisis occuring simultaneously with a private debt crisis.
We read this morning in a Bloomberg news story (May , 2012) – Japan Rating Cut Rings Alarm for Lawmakers Gridlocked on Taxes – that the ratings agencies are still trying to assert their relevance by downgrading Japanese sovereign debt.
We have been there before – and the Japanese government at the time (early 2000s) ignored the supposed loss of credibility and continued to use deficits to stimulate it ailing economy. Debt continued to be issued at near zero yields and bond tender bid-cover ratios didn’t blink (remaining high).
The OECD, another organisation trying to assert its relevance when it has been shown by this crisis to be completely irrelevant – warned the Japanese government that it was ((Source):
… pushing Japan’s public finances further into uncharted territory.
They said as much – more than twice – in the last 20 years. Again – their predictions, regularly rehearsed in their publications and media statements – never came to anything.
All of their utterings resemble – in Pooh Bah’s words (from Act II of the opera Mikado) – “Merely corroborative detail, intended to give artistic verisimilitude to an otherwise bald and unconvincing narrative”.
Doesn’t the fact that Japan has recorded good growth (with a reviving private sector) in recent quarters while Europe and the UK are heading backwards with dismal confidence levels being recorded in the private sector and the entire monetary system in the case of the Eurozone on the brink of collapse – tell these characters anything?
At least sometimes you read an article that really understands the situation. Such was the case when a central banker friend of mine (thanks TM) send me some documents today.
One of those documents was written by Paul McCulley, former Managing Director at PIMCO and is now involved with the Global Interdependence Center. You might say as a former portfolio manager (a very large one at that) Paul McCulley might have some operational experience.
He had earlier written this PIMCO paper, reprinted in this Levy Institute paper in 2010 – Global Central Bank Focus: Facts on the Ground – which explored “the tyranny of arithmetic for the flow of funds” (which we call the sectoral balances framework) where as a result of “double-entry bookkeeping” used in the National Accounts:
… the only way that one of the four sectors can run a deficit or surplus is for one or more of the other three sectors to run the opposite
Where the four sectors are the private households and firms and the foreign sector (taken together to be the non-government sector) and the government sector.
Paul McCulley in that brief note contends (correctly) that as a result of this tyranny:
… any notion that fiscal austerity in the developed world will not be a cyclical drag on global aggregate demand growth, much less boost it, must rest on the presumption that (1) the household and business sectors in the developed world will reduce their surpluses and/or (2) that the emerging world will reduce its surpluses with the developed world.
He concludes that the Ricardian-equivalence arguments used to support the argument that private domestic spending will replace the spending losses arising from fiscal austerity ignore “why the private sector in the developed world is running a financial surplus”:
… deflated asset prices, which have undermined the debt that had been applied to inflated asset prices. The private sector in the developed world wants to get its financial house in order! This is a profound structural change, running in parallel to a permanent downsizing of the shadow banking system and derisking of the conventional banking system. Simply put, both the demand and supply curves for private sector credit creation have shifted inward.
Please read my blog – Pushing the fantasy barrow – for more detailed discussion on why the Ricardian Equivalence notion is both theoretically and empirically flawed.
But the important point is that the crisis was, in part, caused by excessive private sector debt extending out into the margins of risk, which has proven to be unsustainable.
Households and firms are returning to more prudent balance sheet practices and the only way they can do that is to “de-lever” – that is, bring down the debt levels – a process which takes considerable time.
As Paul McCulley notes:
… the only way that can happen without increasing the risk of a deflationary depression is either for the developed country governments to continue to run large financial deficits and/or for the emerging countries to reduce their financial surpluses. Again, the tyranny of arithmetic.
The evidence over the last several years is that a major rebalancing of current accounts across the world is unlikely to occur in the near future. While that might be a policy discussion that is worth having, the fact is that the damages of recession arise daily and then have long-lived effects. Long-term unemployment not only reduces the prospects of the victim but then bestows that disadvantage onto their children. Overlapping generations of disadvantage emerge from a deep and enduring recession.
The world is now in its fifth year of economic crisis and some teenagers will become adults having never worked because of the fiscal austerity.
In combatting the fiscal austerity logic, Paul McCulley reminds us that:
Current fiscal deficits in fiat currency countries are not the cause of the Great Recession but the consequence of the Great Recession, which was the consequence of the blowing up of asset price bubbles and Ponzi debt arrangements in the private sector. If current fiscal deficits had not been allowed to unfold, the Great Recession would now be the Great Depression 2.0.
And importantly, the “fiscal deficits are facilitating the private sector’s desire to save more, delevering their balance sheets. Remember, the government
sector’s liability is the private sector’s asset!”.
When there is a “cyclical deficiency of aggregate demand” because private spending growth has been reduced “fiscal austerity would only add to that deflationary cocktail”.
He also fully understands the difference between say the US or Japan – fiat currency-issuing nations and the Eurozone:
… the vigilantes have fled Greece, but Greece does not have a fiat currency; Greece is a risk asset, and all risk assets depend upon growth for valuation support. And fiscal austerity is not the path to growth if everybody wants to do it at the same time.
So “cyclically speaking, current fiscal deficits in fiat currency countries are a blessing, not a curse”.
He provided a more in-depth treatment of these issues in this recent paper – Does Central Bank Independence Frustrate the Optimal Fiscal-Monetary Policy Mix in a Liquidity Trap? – (March 26, 2012). It is worth reading carefully.
The tryanny of the arithmetic is, of-course, an accounting tyranny and requires behavioural understandings to allow it to be translated into policy analysis.
The starting point is that the crisis was caused by the excessive growth in private debt holdings which led to unsustainable balance sheets and so the first and essential requirement of a recovery is that this damaging process be reversed – as quickly as possible.
As Paul McCulley says that private sector “has to” deleverage as it “is a part of the economy’s healing process and a necessary first step toward a self-sustaining economic recovery”.
That observation then conditions how we understand what governments should be doing right now. Trade patterns react to cyclical events (imports fall for example) but fundamental change is of a more structural nature and takes time. Productivity shifts have to occur, relative inflation rates have to be reduced and the like.
Exchange rate movements assist in this process but like private sector de-leveraging – these shifts in balances take time.
So the many nations with current account deficits the only way forward is to expand fiscal deficits.
Paul McCulley says that private “deleveraging”:
… is a beast of a burden that capitalism cannot bear alone. At the macro level, deleveraging must be a managed process: for the private sector to deleverage without causing a depression, the public sector has to move in the opposite direction and re-lever by effectively viewing the balance sheets of the monetary and fiscal authorities as a consolidated whole.
This recognises that the treasury and central bank operations are intrinsically linked (on a daily basis) and it is fraught to start thinking of the central bank as “independent”.
Please read my blogs – The consolidated government – treasury and central bank and Central bank independence – another faux agenda – for more discussion on this point.
Paul McCulley says that fiscal austerity at a time when the private sector will not spend sufficiently “makes as much sense as putting an anorexic on a diet”.
The rest of the paper discusses how this affects the role of the central bank. He says that when when private spending is subdued “someone simply has to borrow and invest to fill missing demand” and this is a “a game changer” for central banks.
The situation moves from one where the central bank will be “policing the government to keep it from borrowing too much” (as the economy approaches full employment) – “to one of helping it to borrow and invest by targeting to keep long-term interest rates low by monetizing debt, with the aim of killing the fat tail risks of deflation and depression”.
Paul McCulley says that:
In the present circumstances, however, the problems are austere governments, while central banks know all too well that someone must borrow and spend to avoid a depression. The problem for central banks currently is not to protect their independence, but to help governments let go of their fears of false orthodoxies that hold them back from borrowing and investing.
The paper continues to discuss how the central bank has to play this role. There is a lot of interesting historical material presented.
I don’t entirely agree with some of his interpretations but those disputes are minor relative to the main message – some sector has to run deficits right now and an understanding of the circumstances of each sector leads to the conclusion that governments have to be the saviours.
Those advocating fiscal austerity or those who claim that the amount of outstanding private debt is simply too large for the Government to replace with public debt” fail to understand the basic tyranny of the arithmetic.
Conclusion
The next time you hear someone tell you that the private and government sectors have to reduce their debt to resolve this crisis ask them to outline, in detail, the tyranny of the arithmetic. My bet is that very few will know where to start.
Even debt-obsessed economists get this wrong.
The inescapable rule is that if one sector is running a surplus then at least one other sector has to be running a deficit. In times of private de-leveraging, it is fairly obvious which sector has to be supporting that process with commensurate deficits.
That is enough for today!
“At the time, Steve Keen was running the line that governments would have to inflate away the nominal debt to reduce the real burden to maintain fiscal sustainability, a thoroughly orthodox line.”
That thinking may have evolved a little now, but you’ll have to ask him to be sure.
The debt jubilee idea currently proposed seems to be ‘quantitative easing for the masses’, which is essentially the central bank creating liabilities (which is public ‘debt’ in the vernacular) and then using that to clear out excess private debt in the household sector – with anybody short of debt just keeping the cash as a bonus.
That process shifts the private debt into ‘public liabilities’ as MMT would see it – the consolidated government sector consisting of the central bank and government would see its balance sheet expand and those central bank liabilities called commercial bank reserves would shoot up as they have done under QE.
But I think it would create a vast quantity of equity capital in the private banks – so the only constraint on the banks from then on would be demand for loans at the price on offer. Capital ratios would be completely ineffective (assuming they ever had much of an effect in the first place). Potentially a problem without better regulation.
It seems more of a redistribution than anything else. The government starts paying the banks bank reserve interest rather than the private sector paying the banks loan interest. So the macro impact seems to be from the shift of that money from the banks to individuals – a propensity to consume difference I presume – and the gifts of cash to those without debt.
That and freeing up the private sector logjam so they can start borrowing again.
Bill, while I understand we could without government bond sales, I think we should at least mention it would require a wholesale change in the financial markets. Of course, a change in the opposite direction we are currently heading as well as a historic change.
Your point that we cannot all delever at the same time is spot on and I think should be expanded. Right now we have a very leveraged-deleveraging occurring, where one end of the fulcrum is 0.1% of the population, with the rest stuck underneath the other end of the lever being crushed. Is the pressure decreasing?
This is one of those processes where we need to look inside the macro at the private sector in order to to see the deleveraging process.
The more I look at the economy long term, the old ‘normal’ was exploitative, this new ‘normal’ is extractive with no end in sight. While history repeats itself, the tune changes a little bit each cycle. I’m not sure we have identified what makes this go round different.
Great article. The idea of “not everyone can deleverage at the same time” is so simple. Yet nobody seems to understand it. Including “our” world leaders.
I have a question specifically about the EU situation: there’s talk now about another central fund (ESM). What I really fail to understand, is why they decide to have the fund be financed by the individual countries, who have to borrow the money on the markets. Why? Why depend on the markets for that? The only result is that inhabitants of the donating countries feel that “their money” is stolen from them by their own government and given to the “bad countries”. This will lead to so much social uproar everywhere and more votes for the extreme (left/right) populist parties.
Why not just simply have the ECB write a cheque worth 1 trillion or whatever is needed (created out of nothing) and spend the money where it’s needed? Or have the ECB garantee from now on every government debt within the EU? You could solve the complete balance sheet problem and too high interest rates for the southern countries in, literally, one day. Without any negative consequences. Since the new funny money is just created to fill up the debt gaps, it’s not directly spend into the economy, so no fears for hyperinflation.
Everybody can default and deleverage at the same time
” Keen is quoted as saying: Ultimately, we’re going to see governments changing across either to abolishing debt, or to literally printing money rather than running out debt to finance their spending … We know this crisis was caused by too much debt, how on earth do we think that getting into more debt is going to solve the problem.
At that point you realise that basic concepts about the monetary system are not grasped. ”
Bill, it seems to me that you are misinterpreting what Steve Keen was saying. I have heard him speaking on this issue many times, and he has always been clear about the distinction between private debt and public debt, maintaining that the buildup of private debt is the real problem, not (so called) public debt. So, when he simply uses the word “debt”, as in the quote above, it should be interpreted to mean “private debt”.
@MamMoTh:
“Everybody can default and deleverage at the same time”
Wouldn’t that create the biggest ever transfer of real resources from people to banks in history? To take one type of loan for example, if everyone defaulted on their mortgages in Australia, banks would suddenly own 1/3 of all the houses.
“the distinction between private debt and public debt, maintaining that the buildup of private debt is the real problem, not (so called) public debt.”
Spending equals income. So if the government / public sector reduces its spending, it also reduces the non-government sectors income.
The Howard years in Australia are proof enough. Growth was essentially on the back of private sector consumption on credit.
OK, I have several points I would like Bill to respond to if he would. Let me state at the outset that I am largely convinced by the MMT description of the modern money economy. I have some minor reservations about some aspects of MMT. These reservations are more about the evangelical and exaggerated rhetorical tone sometimes adopted rather than about the substance of MMT itself.
Point 1. A description of the money (accounting or financial) economy does not exhaust all the interesting and important things about an economy. Also to be taken into consideration are the real economy (real goods and services), capital-wage relations, the labour market, institutional arrangements, broad considerations of political economy (politics, class relations, law, legitimisation), international politics (trade, diplomacy, war) and finally the availability and sustainability (or otherwise) of natural resources.
Point 2. I understand Bill’s concentration on MMT (the formal money economy). It is important and if you get it wrong (budget austerity in a recession for example) you can do a lot of damage to general economic prospects, employment levels, capacity utilisation and the lives of many, many people. However, I refer to point 1. It does not exhaust all the issues we should be looking at.
Point 3. I hope Bill does not take it too amiss when I refer to what I termed the “evangelical and exaggerated” rhetorical tone of some his posts. I am not referring here to his sometimes trenchant criticism of ideological neoliberal clusters like “the troika”. That criticism is fully warranted and needs expression because mainstream discourse in these matters is pervasive and wrong. I refer more to expressions like (I paraphrase loosely) “sovereign governments with a fiat currency are not revenue constrained, can never run out of money and can print/electronically credit as much money as they wish”. Here is another example or two (I paraphrase loosely again); “governments can spend without taxing” and “taxes do not finance government expenditure”.
I hope these are not excessive characterisations of some of Bill’s rhetorical expressions. Now Bill knows what he means and within the context of fully fleshed out MMT theory he is technically correct. You and I (if we have even a very basic understanding of MMT) also know what Bill means. However, these sweeping rhetorical expressions sound very odd (even eccentric) to the ears of people propagandised by years of mainstream neoliberal humbug. As such, they can be easily pilloried and dismissed as follows. “He thinks the government can print endless money.” “He is blind to the danger of hyper-inflation.” (I know Bill has addressed exaggerated hyper-inflation fears in other posts.)
Point 4. An expression like “the government can spend without taxing” is technically correct in one sense and technically incorrect in another sense. Yes, it can spend more than it raises in taxes (deficit spend) by printing and/or electronically crediting extra monies in any one year or over any number of years on balance. In the other sense, a government cannot spend very substantially and continuously whilst not withdrawing any spending power (via taxes) from the private sector or it will cause high inflation and debase the currency. This is a practical limit on spending without taxing. I know Bill also addresses this issue but some people don’t read the whole theory they only take “grabs” and “sound bites” from the blogs or the mainstream media. That being so, it behoves MMT advocates to choose their language very carefully. MMT advocates should commence their narrative in a conventional order and then take their conventionally educated (neoliberal propagandised) auditors with them.
“It appears to the ordinary person that a government taxes in order to be able to spend. And in a sense this is true but it is not the whole truth. Most of us know that a government can spend more in one year than it takes in taxes in that year. This occurs when a budget is in deficit. Outlays are greater than taxes or receipts. Where does this extra money come from? Well, sometimes a government can be just like a household. It can use savings (previous surpluses) or it can borrow to spend more than its tax income and it borrows this money by issuing bonds to private markets or in transactions with its own central reserve bank. But sometimes a government is not like a household and it can print its own new money as physical bank notes or as electronic credits to private banks or private accounts when paying its bills.
It is normal for governments which issue their own currency to print new money from time to time. After all, where would legal tender currency come from if a government did not create it? As the economy grows, new money is needed to meet all transaction needs. If a government did not print new money, there would be a circulation shortage and this would strangle consumer and business activity. It might result in deflation (prices falling because money is scarce) and deflation has historically been associated with severe recessions and depressions. So as the economy grows, the government needs to create new money (print money) to keep pace.
Generally, sensible governments do this new money creation at the appropriate time. It is not appropriate when the economy is booming and private individuals and entities are flush with money. If extra money was printed at this time it would create excess inflation. It is however appropriate to print money in a downturn. When the economy has slumped, the stimulus of extra government spending can boost consumption and thus business activity and return the economy to a growth phase.
Overall, in the long term, governments issuing their own currency spend more than they tax. They do this by printing new money. If they did not do this then the money supply would not grow in tandem with the real economy. In this sense, we can say that governments spend (in part) without taxing. They spend taxes but they also spend new monies from their fiat money creation process.”
This is an example. I hope it is correct and not too tendentious. This is what I mean by starting the narrative in a conventional way and leading a conventionally educated (propagandised) person to the understanding that MMT is not radical, not somehow topsy-turvy but is in fact a correct and objective description of how the fiat money system actually works.
Also, I don’t believe it helps to hold too pedantically that taxed monies are destroyed and the full new budget monies are created. If taxed monies are 2 units and the budget spend is 3 units then the following statements are equivalent;
2 (existing units) + 1 (new unit) = 3 units.
-2 (existing units destroyed) + 5 (new units) = 3 units.
These statements are equivalent for notional units like fiat money although these statements are not equivalent if we are talking about real units like cars for example.
Grigory, I don’t think the banks will be very happy owning those houses they won’t be able to sell.
Anyway, they will have to write off their loans, and their government bonds.
Not sure many banks will survive.
Ikonoclast.
Is that post a joke ?
No, Andy. Why do you ask that?
Ikonoclaust
I may be wrong but my understanding is that the emergence of MMT ideas to the wider public over the past couple of years all started with this blog. I’ve heard Randy state that.
Suggesting the man changes his style now makes no sense to me.
Scholarly articles devoid of rhetoric appeal to a narrow audience.
Ikonoclast,
“Well, sometimes a government can be just like a household. It can use savings (previous surpluses)”
Only perhaps state and local governments can “save” surpluses for spending later. Governments though cannot “save”: the sole contraint on government spending is excessive inflation which would not be any less a problem if a government were spending money it had previously “saved” than if it “printed” the money. This is why it makes no sense to talk of governments either “printing money” or “saving”.
Everytime, without exception, a government deifict spends, the “money” comes from nowhere.
Kind Regards
In reply to Charles and others.
1. Yes my sentences of “Sometimes a government can be just like a household. It can use savings (previous surpluses)” are dubious, on one view, in relation to a federal govt using a fiat currency. It has some support in one sense although an MMT advocate might not want to phrase it like that. I wrote it in the spirit of telling the narrative from a point that will take conventional thinkers along with the MMT story.
No-one has responded to my simple mathematical-philosphical point that;
“If taxed monies are 2 units and the budget spend is 3 units then the following statements are equivalent;
2 (existing units) + 1 (new unit) = 3 units. (Meaning tax monies are conserved and re-spent and some new monies are created by fiat)
-2 (existing units destroyed) + 5 (new units) = 3 units. (Meaning tax monies are destroyed and all new fiat monies created)
These mathematical statements are equivalent for notional units like fiat money although these statements are not equivalent if we are talking about real physical units like cars for example.”
My philosophical point is that it makes no more sense to say the the tax monies are destroyed than to say some are saved by a surplus. If the one statement is arbitrary and notional then the other statement is also arbitrary and notional. When there are two ways of looking at something involving quantification of notional items and the net sum comes out the same there is no validity in preferring one view over the other. QED.
I challenge anyone to fault that proof.
2. With regard to my criticism of Bill Mitchell’s rhetorical style and dogmatic insistence on certain arbitrary points (as discussed above) I will say this;
A. I respect Bill Mitchell’s work, output, social democratic credentials and persistence in fighting against various pernicious neoconservative doctrines.
B. Bill has put his work out on a public forum and I am sure he is the last person who wants only total uncritical agreement on every single point.
C. I reserve my right to make what I view as constructive comments on this forum, subject to Bill letting them stand. (It is his blog after all and he has the right to rebut me or even take my comments down.)
D. I do think that the MMT “story” could told in a slightly altered format and sequence in such a way as to carry along those currently propagandised into accepting a host of neoclassical fallacies. My suggested “story” was a quick, clumsy sketch and made some relatively insignificant compromises to take people along with the MMT “narrative”. That’s my point of view folks but I do hold my “philosophical” point (about the notional equivalence of a fiat currency issuing government “destroying” or “saving” taxes) is logical and irrefutable. My point is that, if it is notional, why make a dogmatic point of arguing something that will make many shallow conventional thinkers immediately think dismissively that MMT is a crank proposition?
“I do think that the MMT “story” could told in a slightly altered format and sequence in such a way as to carry along those currently propagandised into accepting a host of neoclassical fallacies. ”
The spending cycle is just that – a cycle. Therefore every linearisation of that cycle is a valid viewpoint.
The trick neo-classicals use is to start the linearisation at borrowing, and then create a false mental link to unsustainability – because they never close the circuit.
Starting the linearisation at spending provides a different view, and if that linearisation refers to a consolidated balance sheet of the Treasury function and the Central Bank function of government then it is absolutely correct to say that spending comes from nowhere and taxes disappear. That is what happens on that balance sheet.
But it is also correct to drop down below that abstraction and have separate balance sheets for both Treasury and Central Bank. Then you can start talking about ‘borrowing’.
I often point out that if you own a bank it makes no rational sense to borrow from anywhere other than the bank you own – because what you pay in interest comes back to you as a dividend. So if the government is truly ‘borrowing’ when it sells bonds, it is acting irrationally.
Neil Wilson, traditional QE means simply an asset swap where bonds are exchanged for money. Private sector gains no new financial assets in these transactions.
Whereas steve keens’s version of the QE private liabilities would go down, without corresponding drop in the assets because what private sector would loose as claims on debtors, it would gain as claims on government.
When liabilities go down and assets stay the same there is gain on net financial assets.
Btw, it’s gains on (net) wealth that generate more spending, not changes on money stock as we see from orginal QE that did create money but not new wealth, and therefore were a failure.
Ikonoclast, Neil,
MMT offers a different reference frame to classical economics.
An imperfect analogy is either geocentric or heliocentric model of the solar system. In theory as long as relative movements of objects are depicted correctly, none of this models has any advantage… wrong! There is a concept of an inertial reference frame (in the classical but also relativist physics where the curvature of space-time was introduced). The reference frame related to the centre of Earth may be inertial as long as it is not rotating with the Earth. The original geocentric system did not have an inertial reference frame what can be demonstrated with an experiment with a Foucault pendulum.
What does it have to do with economics? If we describe the monetary system of a country as a collection of linked balance sheets then we need to place the central bank at the top of the hierarchy. The set of government accounts at the central bank plays a special role in that system. Government can spend whenever… not necessarily true (with a small exception…). Unless a direct overdraft at the central bank is allowed, the government needs to have money on its accounts at the central bank before it spends. The principles of double-entry accounting still apply. The act of replenishing government accounts is called financing. Financing can be achieved primarily by raising taxes or selling government securities. This is the classical view.
We all know that in MMT the central bank and government are aggregated etc. It is assumed that when the government spends it creates money ex nihilo and when it levies taxes, money ceases to exist. The key feature of the view from this vantage point is that money has only any economic impact if it has been spent into existence to the non-government sector. The internal balance between the Treasury and Central Bank is irrelevant. It is like an individual owing money to himself.
So where is my Foucault pendulum and what am I still doing on this blog? In term of causality, does the government need to raise pre-existing funds before it spends or does it spend money into existence?
In my opinion we need to ask the same question Michal Kalecki asked on pages 45 and 46 of “Theory of Economic Dynamics”
“Does it mean that profits in a given period determine capitalists’ consumption and investment, or the reverse of this? The answer to this question depends on which of these items is directly subject to the decision of capitalists. Now it is clear that capitalists may decide to consume and to invest more in a given period than in the preceding one, but they cannot decide to earn more. It is therefore, their investment and consumption decisions which determine profits, and not vice versa”.
In the gold money era the government was constrained in its (especially military) spending by the need to acquire gold/solver. In the gold standard era this constraint was relaxed somehow – it was a soft constraint. In the fiat money era the government can spend whenever such a decision is made. Modern taxation systems do not guarantee revenue which depends on the level of economic activity (this is related to “automatic stabilizers”). My Foucault pendulum has clearly changed its swing plane, suggesting that Bill’s view is correct.
The trouble is that the classical and Functional Finance views are like a Necker Cube. You either see it one way or another. Without additional stereoscopic information the brain switches between 2 different ways of rendering the image but one will never see it both ways. I would add that writing harsh words towards the people who see the cube in a certain way will not necessarily flip the view the other way around.
“Btw, it’s gains on (net) wealth that generate more spending,”
Is it?
Generally having more money generates more spending.
“When liabilities go down and assets stay the same there is gain on net financial assets.”
There is and I mention that. You end up with more reserves owned by the banks, and the banks getting a reduced income from the reserve interest payment. But that is accompanied by a destruction of private sector financial assets and liabilities.
The question then is whether the real asset values stay the same or come down. The Debt jubilee (or for that matter Job Guarantee) can’t happen in isolation – there has to be a re-regulation of the banks which would reduce their capacity to increase the private debt to GDP ratio. Otherwise we just go back ten years and start the bubble again.
Less borrowed money in the system generally means a reduction in house prices.
So although there is an increase in government sector financial assets by the Debt Jubilee, they are created in such a way as to make sure that they are in their final resting place immediately. The corresponding commercial bank liability created is used to annihilate a commercial bank asset (the loan), while at the same time loan demand is suppressed so it can’t be recreated.
The dynamics of the process, as compared to stimulus spending, are different, and fascinating.
If the banks are sat on all this excess equity they can’t use, are they going to distribute it to their shareholders? Does that then drive pension investment asset prices, or commodities again?
“Generally having more money generates more spending. ”
If that were true orginal QE would have worked, right?
Saving desires get satisfied when people feel wealthy enough, and wealth does not have to be in money-form. People could own shedloads of goverment bonds for example. Take these bonds away and people will start saving, even though their money possessions would say the same.
This is known in the literature as “wealth effect”. I think it is crucial in understanding fluctuations in aggregate demand, for example how house price crash produces wealth shock that gets consumers saving more.
I will put up my philosophical challenge question for the 3rd and last time. Can anyone directly refute it?
No-one has responded to my simple mathematical-philosphical point that;
“If taxed monies are 2 units and the budget spend is 3 units then the following statements are equivalent;
2 (existing units) + 1 (new unit) = 3 units. (Meaning tax monies are conserved and re-spent and some new monies are created by fiat)
-2 (existing units destroyed) + 5 (new units) = 3 units. (Meaning tax monies are destroyed and all new fiat monies created)
These mathematical statements are equivalent for notional units like fiat money although these statements are not equivalent if we are talking about real physical units like cars for example.”
My philosophical point is that it makes no more sense to say the the tax monies are destroyed than to say some are saved by a surplus. If the one statement is arbitrary and notional then the other statement is also arbitrary and notional. When there are two ways of looking at something involving quantification of notional items and the net sum comes out the same there is no validity in preferring one view over the other. QED.
I challenge anyone to fault that proof.
Neil: The Debt jubilee (or for that matter Job Guarantee) can’t happen in isolation – there has to be a re-regulation of the banks which would reduce their capacity to increase the private debt to GDP ratio. Otherwise we just go back ten years and start the bubble again.
The Job Guarantee can happen in isolation. This underscores its fundamental nature – and the lunacy of a monetary economy without one. A sensible libertarian/Austrian/ night watchman state would be financially unstable, would have panics every 7 years like the 19th century USA, would have private debt to GDP bounce up & down with bubbles & busts. But with a JG, there would be no giant problem in reality, as opposed to financial fun & games. It would just be a (comparatively) fun roller coaster ride, not like all-too-real horror movie versions throughout history.
The government budget is for one fiscal year.
Seriously, it is like banging your head against a brickwall reading cetain peoples posts.
No names mentioned of course.
“If that were true orginal QE would have worked, right?”
No, because individuals didn’t have any more money. QE is about small price changes, not quantity. It annoys the hell out of me when they say the BoE printed £325bn of money, when in reality their actions are about reducing Gilt yields by about 0.25%.
“This is known in the literature as “wealth effect”.”
Yeah. But it is limited. To have a wealth effect, you have to feel that you have it and can use it. ‘Asset rich, cash poor’ is the counterbalance to that, and this recession has had a constraining effect on cash flow.
“I challenge anyone to fault that proof.”
It’s a bit of a non-sequitur. You should be doing accounting – according to the rules of accounting.
And in the rules of accounting if you credit taxes onto a consolidated balance sheet, the balance sheet shrinks and the taxes disappear. And if you spend then the balance sheet expands.
To get the spending to appear to come from a taxes pot, you have to change the accounting policy to show that. But since you have to spend first, before the taxes can be paid it is always going to be overdrawn.
“The Job Guarantee can happen in isolation. This underscores its fundamental nature – and the lunacy of a monetary economy without one.”
Politically I doubt that. It is likely that the gyrations in the financial system would be blamed on the ‘welfare system’ and moves would be made to dismantle it as the pendulum shifted.
You don’t want a ‘New Deal’ approach where the system is dismantled after a period of time.
Reply to Neil Wilson.
Oh well, I guess there are two worlds, the empiriological world and the accounting world… and never the twain shall meet. The fact remains you cannot win an empiriological argument with accounting “fictions” i.e. the notional truths of accounting. In the real economy, taxes function to reduce to private consumption. That power, to consume without extra inflationary potential, is transferred to the government. In addition, I accept that governments can deficit spend, without significant inflationary potential, if the economy suffers from under-utilisation of labour, machinery and resources. Your view is merely an accounting fiction as is also the other view of taxes. Both are arbitrary views. As I said before, there is no basis for preferring one view over the other (taxes are destroyed or taxes are not destroyed) when the units and accounting are arbitrary and notional.
I suspect accountants, managers and business people in general would benefit greatly from learning a bit of physics and philosophy. Then they would come to understand how unreal and ephemeral most of their constructs are.
“Your view is merely an accounting fiction as is also the other view of taxes.”
It’s not a fiction. It is as accurate a description as your description. The question then is which description has the most political use in forming a view of the world
The ‘Taxes fund spending’ is designed and propagated specifically to box the government into the corner. It is no more accurate than ‘spending funds taxes’, which leads to a different political viewpoint.
” In the real economy, taxes function to reduce to private consumption. That power, to consume without extra inflationary potential, is transferred to the government. ”
Again that is just a viewpoint. The other viewpoint is that the government did the consuming first, and they merely have to organise things to prevent the private sector over-consuming alongside that. And the theory that suggests the latter is a better viewpoint is the paradox of productivity – modern economies don’t need all the labour on offer, and therefore will always underproduce unless stimulated.
It’s a shame we are having this disagreement. Perhaps I am most at fault through intellectual pride and pedantry. I am, for the most part, in agreement with the main descriptive and presecriptive parts of MMT. As a final comment I will say this. In a system (the political economy) with multiple connections and multiple feedback loops endogenously and many exogenous determining factors and limits (in the earth’s crust, in the biosphere and even in terms of insolation), it is not valid to assign causal primacy at any point in the loops.
Speaking more broadly, the search for causation (especially strict one-to-one and linear causality) is a scientific and philosophical mistake. We need to search for laws (natural laws) not causes. Laws relate or model natural phenomena in mathematically consistent ways. The search for laws is an empirical and scientific quest. The search for “causes” suffers from an infinite regression and finally terminates in metaphysics or mysticism. For complex problems, the search for empirical causes always fails (on a strict test) to account for the whole linear linked series of causes of any event or phenomena (right back to the Big Bang if we reason reductio ad absurdum) and it also fails to cope with analysing systems with multiple feedback loops where it is not possible to assign primacy to any one “cause” at any one point.
I could write a lot more but it will take us too far away from the topic.
I agree with Neil. It’s all “notional”. Of course one can say whatever one likes. But if one tries to be internally consistent across the board & as consistent as possible with ordinary speech, (Neil’s “which description has the most political use in forming a view of the world”) , if one tries to use words the same way as everyone else, insofar as is possible – then these are “clear bases for preferring one view over the other”. And then “taxes destroy money” is clearly preferable.
I suspect accountants, managers and business people in general would benefit greatly from learning a bit of physics and philosophy. Then they would come to understand how unreal and ephemeral most of their constructs are.
I suspect physicists and modern philosophers in general would benefit greatly from learning a bit of accountancy, management and business. Then they would come to understand how unreal and ephemeral most of their constructs are. 😉
“I suspect physicists and modern philosophers in general would benefit greatly from learning a bit of accountancy, management and business.”
Engineers learn enough physics and philosophy to get the bridge to stay up. Beyond that its trial and error to get the best design for a bridge.
The same applies to any other designed system. Take a view, but most importantly quit the navel gazing and try something.