Scottish-born economist - Angus Deaton - recently published his new book - An Immigrant Economist…
In the days following my blog – Neo-liberals invade The Greens – I have had some interesting responses. Mostly they have been negative and personal but some have been positive and constructively trying to develop the debate. My blog was not an attack on green values – far from it. But it did pinpoint major macroeconomic failings with the current official policy of The Australian Greens which I consider need to be remedied in order to render the other excellent components of their platform viable. I would also note that it is very dangerous to start critiquing a theoretical argument if you really do not understand the basis of the argument. Here is some thoughts in this regard.
Mike Beggs tries such a rebuttal in his Mitchellnomics blog. At the outset, I am happy that Mike is actually engaging with the view I present unlike most progressives who refuse for whatever reason to do so. I think the only way to advance public debates is to engage in discussion and sort out differences in perspectives and develop better technical understandings of how economies work. So I was happy to see Mike’s comment.
I would also say that characterising the articulation of modern monetary macreconomics as Mitchellnomics is to dramatically and unfairly understate the long tradition in progressive economics which includes the work of Abba Lerner, Hyman Minsky, Wendell Gordon, and others in years gone by who all understood this stuff and made significant contributions to the literature that I have built on. It also ignores the host of modern macroeconomists who are at the top of the game who also understand and write about fiat monetary systems. I work with some of these authors and know of the others. They have strong reputations and many work as consultants with international organisations and foreign governments (as I do) providing high level advice in applying the modern monetary theory. So we are not members of the Flat Earth Society
The next point I would make is note a caution that I have carried with me since my student days. As a student I was always arguing against the neoclassical orthodoxy that appeared in our textbooks and was being taught to us. But I adopted the rule that I would never criticise something that has a technical basis until I really was convinced I understood the theoretical framework as well as those who were advancing it. I studied mathematical economics, econometrics, mathematical statistics, history of thought and read as much as I could to make sure I was on solid ground when I launched my attack.
The point is that you have to be sure you know what you are talking about before you start accusing others of being theoretically deficient.
Mike Beggs falls into this trap and unfortunately reveals his lack of understanding of the modern monetary system. He starts his critique by saying that:
Mitchell’s views on money and government financing are problematic. Though he presents it as a case of “progressives who understand how the modern money system operates” versus “neo-liberal economics”, his ideas on money are a little eccentric even within the post-Keynesian or ‘heterodox’ community, hardly the obvious consensus he portrays with such confidence.
I don’t portray any consensus at all. I divide macroeconomists into those who understand the way a fiat monetary system operates and those who do not. Within those who do not are the orthodox neoclassical school, the Austrians and other anti-government theorists who have been labelled deficit hawks. They advocate no deficits and no public debt. The government should not spend beyond tax revenue and that revenue should be minimal.
But also within the camp that clearly doesn’t understand how a fiat monetary system operates are the hoard of old fashioned Keynesians and the majority of the so-called Post Keynesian economists who have been labelled deficit doves. They want to have stimulus packages and so argue that deficits and debt are permissable but must be sustainable. This is where they demonstrate their lack of understanding. They consider the sovereign government does have a budget constraint and must issue debt but this is fine as long as the Debt/GDP and Deficit/GDP ratios are within acceptable limits. They derive mathematical expressions of what is acceptable and what is not.
This Short Paper provides a good comparison. Modern monetary theorists emerge out of functional finance theory developed by Abba Lerner.
In general, Post Keynesians are fairly weak in macroeconomics. The most coherent group of macroeconomists in the Post Keynesian tradition is comprised of the modern monetary theorists to which I would claim membership.
Beggs then writes that Mitchell:
… says the federal government is a ‘monopolist’ in the issue of currency. This is not true, because the national currency is one among many. Everyone has the option of converting their money into a foreign currency. Most of us don’t do it unless we’re going on holiday or buying something on the internet, but of course managers of financial wealth are always comparing currencies, and if one national currency is expected to lose its value, it will be sold for another.
If Mike represents the sort of macroeconomics logic that is influencing The Greens then this accusation of my ignorance really demonstrates why they are in so much trouble with their macroeconomic policy.
In a fiat monetary system, the national government is the monopoly issuer of … (wait for it) … its own currency! The Australian Government has a monopoly on the issuance of the AUD and the US Government has a monopoly on the issuance of the USD and so on so forth. Of-course, there is a foreign exchange market which permits these currencies to exchange against each other to faciliate trade.
Currently I have little stocks (in a box) of USD, Euro, Taiwanese notes, Filipino pesos, Pounds, and probably some other currencies. So I know about foreign currencies.
But here is the essential point that Mike doesn’t understand. I can never use these currencies to extinguish my tax obligations to the Australian government! I cannot pay them in USD or Pesos or Euro. So the monopoly power that the Australian government has in its own currency is powerful and binding on us.
It is also a non-convertible currency which means that the only reason we will ultimately hold it is because we have to get it to pay our taxes. I have been doing work lately in Central Asia where multiple currencies might be used in the same country (often USD and the local currency). This still doesn’t undermine the demand for the local currency by anyone who has tax obligations in those countries. They have to get the local currency for those purposes. They may use the other currencies here there and everywhere but they have to sometimes get hold of the sovereign currency as long as the national government can make the tax obligations stick.
What this means is that the national government can exploit the monopoly power and spend whatever amount of the currency it likes. It also means that it is not revenue constrained.
If you want to understand the essence of the fiat monetary system then you have to come to terms with that fact. Governments might voluntary act differently to this (see below). But the essence of a non-convertible fiat currency system is that the monopoly issuer has sovereign rights to spend as much as they like on things that are available for sale in that same currency.
So convert your $AUDs into whatever currency you like Mike, but then try paying your taxes in the foreign currency. And be prepared for disappointment.
Beggs then abandons the theoretical attack and instead starts offering opinion. He also uses neo-liberal terminology which I find odd given he describes himself as a student of political economy (at a progressive school).
Even if Mitchell were right, and the federal government could expand its expenditure as much as needed for full employment by printing money without sparking inflation, the fact that financial managers would expect it to be inflationary would be enough for the dollar to dive.
First, the terminology “printing money” is a neo-liberal construct. In the next part of this blog I deal with that (see below).
Second, I advocate initially that the Government should, as a priority, hire as many workers on a fixed minimum wage, who cannot find work. Our research shows this would require (in May 2008) an investment of $8.3 billion to create 577 thousand full-time equivalent jobs in Australia. The projected budget deficit for the next 12 months will be $58 billion and no-one is suggesting that will cause inflation. They are actually suggesting it will arrest deflation.
But more significantly, from a theoretical point, and as I explain in more detail below, this would not require the Government to buy anything much at “market prices” (that is competing with the non-government consumers and investors for resources). The unemployed have no market price! Buying as many of them as is required to achieve full employment cannot be inflationary.
Millions of jobs have been created in many countries now by employment guarantee-type schemes (some of which myself and my colleagues have direct experience in as consultants) in the last several years as the reaction against market liberalism gathers pace. There has been no inflation nor wholesale sell-off of these currencies. In fact, in some of the countries, foreign direct investment (facilitated by the so-called financial managers) has increased as investors sense that growth and stability will underpin profit opportunities in these countries. Far from undermining the balance of payments these schemes have improved the capital accounts and helped the currency.
Begg then abandons the financial markets fear strategy and further demonstrates his lack of understanding of how the banking system actually operates. He says:
And anyway, I don’t think Mitchell is right that it would not be inflationary, even if speculators happened to agree with him. When government expands spending with new currency, most of that currency will end up in bank reserves. This allows the banks to expand their lending and the money supply to a significantly higher degree, since they can carry deposits to a multiple of reserves. Mitchell would probably respond that if inflation developed, government could beat it by cutting back its spending again, or soak up the currency with open market operations. But this relies on some pretty heroic assumptions about the government having fine, well-timed control over its expenditure and ability to predict bank behaviour and its ultimate impact on demand.
Where does one start disentangling the errors of this reasoning?
First, private banks do not need reserves to lend. There is no money multiplier in a fiat monetary system. Please read my blog – Money multiplier and other myths – to learn more about this.
A neo-liberal will say that banks need to build up reserves before they can lend. This is totally fictional when it comes to a description of how the banking system operates. Loans create deposits! Banks lend to any credit-worthy customer and then worry about their reserve positions later. If they are short of reserves they just borrow them in the interbank market or from the central bank.
Second, net spending by a sovereign government will clearly add to reserves. That is how spending works (not by “printing money” as he claimed earlier). But a budget deficit doesn’t expand the capacity of the banks to lend. That is a totally fictional claim. The banks can always lend if there are credit-worthy customers looking for loans. The largest expansion of credit in our history occurred when the national government was running record budget surpluses.
So this money multiplier conception of the world just displays ignorance. Sorry!
There is also a difference between the conceptual point that the sovereign government is not revenue-constrained and therefore can spend what it likes and the practical point that the net spending should be sufficient to fill the spending gap left by the desire of the non-government sector to net save. Nothing less and nothing more. Clearly too much net spending relative to the real capacity of the economy may be inflationary (see below).
Critics of modern monetary theory always try to conflate the two, just as Mike has done here. They know that they can move almost seamlessly, or so they think, from linking statements I make about the capacity to spend to a conclusion that anything I advocate with respect to policy would be inflationary.
In fact, among the progressive economists I advocate much lower net spending levels than is typical. The Keynesians believe in generalised expansions which means that the government largely relies on the private market to increase employment levels by purchasing goods and services at market prices. So massive infrastructure projects are commonly advocated. But this strategy has no inflation control built into it.
I advocate (as noted above and below) that initially the government should introduce an employment guarantee to eliminate unemployment. This doesn’t require the government to compete with the private sector for resources that the latter sector may be wanting to deploy and further the outlays required are minimal compared to what you would require to create an equivalent number of jobs in the private sector paying market wages.
Moreover, even if the budget deficits created such buoyant conditions that the banks felt it was time to lend again (having faith that borrowers would be able to repay their loans) then the automatic stabilisers are going to quickly reduce the deficit anyway via the increased tax revenue and reduced welfare outlays. As the private sector expanded the public sector would contract automatically. Only a belligerent national government would try to retain a particular deficit size in the face of a private expansion.
Beggs then decides to go back to theory. He says:
Finally, Mitchell’s claim about the public sector deficit being the mirror-image of private sector saving (the balance of payments deficit/surplus aside): This is true by definition, but means very little. Perhaps he expects people to confuse ‘private sector saving’ with ‘household saving’. You can see why households as a group would want to have net savings over a period. But if their financial assets are to represent net claims over future real goods and services, they need to be claims on firms – shares and bonds, either directly or through banks, pension funds and other intermediaries. In other words, household savings are ultimately claims on firms, i.e. business debt.
But both firms and households combine to form Mitchell’s ‘private sector’. Why would firms and households collectively want to save over the long term in claims on the government? Except to the extent that governments are producing goods and services for sale, their income comes ultimately from taxation (or, if Mitchell ran the government, perhaps inflation) – which is a claim on the private sector!
Hmm. First, you cannot put the foreign balance aside, Mike. Sorry.
Second, what I actually say is that the government balance is the mirror image of the non-government balance. Please read my blog – Norway and sectoral balances – to learn what I actually talk about here.
Third, what it means is very significant. It means that if the government sector is pursuing surpluses then the non-government sector overall has to be in deficit! That comes from an understanding of national accounting which is the first lesson that a student of macroeconomics is given but which is also usually quickly forgotten. So if we then disaggregate the non-government sector, and realise that Australia will typically run a current account deficit, then if the government sector is running a surplus the private domestic sector has to be running a deficit. The only way the private domestic sector can spend more than it earns when the government sector is running a surplus is to draw on the savings of the foreigners (that is, increasingly become indebted).
As a growth strategy that is not sustainable. This is crucial for understanding why in history, recessions always follow periods when governments have tried to run surpluses. I didn’t invent any of this. Once the private domestic debt levels get too high the dynamics change and the private domestic sector seek to increase savings. The fiscal drag coming from the budget surpluses then bite badly and the economy nose-dives as the spending gap widens. The automatic stabilisers then force the budget into deficit until it is equivalent to the desires to net save by the non-government sector (however, that desire is distributed between the domestic and foreign components of the non-government sector).
I don’t expect anyone to confuse “private sector saving” with “household saving”. The sectoral balances that I write about do not require any such confusion or conflation. Please read the blog on sectoral balances to understand this.
Fourth, the government does not require income per se. Taxation is not income to a sovereign government. The non-government sector cannot fulfill its tax obligations unless the government has spent first. Where does the non-government sector get the currency from (thinking logically in first principles) if the government never spends, given the monopoly the government enjoys?
Mike finishes with some quasi-Marxist conclusion:
The Greens should take full employment seriously. But they also need to realise the extent to which full employment requires a radical reorganisation of how wealth and investment is controlled. It would mean a full-on fight with wealth-owners. The fundamental problem with Mitchell’s analysis is that he makes it sound all too easy, just a technical problem that could be easily solved if only governments weren’t blinded by ideology.
I agree there needs to be some major changes in wealth distribution.
But as far as moving to full employment is concerned it is actually an easy thing to achieve if there was a political will to do it. The whole point of my blogs on this topic is to show that as first principles go – the sovereign government could easily announce tonight that it will unconditionally employ anyone who wants to work at the federal minimum wage – and those jobs would be created tomorrow and the wages would start flowing next week – and with some organisation the workers would start working soon after rebuilding public spaces and restoring community services to the aged, the sick, the young and anyone other area of unmet need.
There would be no financial constraint on it doing that.
It would not be inflationary if they bought the labour “off the bottom” – that is, never competed with the private sector for Job Guarantee labour (so a fixed minimum wage).
Hundreds of thousands of workers would be valued by their communities by offering productive outputs.
The fact we don’t do that reflects political constraints imposed by ideology. There is nothing economic or financial preventing us. Millions of jobs are being created in countries around the world in programs like this by governments that are overcoming the damaging neo-liberal antagonism to budget deficits and direct job creation schemes. We are just losers here for allowing our Government (and the major political parties including The Greens) to ignore its fiscal capacity.
Once we overcome that problem, then we can argue about the wealth distribution and the other matters that we want to fix up.
I don’t see that a simple, obvious, easy, and available solution renders an analysis problematic if it reflects a deep understanding of the way the fiat monetary system actually works. It might be that a person has a distaste for full employment (like GreenMan the other day). But let them say that. You can still understand the way the fiat monetary system works and argue that the government should use its obvious fiscal capacity to maintain high unemployment.
But Mike doesn’t even get the first base.
Gold standard and fixed exchange rates – myths that still prevail – Redux
I followed up the Neo-liberals invade The Greens blog with a blog Gold standard and fixed exchange rates – myths that still prevail, which was intended to supplement the earlier discussion because it was clear to me that some readers (and a few who left comments) did not fully appreciate the historical fact that Australia and elsewhere had moved away from the earlier convertible currency, fixed exchange rate monetary systems into what is known as a fiat monetary system. The two systems are not similar and rules governing public finances in the former (include revenue constraints etc) do not apply in the latter.
This brought a very interesting and instructive comment from Sean Carmody which I welcome. The comment says:
As you describe the operation of fiat currency, it is the Government that prints money. In Australia (and most other countries with fiat countries) this is not in fact how it operates. It is the Reserve Bank of Australia that is responsible for printing money. This can be done either by physically printing notes or minting coins or, more substantially, by means of the Reserve Bank buying Government bonds, increasing the balance of the Government’s bank account. This increased balance, which can then be transferred to the bank account of other banks when the Government purchases goods or services, effectively creates new money and is often referred to metaphorically as printing money. So strictly speaking, the Government can only raise money through taxes and borrowing, but where borrowing is provided by the Reserve Bank rather than the private sector, the effect is to “print money”.
This point may appear to be an irrelevant technicality but, since the Reserve Bank is independent of the Government with a strong focus on, it is possible (in principle at least) that the Reserve Bank may refuse to purchase Government bonds if they thought that the printing of money was reaching a level that risked significant inflation.
First, a small matter of terminology. Readers of this blog will know by now that I don’t think the use of the term printing money is very instructive, not the least because it is ideologically-loaded to invoke Zimbawbe-style references linking budget deficits to inevitable inflation. But while governments do print money (notes and coins), all major public spending is done via the crediting of bank reserves or by issuing of cheques (which amounts to the same thing).
This is irrespective of whatever else the government does in terms of draining the reserve adds that arise from this spending (increasing taxes; issuing bonds or nothing). So all government spending might be constructed as “printing money” because it involves the same processes. Understanding this will allow you to see through the loaded neo-liberal connotation which says that spending that adds to bank reserves but is not drained is “printing money” while spending that is accompanied by reserve drains is not.
Second, the substantive point that Sean makes demonstrates categorically what I have been writing about for years. I do not disagree with Sean’s excellent depiction of the way monetary operations are organised and executed in Australia. But we should be very clear to distinguish operational matters that are voluntarily chosen to suit some ideology and those that are logically dictated by the underlying essence of the particular monetary system in place.
The Government can introduce legislation that establishes the relationship between the treasury arm and the central banking arm of government in whatever way it can politically accomplish. The Government can voluntarily require itself to issue debt $-for-$ every time it net spends and force itself to fund all this debt from the private markets. Read my blog – Will we really pay higher interest rates? where I trace some of the documentation that led to the establishment of the Australian Office of Financial Management which shows that the national government did just this. They imposed a voluntary restriction on itself for ideological purposes (to impose “fiscal discipline”).
The Government could equally legislate that every time it wants to spends a dollar it has to first drive a truck from Canberra to some random city in Australia and collect a dollar from an employed citizen. If it could politically get away with this then that would define how the government sector interacted in a fiscal sense with the non-government sector. It would be stupid but they could do it.
The point being made is that I do not dispute Sean’s perspective but it highlights that Governments can voluntarily impose whatever it likes on itself. It can thus act as if it is revenue-constrained and institute mechanisms to give weight to this conception. In doing so it is denying the underlying essence of a fiat monetary system and the opportunities that such a system – freed from the convertibility and fixed exchange rate constraints – provides.
These voluntary constraints that Sean describes then largely work against the capacity of the sovereign government (such as Australia’s) to generate full employment. It is in that sense, that I always stress that the Federal Government chooses the unemployment rate by how it conducts its fiscal operations. Voluntarily operating in a strait-jacket when the underlying characteristics of the monetary system that you are functioning within permit otherwise is what I call reprehensible fiscal conduct.
My aim is to highlight this voluntary choice by government – to drive a wedge between what the underlying characteristics of the monetary system permits and what the government chooses to do.
Third, the Reserve Bank is part of what I term the consolidated government sector because its monetary operations (gold sales, foreign exchange transactions, open market operations) create and destroy net financial assets in the non-government sector in just the same way that treasury operations do. The fact that we pretend they are independent institutions and create structures to perpetuate that myth is irrelevant. So the RBA is not independent of Treasury in a deeper conceptual sense. It must coordinate its operations to be in tune with the Treasury activities – to ensure reserves are managed consistent with the monetary policy ambitions it is pursuing.
More significantly though, the elected government of the day appoints the RBA Board and can overrule in the Parliament any decision that the RBA makes that it doesn’t like. While this would be rare it is possible and render the chimera of independence a nonsense.
I was presenting a paper at a major fiscal policy conference in Canberra (at ANU) in 2002 with my co-author Warren Mosler. The paper was about fiscal policy and full employment and the largely conservative audience were not impressed. To short-circuit their disdain, we asked a member of the audience – one David Gruen who was then Research Director of the RBA (now in the Federal Treasury) – whether “the RBA would ever bounce a Treasury cheque”. After his initial incredulous reaction that someone would dare to ask him this question he replied along the lines of of-course not.
In one statement the audience was told that the Federal Government of Australia is not revenue-constrained. So the possibility of the RBA refusing to buy Treasury bonds is as remote as that of the Parliament sacking the Governor because they didn’t like what the RBA did on some particular day.
Once we acknowledge this reality we can better discuss the consequences of net spending. A much more interesting and valuable topic.
Sean’s second point is about inflation where he suggests that most economists “who express concerns about significant growth in Government fiscal deficits fully understand that there is technically an endless ability to meet these deficits” but “believe that there is a practical limit rather than a technical one since unconstrained money printing is ultimately inflationary; witness Zimbabwe.”
The Z-word now joins the R-word, the D-word, the T-word and the B-word!
But I would suggest that the major commentators never say they understand this point and write as if there is some revenue constraint. The innocent public are never informed that the major issue is about inflation rather than funding and insolvency.
More importantly though, readers of this blog will know that I never advocate unconstrained net spending. Expanding nominal demand (from any source – consumption, investment, government, net exports) will become inflationary if it becomes excessive relative to the real capacity of the economy to provide goods and services in return. I always emphasise that point. But when you have more than 11 per cent of available labour resources underutilised (either unemployed or underemployed) then it is hard to imagine that the economy is close to the inflation barrier.
So the public debate should reflect that – not invoking the Z-fear from the outset.
Further, to get the best employment boost from every dollar of net public spending, the first thing you should do is introduce a Job Guarantee. This involves, as readers will be aware, an unconditional employment guarantee at the federal minimum wage to anyone who is without work and wants to work. These labour resources are at zero bid meaning no private employer is demanding them. When the government offers to buy this unemployed labour at a fixed price it cannot be inflationary.
Further, it provides a very sound guide to how far the deficit should expand – the last worker who comes through the Job Guarantee door looking for work is tells the Government the limit of the expansion. The government may choose to provide cash handouts and build public infrastructure as well but those policy initiatives involve competing for resources in the market which may eventually press up against an inflation barrier. There is no market for the unemployed so they are the first thing governments should seek to buy up.
Anyway, Sean, thanks for the productive input!
Digression: Catching up
I have been very busy lately and travelling a bit. I intend to catch up on comments over the next week. Many are really interesting and all are welcome!