When New is Old and just another exercise in denial

There is now a so-called “New View of fiscal policy”, which, in fact, is not all that different to the “Old View” although the proponents are hell-bent on convincing us (and presumably themselves) otherwise. The iterative bumbling along of mainstream economists, dammed by reality but steeped in denial, continues. The latest iteration comes from the Chairman of the US Council of Economic Advisors, one Jason Furman, who was supervised in his doctoral studies by Greg Mankiw at Harvard. He is also “closely linked to Robert Rubin” a classic “Wall Street insider” who was Treasury secretary under Bill Clinton and a gung-ho deregulator with a seedy past (in January 2009, he was named by Marketwatch as one of the “10 most unethical people in business”). Please see – Being shamed and disgraced is not enough – for more on Rubin. Furman’s lineage is thus not good. Furman supports free trade, social security private accounts and Wal-Mart’s labour practices which allows it to offer such low prices (for junk!) (Source). Furman is part of the core ‘Democrat neo-liberal establishment’, which received its comeuppance in last week’s Presidential election. His views on fiscal policy should come as no surprise then.

On November 2, 2016, Furman published an Op Ed on the Voxeu.org site – The New View of fiscal policy and its application – which asserts that the GFC has led to the “landscape of the fiscal policy debate” changing “over the past decade, with academics and international organisations moving away from an ‘Old View’ of fiscal policy as ineffective”.

He outlined:

… the five principles of a ‘New View’ of fiscal policy, which increasingly appreciates that expansionary fiscal policy is effective in a world of persistently low interest rates, low growth, and strong international linkages.

‘Scuse me while I kiss the sky!

To cope with what is to come, let’s take a little time out (3 minutes 20 to be exact) to enjoy one of the best guitar players of all time singing about being disassociated from reality.

I guess I should be happy that the mainstream are giving ground and finally recognising that fiscal policy is an effective policy tool after teaching students and advising politicians for three or more decades that it was not to be used to stabilise the fluctuations in the non-government spending cycle.

But when the concessions are so qualified and the rationale really just a restatement of the prior flawed theories then you can understand why I turn to Jimi Hendrix to sustain myself through the day!

Furman is correct in stating what the Old View claimed:

  • Discretionary fiscal policy is dominated by monetary policy as a stabilisation tool because of lags in the application, impact, and removal of discretionary fiscal stimulus.
  • Even if policymakers get the timing right, discretionary fiscal stimulus would be somewhere between completely ineffective (the Ricardian view) or somewhat ineffective with bad side effects (higher interest rates and crowding-out of private investment).
  • Moreover, fiscal stabilisation needs to be undertaken with trepidation, if at all, because the biggest fiscal policy priority should be the long-run fiscal balance.
  • Policymakers foolish enough to ignore (1) through (3) should at least make sure that any fiscal stimulus is very short-run, including pulling demand forward, to support the economy before monetary policy stimulus fully kicks in while minimising harmful side effects and long-run fiscal harm.

The point is fails to make is that the “Old View” never had any veracity. It constructed reality in a particular way to satisfy the ideological preference by mainstream economists against active fiscal interventions to maintain full employment.

It was in the interests of the elites to create a theory of the economy that allowed unelected and mostly unaccountable central bankers to take over macroeconomic policy – even though the mainstream construction of what they were doing was inapplicable to a modern monetary economy – for example, they claimed monetary policy was about controlling the money supply.

Please read my blogs – Money multiplier and other myths and Money multiplier – missing feared dead – for more discussion on this point.

It was in their interests to claim that increasing fiscal deficits would increase interest rates and damage the spending prospects for firms seeking to invest (the crowding out hypothesis) because it provided a powerful political point that would extend the coalition against deficits (excluding government handouts to business).

But there has never been any validity to those claims.

The ‘financial crowding out’ hypothesis, which is a central plank in the mainstream economics attack on government fiscal intervention.

At the heart of this conception is the classical theory of loanable funds, which is a aggregate construction of the way financial markets are meant to work in mainstream macroeconomic thinking. You will still find major mainstream textbooks teaching this stuff.

The original conception was designed to explain how aggregate demand could never fall short of aggregate supply because interest rate adjustments would always bring investment and saving into equality.

At the heart of this erroneous hypothesis is a flawed viewed of financial markets. The so-called loanable funds market is constructed by the mainstream economists as serving to mediate saving and investment via interest rate variations.

This is pre-Keynesian thinking and was a central part of the so-called classical model where perfectly flexible prices delivered self-adjusting, market-clearing aggregate markets at all times. If consumption fell, then saving would rise and this would not lead to an oversupply of goods because investment (capital goods production) would rise in proportion with saving. So while the composition of output might change (workers would be shifted between the consumption goods sector to the capital goods sector), a full employment equilibrium was always maintained as long as price flexibility was not impeded. The interest rate became the vehicle to mediate saving and investment to ensure that there was never any gluts.

So saving (supply of funds) is conceived of as a positive function of the real interest rate because rising rates increase the opportunity cost of current consumption and thus encourage saving. Investment (demand for funds) declines with the interest rate because the costs of funds to invest in (houses, factories, equipment etc) rises.

Changes in the interest rate thus create continuous equilibrium such that aggregate demand always equals aggregate supply and the composition of final demand (between consumption and investment) changes as interest rates adjust.

According to this theory, if there is a rising fiscal deficit then there is increased demand is placed on the scarce savings (via the alleged need to borrow by the government) and this pushes interest rates to ‘clear’ the loanable funds market. This chokes off investment spending.

So allegedly, when the government borrows to ‘finance’ its fiscal deficit, it crowds out private borrowers who are trying to finance investment. The mainstream economists conceive of this as the government reducing national saving (by running a fiscal deficit) and pushing up interest rates which damage private investment.

The analysis relies on layers of myths which have permeated the public space to become almost self-evident truths. This trilogy of blogs will help you understand this if you are new to my blog – Deficit spending 101 – Part 1Deficit spending 101 – Part 2Deficit spending 101 – Part 3

The basic flaws in the mainstream story are that governments just borrow back the net financial assets that they create when they spend. Its a wash! It is true that the private sector might wish to spread these financial assets across different portfolios. But then the implication is that the private spending component of total demand will rise and there will be a reduced need for net public spending.

Further, they assume that savings are finite and the government spending is financially constrained which means it has to seek ‘funding’ in order to progress their fiscal plans. But government spending by stimulating income also stimulates saving.

The Ricardian Equivalence myth has been used recently in the crisis to justify the harsh austerity inflicted on Eurozone nations. It was claimed that the private sector was deliberately not spending because of government deficits as they were ‘saving’ to pay for future tax increases to pay back the deficits.

There has never been any empirical support provided for this hypothesis. When governments cut spending and push up unemployment that places a further break on non-government spending.

I discuss the Ricardian Equivalence nonsense in detail in these blogs – Pushing the fantasy barrow and The fantasy Barro(w) is still being pushed.

Finally, there has never been a valid case made for establishing “the biggest fiscal policy priority” to be “long-run fiscal balance.” This fiscal rule has never been justified.

The reality is that the fiscal balance should be whatever is required, given non-government overall saving desires, which includes the state of external balance, to achieve full employment.

I explain that in this blog – The full employment fiscal deficit condition – for more discussion on this point.

So the “Old View” was always flawed and deeply so.

The “New View” outlined by Furman is just a rescue attempt to keep the underlying credibility of ‘Old View’ economists intact after it was exposed for what it is during the GFC.

Furman lists five aspects of this so-called “New View”:

1. Furman writes: “fiscal policy is often beneficial for effective countercyclical policy as a complement to monetary policy.”

Note – fiscal policy is still seen as a “complement”. Monetary policy is still seen as being useful but constrained now in effectiveness by the low interest rate regimes.

Modern Monetary Theory (MMT) economists differ here. We say that monetary policy is typically ineffective and totally unsuited to the task of maintaining full employment and price stability.

If it works at all, it maintains price stability by creating mass unemployment.

Please read my blog – Monetary policy has to work hand-in-glove with fiscal policy to be effective – for more discussion on this point.

Fiscal policy should be the primary counter-stabilisation policy tool. Nothing in the last 30 years has changed that conclusion.

2. Furman writes: “discretionary fiscal stimulus can be very effective and in some circumstances can even crowd in private investment. To the degree that it leads to higher interest rates, that may be a plus, not a minus.”

The current literature finds that “fiscal expansion can have large positive effects” thus negating many research articles that claimed that cutting deficits was expansionary even when non-government spending was weak.

The fact is that prior studies have always been dramatically flawed in one way or another and should never have been seen as representing reliable knowledge.

However, Furman thinks the ‘newly discovered’ effectiveness of fiscal policy is because “monetary policy is constrained” and “will not partially offset fiscal policy through interest-rate or exchange-rate channels”.

This is just a version of the “Old View” with some assumptions altered. However, fiscal policy has always been effective in stimulating output. It was just a wall of lies hiding behind bizarre economic theories (such as Ricardian Equivalence) to advance the ideological attack on government activism.

Expanding deficits actually puts downward pressure on interest rates through their effects on bank reserves. The trilogy of blogs noted above explains that in detail. The “Old View” was never right.

3. Furman writes: “fiscal space is larger than generally appreciated because stimulus may pay for itself or may have a lower cost than headline estimates would suggest and countries have more space today than in the past.”

I have provided extensive critiques of the mainstream concept of “fiscal space” in the past. The mainstream believe that currency-issuing governments will run out of money if bond markets baulk at purchasing their debt instruments. That will happen, so it goes, if deficits are too large or public debt to high.

The idea is nonsensical. A sovereign government is never revenue constrained because it is the monopoly issuer of the currency. It does not need to ever borrow funds from the non-government sector.

Such a government can never run out of money.

The only reason it continues to issue debt etc is to provide corporate welfare to the elites who demand every dollar of bond they can get their grubby hands on and because the elites know they can use the ‘debt’ argument to further their attacks on government spending when they want to.

If governments used their currency-issuing capacity to spend without issuing matching debt to the non-government sector then one of the most powerful politico/ideological avenues to attack government spending would be lost. Not to mention the on-going corporate welfare in the form of a risk-free annuity in which to park liquidity in uncertain times.

The only relevant meaning to the term fiscal space is constructed in terms of available of real resources. A currency-issuing government can always purchase anything that is for sale in the currency it issues, including all unemployed labour.

So if there is mass unemployment – there is fiscal space.

That means that increasing deficit spending can be accomplished without pushing nominal spending to the point where aggregate demand outstrips the real capacity of the economy to respond to it real terms (by producing more output). In that sense, fiscal space is about the available real capacity to be brought into productive use without accelerating inflation.

Please read the following introductory suite of blogs – Fiscal sustainability 101 – Part 1Fiscal sustainability 101 – Part 2Fiscal sustainability 101 – Part 3 – to learn how Modern Monetary Theory (MMT) constructs the concept of fiscal sustainability.

4. Furman writes: “more sustained stimulus, especially if it is in the form of effectively targeted investments that expand aggregate supply, may be desirable in many contexts … Sustained fiscal policy may be necessary because the global economic climate is showing symptoms of persistently inadequate demand dragging on growth and inflation … fiscal spending creates future fiscal space through increasing government revenue and reducing the debt-to-GDP ratio.”

Furman falls back into the “Old View” mentality – that fiscal space is a financial issue that relates to currency-issuing governments running out of money.

But there is an incredible arrogance about all this “New View” stuff. Until the “Old View” came along in the 1980s (about), it was just a pile of notions that had been repudiated logically and empirically during the 1930s. Its comeback in the 1980s was not due to any theoretical breakthrough or empirical validation.

It was just a reflection of the shifting ideology towards neo-liberalism and disdain for government-induced full employment.

The dominant view after the Great Depression up until the mid-1970s, early 1980s, clearly understood that continuous government deficits were necessary to allow income support for non-government saving overall.

Continuous deficits in the Keynesian period:

(a) Sustained higher real GDP growth rates than have been the norm since the neo-liberal era (“Old View”) began.

(b) Reduced income inequality instead of the rising inequality now (which even the IMF considers undermines growth).

(c) Lower unemployment rates and virtually zero underemployment and hidden unemployment.

(d) Higher real wage and productivity growth.

(e) Higher private saving rates.

Suddenly to rediscover the need for ‘sustained stimulus’ as if this is new is just historically blind.

The reason that fiscal surpluses were possible in the recent period (where they were achieved) was largely due to the atypical non-government behaviour, characterised by the credit binge, which led to the GFC.

Now the non-government sector is trying to resume more typical behaviour, the need for continuous fiscal deficits is clear. There is nothing “New” about that to anyone who understands how the macroeconomy operates (and has always operated).

5. Furman writes: “there may be larger benefits to undertaking coordinated fiscal action across countries … Fiscal expansions can have large positive spillovers, especially when they are internationally coordinated.”

Fiscal policy expansion in one nation can stimulate exports in other countries, inasmuch as it stimulates domestic income growth, which feeds into import spending.

We always knew that. There is nothing “New” about that insight.


I think I will just go and listen to more Jimi Hendrix – cue up Voodoo Child!

That is enough for today!

(c) Copyright 2016 William Mitchell. All Rights Reserved.

This Post Has 20 Comments

  1. “Fiscal policy expansion in one nation can stimulate exports in other countries, inasmuch as it stimulates domestic income growth, which feeds into import spending.”

    This is where so-called helicopter money is dangerous IMV. If everyone received a direct injection of money they might just spend their new-found income on imported goods which does nothing for domestic employment. If the government spends more into the economy then, per se, more jobs are created, more people have money to spend, and it doesn’t then matter if some of that spending is channelled into imports.

  2. Yes the errors are fundamental.The market resides in human hands not invisible ones.
    There is no equilibrium or tendency to equilibrium.
    Mechanisms be they neo liberal price mechanisms ,Keynesianism automatic stabilizers or
    MMT Job guarentees cannot provide an equilibrium that does not and can not exist.
    Not to say that full voluntary employment is not a worthwhile goal and one that can only
    be delivered by monetary sovereign governments in an economy which uses fiat currency.

  3. Nigel all government spending is helicopter money.Fiat created out of nothing by the state.
    ARe pensions which could be used to buy foreign goods dangerous?
    IS Uk NHs expenditure on foreign produced neo natal incubators dangerous?

  4. Kevin,

    You misunderstand me. I am talking about direct injection of money into peoples’ bank accounts that has been called helicopter money. I agree pensions, of which I am a recipient, might be considered as such except that I have spent a lifetime contributing to the growth of the productive capacity of the nation from which I am now benefiting. Surely the “danger” of HM is that it might be spent by the recipient populace to buy goods from abroad which will not add to that domestic productive capacity. Warren Mosler in 7DIF talks about how the US has imported millions of Japanese cars since WW2 and not paid for a single one, which is true; but what about all the Detroit workers that are on the streets?

    So yes, it is dangerous for a nation to buy that neo-natal incubator from abroad unless it absolutely cannot make it at home or the foreign one has a clear advantage in performance. Even worse a nuclear reactor. That’s why UK industry has now not grown at the rate it might have done where it not starved of government investment. (I recently had a debate with a Scotish indyref2 supporter who said Scottish manufacturing output had declined since the sixties, and I found evidence that it has in fact increased several fold during that period – I don’t recall the exact figure. It is just more high tech and less visible than such as shipbuilding, aircraft manafacture etc.) Same goes for the UK as a whole. How much greater would our manufacturing industry be today had we retained what was once a world-leading military aircraft industry instead of buying American, and how many fewer unemployed? Okay if it works both ways, but it doesn’t; the UK is a net importer by a large margin.

    I do understand that money is created in a fiat system by the government, not exactly out of nothing but out of the value of the nation in its productive capacity and future ability to produce. Pity the politicians don’t. Rebecca Long-Baily, Labour Shadow Chief Secretary to the Treasury on today’s Daily Politics: “Money doesn’t grow on trees”. And Ian Duncan-Smith sitting opposite: “Of course we must return to a budget surplus otherwise we will have to continue borrowing at increasing cost or raise taxes”.

  5. Nigel,

    I agree that reliance on imports can put a damper on employment, IF they are not compensated for with quality deficit spending that offsets the demand leakage. The MMT position is that ultimately, unemployment derives from a deficiency in net government spending… other factors may determine the mark that (G – T) needs to meet in order to be “sufficient”, but at all times government has the capability to match demand leakages with an equal injection of net spending. Most particularly, MMT theorists advocate a Job Guarantee that would automatically offset any import-fostered unemployment.

    Granted, we don’t exist in an environment where governments are willing to fulfill their obligation to meet the savings and import desires of the public with offsetting money creation, let alone implement a Job Guarantee. But it should always be emphasized that in any circumstance, government has the capacity to spend in deficit to offset demand leakages such as current account deficit and private savings.

    Self sufficiency is also a worthy goal, though not perfectly attainable. But again, “because jobs” is insufficient reason – spend right and the jobs will be there, regardless. The more important justification is maintaining a nation’s crucial basic industries rather than being completely dependent on trade for every need. A nation that can provide the basic necessities (food, shelter, etc) for itself is less vulnerable to exchange rate fluctuations or some global crisis that impacts trade.

  6. Agree with all your points Bill, but in times like this I think we should welcome any support there is for fiscal stimulus. Interestingly, the mainstream is joining in the chorus now after being wholeheartedly wrong since the GFC. It has been pathetic to watch up until now. I think this will be the new battleground going forward, and MMT should get more traction, ref. Recent book on Rethinking Capitalism with v good article by Randy. + looking forward to your forthcoming book, really important post-Trump

  7. @David, @Nigel,
    To put some figures on the UK current account deficit (from the UK “pink book”, for 2015):

    3. Current account overview
    To assess recent developments in the UK’s external position, Figure 1 breaks down the current account balance into its constituent parts – the trade balance, the primary income balance (which comprises of investment income, compensation of employees and other primary income), and the secondary income balance that captures transfers between the UK and other countries (for example official payments to and receipts from EU institutions and other international bodies). It shows that the UK has recorded a current account deficit every year since 1995. From 1998 to 2008 the deficit widened, peaking at 3.5% of nominal gross domestic product (GDP) in 2008. In subsequent years, the deficit narrowed slightly but widened thereafter. Latest figures show the current account deficit widening to 5.4% of nominal GDP in 2015, representing the largest deficit (in annual terms) since records began in 1948. This deterioration in performance can be partly attributed to the recent weakness in the primary income balance: due to UK earnings on assets overseas falling relative to the earnings of foreign investors in the UK.
    The UK’s trade balance – the difference between exports and imports – has been in deficit (imports higher than exports) since 1998. The UK currently runs a deficit in trade in goods – which is partly offset by a surplus in trade in services. Data for 2015 suggests that the goods deficit widened to 6.9% of nominal gross domestic product (GDP) from 6.7% in 2014, while the surplus in services remained broadly unchanged at 4.7% over the same period.


    The more important justification is maintaining a nation’s crucial basic industries rather than being completely dependent on trade for every need.

    I agree. One crucial factor is energy, and after half a lifetime of opposing nuclear energy, I have eventually come to the conclusion that we really need to develop small scale nuclear reactors. To be fair, George Osborne did put money into this (or said he was going to). A government that realised it was not constrained by revenues could do the job properly. We used to be world leaders in nuclear technology; we could at least be contenders in future. (And we can put the Hinkley Point white elephant in mothballs). Renewables are all very well, but one needs sustainable carbon-neutral baseload power. (Even George Monbiot is in favour of this).

  8. Nigel-and this from John McDonell_

    “”In the speech, Mr McDonnell also underlined Labour’s commitment to fiscal discipline if it wins power, saying there is “nothing ‘progressive’ about running up big deficits.”

    hardly surprising when we get Trump when the so-called Left can only offer variations of myths.

  9. @Bob, @Simonsky,
    And he even used Cameron’s pathetic “money tree” phrase. How could he.
    FWIW, I’ve emailed Corbyn’s official leader’s address, referring him to Bill’s, Randy’s, and Warren’s material.
    (I imagine it will just be filtered via an assistant and forgotten, but one can but try).

  10. Bill –
    Why do you continue to insult Ricardo by claiming the Ricardian view to be that fiscal stimulus would be completely ineffective? He never reached that conclusion!

  11. I should have pointed out in my second post that I did only say “dangerous”, it doesn’t necessarily pan out that way, and probably doesn’t. MMT also hates free trade, as Bill is detailing in his current string of three blogs, so you can always impose import tarriffs if you want to block certain imports to protect domestic industries.

    I have just come across the this quote from Donald Trump – “”You never have to default, because you print the money.” (May 2016).

  12. I have just come across the this quote from Donald Trump – “”You never have to default, because you print the money.” (May 2016).


    Trump did indeed say that but so did Greenspan. The irony is that it has been pointed out by right wing ideologues while the ‘official Left’ NEVER voices it – this is surely the irony of ironies?

    However, it sounds like Trump’s plans for infrastructure might not be deficit spending but rather huge tax cuts for corporations to carry out the work who will then maximise shareholder gains by using tolls and taxes on the ‘beneficiaries’ of the work.

  13. Mike Ellwood,

    Unfortunately there seem to be few (or any?) MMT representatives in official positions in the UK. I’ve not heard of any, though Bill would have mentioned them if there were.

    UK is pretty much an MMT free zone.

  14. Bob, McDonnell had a chance to talk to Bill when Bill was in the UK and fucked it up. I asked him what went wrong and all he could was shrug his shoulders. I think he is unteachable. Corbyn should sack him but he won’t. I may be being unfair, but when thinking of McDonnell, the early Trotsky comes to mind.

    Mike, I and others have sent both McDonnell and Corbyn material and have seen no result whatsoever. This approach will not work, it seems.

    Some commentators have drawn a comparison between Trump and Hitler. The more apt comparison is with Mussolini. M set up a social security system. Such a caring guy.

    Nigel, yes, Trump seems to one of the few who have understood the position of money in a fiat economy. But he still has to convince his compatriots in Congress to pass his funding program, and they are mostly neoliberals.

  15. @Simonsky, @Larry,
    Someone on another blog mentioned the Cambridge Centre for Economic & Public Policy, as being a possible focus for MMT ideas. I had a look on their website, but other than James Galbraith apparently having an affiliation there, I could not see anything of interest.
    By the way, could @Bill, or anyone who cares to answer, kindly confirm (or deny) for me the following:
    Given that the UK currently has at least a 5.4% GDP current account deficit (and likely to rise, if anything in the short term), am I correct in thinking that this means that the fiscal deficit needs to be at least 5.4% GDP or larger, to avoid a non-government sector deficit?
    Or is it not quite as simple as that?

  16. @ Mike

    Yes, to avoid a private domestic sector deficit. The non-government sector includes the foreign sector.

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