I have been travelling for most of today so I have to keep this post…
Yesterday, regular commentator JKH wrote a very long comment where he/she challenged some of the statements and logic that modern monetary theorists including myself have been making. While I don’t want to elevate one comment to any special status – all comments are good and add to the debate in some way – this particular comment does make statements that many readers will find themselves asking. In that sense it is illustrative of more general principles, points etc and so today’s blog provides a detailed answer to JKH and tries to make it clear where the differences lie. Some of these differences are at the level of nuance but others are more fundamental.
To also make it a little more interesting my mates Warren Mosler and Scott Fullwiler who were mentioned in the comment by JKH also decided to send me their version of a reply which I dutifully acknowledge throughout. To make it clear who is saying what, all comments other than my own are in blockquote format with the notation: JKH, Warren or Scott on the first line before the statement.
Scott started his reply with a personal message to JKH:
Scott F: Dear JKH Thank you for the comments. You are certainly one of the more thoughtful commentators of all those who post to this and related blogs, and I appreciate the fact that you don’t just “buy” what we’re selling but rather subject it to very careful thought. Of course, as you probably expect, I think your entire critique either misinterprets or otherwise misunderstands the points we’ve made. So, respectfully, I have made the following rejoinders. That I and others took your comments seriously enough to respond at length hopefully shows that we have a good deal of respect your views and your analysis, continuing disagreement or points to be discussed further notwithstanding. Finally, I should note that overall I am in far more agreement with you than I am with neoclassicals … and even the points of continued disagreement are more easily discussed/debated given that we have for the most part a common language and common understanding of accounting.
Okay, pleasantries over lets see where the discussion takes us.
JKH started with the statement:
JKH: My general impression however is that in making the case you and the others are combining the correct explanation of operational capability with a near-rejection of the real world importance of balance sheet “policy” restraints or constraints.
My view is that this is not what I do. I first consider that what is held out as a financial constraint is usually not that at all. Typically, in macroeconomic policy the constraints are political and voluntarily imposed. The sophists then dress these political constraints up as financial constraints using gold standard type macroeconomic models which appear throughout the literature to avoid addressing the real issue.
My assessment is that if the general populace was better educated in these matters – that is, understood the actual operational capabilities of the national government it would be very difficult for the politicians to conflate their own ideological desires with the concept of a financial constraint. In that context, telling us that we had to have 5 or 8 per cent unemployment and rising underemployment because the government cannot afford to purchase all the labour and even if it did it would be inflationary, takes on a different slant.
We would know that they could afford to fully employ the available workforce as long as their were sufficient real resources available to provide the extra food and other things the higher employment levels would invoke. This would then require a higher level of sophistication in the public debate. Are there the extra resources? How close to real capacity are we? That would then promote new research that focused on the nub of the problem rather than the array of dishonesty that parades as knowledge out there in the form of academic papers – which say the government has a financial constraint and will cause higher interest rates, higher taxes, higher inflation if it bucks against it.
Businesses would also have to justify their opposition to true full employment in more sophisticated ways because we would all know that the usual reasons they give – again relating to government budget constraints – are all deeply flawed.
I also would not use the term “balance sheet policy restraints” because that implies that there are financial matters that are at play. By your own admission there are not. I will deal with this in more detail later because I know you think there are “financial issues”.
Warren said at this point that:
Warren M: I for one criticize these policy constraints as counterproductive all the time. That’s hardly rejecting their importance- in fact, that’s pretty much the entire problem!
While Scott added (note Scott provided several points rather than a line by line commentary – so I am threading them in where I can and some of this comments apply to later points as well):
Scott F: We don’t reject “policy” restraints or constraints as you call them. The point is that the intellectual foundation of such restraints/constraints is most often either a misunderstanding of the operations OR the restraints actually do exist but only under different monetary regimes. Get rid of those foundations, and we can then have an honest discussion about the interest burdens you mention. Further, and related, we have ALWAYS and REPEATEDLY acknowledged the inflationary potential of either debt service burdens or just overly large deficits in general. Our point is that THIS should be the issue to debate in regard to macro policy, NOT the stuff that comes from a flawed understanding of operations or the monetary system. Again, our point is that unless you get rid of the flawed intellectual foundations of current policy debates, you can’t have an appropriate discussion of policy or of the “practical constraints” that definitely do exist and which we acknowledge exist.
JKH then continued:
JKH: E.g.: It’s quite clear the government has the operational capability to spend ’till the cows come home, creating broad money and bank reserves in the process. There is no operational limit. But there is a real policy concern in terms of practical balance sheet debt and the interest burdens associated with it. And in the real world, that translates to the notion of a policy limit. And a policy limit is a constraint of sorts. My general impression is that your associated school of thought tends to demote the importance of such practical constraints in order to emphasize the correct operational understanding.
Okay, so there are no financial constraints. We all agree on that. So it would be good jettison all the macroeconomic theory that construes the government budget constraint as an ex ante financial constraint instead of seeing it as an ex post accounting statement, with no operational relevance.
Then we also agree that the public perception of rising public debt arising from the fact that we have been erroneoulsy conditioned (relentlessly) to equate the household budget with the sovereign government’s budget presents a problem to a government who wanted to increase spending. A political problem rather than an economic problem.
I make that distinction because I do not accept the relevance of the Ricardian equivalence theorem. For non-economists – this piece of neo-liberal dogma says that the non-government sector (consumers explicitly) having internalised the government budget constraint will negate any government spending increase whether the government “finances” its spending via taxes or borrowing. So if the government spends and borrows, consumers will anticipate higher future taxes and spend less now offsetting the stimulus).’
I also reject the Policy ineffectiveness proposition from Sargent and Wallace which says that because private agents have rational expectations (RATEX) and truly understand the exact nature of the economic model, the government is powerless to influence real output levels. Private agents will anticipate perfectly what is going on and adjust their behaviour to offset the public policy. I recall Arthur Okun once saying that if we all knew the exact structure of the economy then there would be no need for economists – we would all be forecasters with 100 per cent expectational accuracy! I have noted that none of the RATEX exponents ever turned in their highly paid cosy academic or other positions in response to Okun’s challenge.
I think Modern Monetary Theory (MMT) shows that in a technical sense (after understanding how the operational matters work) that deficits will drive down interest rates unless there is some offsetting central bank action.
The fact that the government voluntary decides to constrain itself by issuing debt $-for-$ into private markets using auction systems which allow the final bidder to determine the bond yield for that issue doesn’t alter that fact. The rising yields might reflect the perceptions of the markets that the deficits are too large – conditioned by the mainstream economics – just as they may reflect a desire to diversify investment portfolios towards higher risk positions. Whatever, the rising yields have nothing to do with the deficits in an intrinsic sense.
That is the problem though. Our mis-education on these matters and the dominance of the mainstream profession in the public debate allows us all to be hoodwinked and see rising yields and rising deficits as in some way substantiating the loanable funds doctrine of classical thought. All the rest of the spurious conclusions follow from these voluntary (neo-liberal) structures that the government erects to obscure there real capacity to advance public purpose.
So far from ignoring these voluntary contraints I am always writing about them – to emphasise the political nature of the decisions taken and the way the options are presented. But as an educator I think it is also important to provide as much detail as I can about the way the system actually should function from first-principles so that the public can make better conclusions about the way the political process deviates from the intrinsic.
In that regard, I hope that as citizens become more and more informed they will actually engage in debate and ask questions of the politicians and commentators in general. The result might be that pressure is brought bear on these characters to really explain why they will not increase public employment, or why they are selling off excellent public enterprises at huge discounts only to see service delivery fall and private wealth more skewed than before. And the rest of it.
Warren M: Yes, and that’s exactly the problem. Policy makers who don’t understand the monetary system and therefore fail to recognize the policy options that are wide open operationally.
And the policy limit is definitely a constraint of sorts.
For me, those ‘practical constraints’ are public enemy #1.
JKH: The constraint shows up in this example in the following ways. First, the operational capability described requires the freedom for the government to run an unlimited overdraft at the central bank. Overdraft is equivalent to credit on demand. Both are equivalent to monetization on demand.
This is the way you are presenting it. The government is the central bank. The fact that we decide to split the treasury and the central bank up into two entities is misleading in terms of understanding the operational side of the government and non-government interaction. It has also been an ideological venture to claim that the central bank is independent and therefore somehow inflation-first monetary policy is above the political process. Which in my view means we degrade our democracies if the cabinet (whatever executive arrangement is in place) can avoid responsibility for stupid monetary policy by saying some non-elected officials have forced this on the economy.
Monetisation is also a term that is ideologically loaded and not very helpful. It is in the ranks of “printing money” as ill-suited terms when describing how governments spend.
Warren elaborated further on this:
Warren M: Depends on your definition of ‘monetization.’ Years back it was a gold standard term.
JKH then says:
JKH: So here’s the policy reality: When was the last time you saw such a government overdraft of any size on a central bank balance sheet?
What exactly is the point? In Australia, we have established processes where the Australian Office of Financial Management (a division of Treasury) manages all government debt issuance. By law it invokes an auction system to raise private funds exactly equal to the net government spending projection. In other words, imposing on the government a voluntary arrangement that eliminates the need for the central bank to purchase treasury bills prior to government spending.
Before 1982, a tap system was used and the bond issue was regularly undersubscribed and the gap was filled by the central bank buying the bonds. The change to the auction system was designed to impose “fiscal discipline” on the elected government – totally voluntary and totally unnecessary.
As Warren points out you will never see this in the US because “it’s prohibited”. A legal constraint not an economic one.
JKH then says:
JKH: I’m sure you can read my mind for the rest of the argument from there. Suffice to say, there are decisions to be made about converting that overdraft into debt issued by the government, etc. Those are policy decisions that act as constraints on the operational freedom that is the foundation of this line of thinking.
We all agree on that. As Warren says “The problem is allowing the Treasury to spend directly without first issuing treasury securities.” This can also be seen in the voluntary decision in Australia to move from a tap to auction system.
Scott F elaborates further:
Scott F: Your point about overdrafts again misses the point we are making. The deficit always comes first unless the non-government sector borrows to get reserve balances to buy the Treasuries. You can’t buy a Treasury without reserve balances (that’s how they clear), and the reserve balances exist either because of a previous deficit, previous open market purchase (which purchased Treasuries from a previous deficit), or (as mentioned) borrowing from the central bank. Our point is that a deficit for the currency issuer is NEVER about borrowing, and bond sales are NEVER finance operations. Also, the distinction you refer to b/n bond sales and monetization is a false one that I explained in detail in “interest rates and fiscal sustainability” on the CFEPS website.
JKH then goes onto to discuss interest rates and seems to be saying that the central bank doesn’t have control of the short-run rate:
JKH: The idea that debt is an interest rate control mechanism in this sense is quite nifty. I like it as a coherent model of how government expenditure relates directly to choices about interest rate levels. Ground zero for interest rate control is the Fed funds rate. But when investors buy government bonds, they make some judgement about future policy for such interest rate control. But the interest rate issue isn’t entirely endogenous to the fact of control over issuing debt; at the end of the day, it is also a function of the market’s expectations for policy – including the Fed funds rate. That influences the yield curve for government debt. So policy is a big factor once again.
I think that we agree on most of this. As I noted above the bond yields will be influenced by the market demand which in turn will be influenced by perceptions of policy. But this is just a product of the political arrangements that are in place. The government is in effect allowing bond yields to rise. It could avoid issuing the debt altogether and the central bank would be able to structure whatever rates it chose.
Warren elaborated further on this:
Warren M: Agreed, under current institutional arrangements and biases. But operationally the Fed can set a fed funds rate out to 40 years if it wants to and make a two way market at its desired rates, and that’s where interest rates will be. The Fed in fact sets the term structure of rates one way or another.
Scott F provides this response which covers this and later points:
Scott F: Regarding debt and interest rates, you just repeat the point we ALWAYS make (and which I made in ‘interest rates and fiscal sustainability’), which is that the interest rate on the national debt (and thus the size of debt service and by extension the potential inflationary effects of debt service) are monetary policy variables (or in the case of long-term bond sales, related to expected monetary policy). I don’t see where you’ve found anything here that contradicts our arguments here. So, this is another reason why your overdraft argument misses the point … if there are no overdrafts, then the interest rate on the debt sold is a policy variable. Our overarching point has been that interest on debt is NOT set by markets, but rather is essentially a monetary policy variable. This is also the opposite of the neoclassical view and the perspective taken in policy debates, which constantly worries about markets “downgrading” Treasuries or China “dumping” them or refusing to buy them.
JKH then continues to provide specific examples of statements I have made which apparently suggest the government is more powerful than it is:
JKH: My sense also is that your blog and the others seem to be driven by concerns mostly about the policy errors of excessive government surplus tendencies. That’s fine. But I don’t think it’s ideal to blend that concern into the description of operational capability. My impression is that as a result some operational capabilities are exaggerated while others are dismissed.
The examples then follow. A fundamental modern monetary principle is that the government “has no more or less capacity to spend today because there were surpluses in the past than it would have if there had have been deficits in the past”, which we all agree on.
But for JKH the agreement is only at the “pure operational sense” (based on JKH’s professed undestanding of the way “the balance sheets that are involved work”), which then leads to:
JKH: I disagree in a real world policy sense. There is obviously an implication from these debt decisions for sustainable or unsustainable interest on debt burdens.
Once again, what is the real world policy sense other than a political one. If you are saying that eventually the interest burden becomes so great that the government loses its capacity to service it then I disagree entirely. That would be a “pure operational constraint” and suggest that the sovereign government is not 100 per cent solvent (technically) in its own currency. I am sure you do not think it is exposed to insolvency risk.
If you are saying that at some point the interest payments as a % of GDP become so large and private sector spending is such that there is less non-inflationary room available for other discretionary spending then fine that is what taxation is for – to reduce private spending and/or the government can reduces its own spending somewhat. But before that happens the current account, tax revenue (from higher activity) and saving will be taking up a signifcant
part of the adjustment.
But this is just saying that prudent government net spending is limited by the available real resources in the economy left by non-government saving desires.
There is also a certain irony that the voluntary decision to issue debt $-for-$ to match net spending then increases spending towards the inflation threshold.
If you are saying that the public and the commentators etc are so conditioned that they will invoke political consequences on a government that has a debt ratio above some “acceptable” level (read what News Limited deems in their ignorance to be acceptable!) then that is a political constraint – which doesn’t reflect any financial reality or any physical reality (real resource capacity).
Warren elaborated further on this:
Warren M: These are not constraints for policy makers who understand monetary operations and reserve accounting. They become inflation issues rather than solvency issues when policy makers learn how it actually works. Solvency fears fall under “false constraints” or whatever it’s best to call them.
JKH then suggests the following:
JKH: Alternatively, there is an implication in terms of sustainable or unsustainable inflation consequences if governments and central banks choose to keep their liabilities as excess broad money and bank reserves rather than term bond debt.
So you are saying that the government which wanted to reduce its debt exposure could just stop issuing debt (I agree) and keep net spending (I agree). And I think it should do that more often. What are the implications of that? It depends to some extent on what else the central bank does. Lets assume it pays no support rate on excess reserves although the tendency at present is for that those payments to be made which renders monetary policy (expressed as a desired short-term interest rate target) independent of the level of bank reserves.
What if the government continued to net spend but didn’t issue debt to drain the resulting reserve add? Well the net spending would still occur – we all agree on that. So it makes the point that the debt issuance doesn’t fund the spending but rather drains the reserves. That is, the funds that are “borrowed” by the government come from the government.
But moreover, the interbank interest rate would drop to zero as the banks competed to lend out the excess reserves. So monetary policy would be forced to reflect that.
And consumers might decide to spend the excess reserves on consumption goods (run down their bank deposits) and/or buy other financial assets available in the markets. The former choice will increase aggregate demand and the automatic stabilisers will reduce the budget deficit accordingly. Further, if nominal demand was pushing up against the inflation barrier the government could “ratify” this increase in consumption spending and reduce its own discretionary spending to balance nominal demand with the real productive capacity.
Which brings us to Warren’s response:
Warren M: No, that’s not the source of ‘inflation’ but there are ‘inflation’ issues for excess demand from ‘excessive’ deficit spending.
That is you have to distinguish between the way in which aggregate demand enters the spending stream and the consequences of too much nominal spending relative to real capacity. Government net spending doesn’t have a monopoly on being able to push the economy into the inflation zone. Excessive private investment or burgeoing net exports will do the same.
Scott F also says:
Scott F: Your point about inflation consequences in the case a government/central bank “keep their liabilities as excess broad money and bank reserves rather than term bond debt” is mistaken. Indeed, it is bond sales that are more inflationary, if anything, as they bring an additional interest payment that reserve balances (assuming here they are without interest payment) don’t. Again, see “interest rates and fiscal sustainability.”
JKH then suggests the following:
JKH: While there is no capacity effect in terms of pure operational capability, there is in terms of policy freedom at the margin. The fact that there is complete operational freedom in theory doesn’t mean there is complete policy freedom in practice. That is, unless you think governments can issue money or debt without limit and without other financial consequences.
Who ever said there was complete policy freedom. When I am giving a public presentation I always follow up the statement “the government is not revenue-constrained and can spend whatever it likes” with the next statement “but that doesn’t mean it should spend whatever it likes”. The point is obvious – there are definite economic limits on the ability of governments to spend and they are defined by the real resources that are available at any point for sale and are not being utilised (or purchased). Beyond that you get inflation. Note I use the term economic limits not financial limits. There are no financial limits on a sovereign government – only economic and political limits.
The problem is that the political limits that ideology imposes on government spending have in the past 30 or so years meant that net spending is well below these economic limits and the consequences of that are clear – persistently high labour underutilisation.
Warren’s reaction to this is:
Warren M: Yes, you’ve again defined the problem with our policy makers. The consequences are ‘inflation’ and distributional issues. But they never even get that far. In fact, they never get past the solvency issues and ‘intergenerational’ issues that don’t exist operationally.
JKH continues in this vein:
JKH: Governments face these policy decisions about the amount and cost of their debt and the inflation consequences of the money they produce from their expenditures.
The only concern the government should have is working out how it can achieve full employment and price stability. Having bright minds calculating debt ratios and the rest of it is a waste of time in my view. They should really get to understand how the inflation process operates and also the real capacity of the economy. They should invest in human skill development to improve productivity and make more room for inflation-free production and income generation.
The fact that they have spent the last 30 or so years managing underutilised labour and running down our educational and training systems reflects a wrong set of priorities.
Warren notes that he “wishes they did settle on the inflation issue and do some real work on that. But, as above, they never get that far.”
JKH starts getting bogged down on the inflation point:
JKH: They may not understand how their balance sheets work, but nevertheless these policy questions are real. As Mosler seems to say a lot, it is scary that the people making the policy decisions don’t understand how the government balance sheet and the monetary system work. Fair enough. But this doesn’t negate the fact that these policy decisions are issues for somebody to face. You can’t just run deficits without limit and let expenditures create money without limit, even if the operational capability would allow it. And I don’t believe this line of thinking should dismiss policy concerns as a sort of corollary to demonstrating the correct operational understanding. Policy is a necessary reality.
We all agree that policy is a necessary reality. But what is the point other than if nominal demand grows beyond the real capacity of the economy to absorb it you will get inflation.
Further, a sensible government would be happy to achieve full employment and leave it at that. If it desired a greater share of real resources in the public sector then it doesn’t have to expand net spending (nominal demand) beyond the inflation barrier. It can increase taxation and choke of private access to real resources. Yes, that introduces political issues which are clearly real.
But these political issues are indelibly conditioned by the state of the public debate. When we abandoned full employment and went down the neo-liberal line we abandoned a notion of collective will and replaced it with a heightened sense of individualism. The political rhetoric in those early days of the neo-liberal takeover was designed to engage us as individuals – “there is no such thing as society” (Margaret Thatcher) – “the government budget is just like the household budget” (Malcolm Fraser) and more.
The media vilified the unemployed – and placed the blame for the system-failure (lack of aggregate demand) onto them and reconstructed it as an individual failure – bad skills, bad attitudes etc.
So political issues are malleable by the media and the broader debate. If people (back to my earlier point) were better educated then the way the rhetoric engages with us would be different.
Warren’s reaction to the point is:
Warren M: the limits are your tolerance of inflation and any distributional issues. I agree that policy is a necessary reality … and the problem!
Scott F also says:
Scott F: Again, we don’t think governments “can issue money or debt without limit” without there being consequences, but the consequences of excessive deficits or debt service are inflation, not (involuntary) default. To repeat yet again, we’ve ALWAYS acknowledged this. And we have NEVER proposed running deficits without limit or suggested this was a good idea, and we have repeatedly explained how large a deficit should be without going over.
After exhausting the excessive aggregate demand leads to inflation arguments (which ultimately we all agree on), JKH then turns to a more fundamental disagreement, I sense. This is in relation to another fundamental proposition of MMT that – “it is a nonsensical notion thinking that a sovereign government would ‘save’ in its own currency.”
JKH says in reply:
JKH: This one is different, because it’s an example an operational statement with which I strongly disagree. And I think it’s a case where a policy bias against government surpluses has influenced the operational description. I will argue that the fact that a government issues its own currency has nothing whatsoever to do with its capacity to save. Here I’ve reversed roles in the sense that I’m talking about pure operational capability before turning to the question of policy restraints or constraints. First, consider (an operationally feasible case) where the central bank issues currency by purchasing private sector financial assets, rather than by purchasing government debt. And suppose the government has run a balanced budget up to this point. Now suppose the government decides to run a surplus. Now suppose the government decides it wants to manage its books “in paradigm” … So in preparations for a surplus operation, the government “prepares” its balance sheet as follows. The government purchases existing non-government assets (probably financial assets) in an amount equal to the size of surplus it intends to run. At this stage, the government has simply acted as extension of its central bank, putting more money into the system by acquiring existing assets. So the government balance sheet, separated from but connected to the central bank balance sheet, shows non-government assets acquired and an overdraft at the central bank.
Well both Warren and I agree that the private sector now would have new reserve balances at the central bank equal to the financial asset purchases and that their net financial asset position hasn’t changed.
JKH then continues the example:
JKH: The government then taxes the equivalent of the overdraft. Considering this flow effect for its balance sheet consequences, the government has created its own equity position (logical and economic, if not in actual bookkeeping). I.e. the government balance sheet (ex the central bank) now includes non-government assets supported by an equity position on the right hand side. This is the canonical example of something that I’ve argued elsewhere, particularly with occasional Mosler commenter “Winterspeak”. i.e. taxation is a flow that produces government equity at the margin. Equity of course is a balance sheet representation of saving, which is exactly what I’m arguing happens in this example.
We have to be clear on the terms we use. When economists talk about saving they are typically relating it to a household decision to defer consumption (now) to provide for greater future consumption. There are elaborate models which describe the so-called intertemporal decision making environment and its consequences in this regard. But the point is directly related to the fact that households which use the currency that the sovereign government issues are revenue-constrained.
This means that a household has to finance every $ of spending either by working (earning income); borrowing; running down assets previously accumulated which include prior saving. So the act of saving increases the future spending possibilities but, other things equal, reduces the current spending possibilities.
Applying this logic to a government which issues the currency is tantamount to saying that at each point in time that government is financially (or revenue) constrained and has to save now to spend more in the future. This is the basis of the intergenerational myths etc.
It is nonsensical because the sovereign government is not revenue-constrained as you acknowledge so whatever accounting gymnastics it performs on its balance sheet, the government is no better able to spend tomorrow as it is today in financial terms. Its spending today might condition its spending room later if the economy is closer to full employment but that is once again the economic (that is, non-inflationary) limits on spending and has nothing to do with financial constraints being eased by prior saving.
You can call it that and account for that as ‘equity’ but it is of no practical concern. It doen’t make government any ‘richer’ and it does remove net financial assets from the private sector. It’s an accounting entry. And you can call it anything you want. But it isn’t something that alters the government’s ability to spend at will. It is nothing but record keeping – an entry that “accounts” for what was done but has no causal function.
Scott F says:
Scott F: Bill’s point that it is “nonsensical” to think of a sovereign government saving in its own currency is NOT about balance sheets. Throughout your critique, you equate “operational” with “accounting”. But they are not always the same. Accounting is a subset of operational realities, not the equivalent. Operational abilities is a broader term that includes rules (sometimes), laws (sometimes), and logical imperatives of system behavior or function resulting from (for instance) alternative monetary regimes. (Much more could be said here on the differences, but I’ll leave that for another time.) None of us has never said that a government can’t “save” in the accounting sense or that it can’t have “equity” on its balance sheet (indeed, it does already). Our point is that a government that does these things do not build up or otherwise enable some additional or otherwise improved “operational ability” to spend now or later as would be the case for a non-currency issuer. Such additional ability is how a government surplus or saving is normally understood (also for the central bank, as the recent debates over the Fed’s equity demonstrate) by economists and in policy debates, and that is what we are critiquing.
JKH then continues to push this equity point:
JKH: This type of equity is the pure right hand balance sheet type, in this case not represented by an equity financial claim, as is the case with a corporate entity. It is more comparable to household equity as a representation of cumulative net saving. In both cases, equity can be marked to market at one’s choosing, where cumulative net saving undergoes an additional valuation adjustment. But this is just a detail for purpose here. The government in this example has saved.
To which Warren replies:
Warren: Except that household equity gives households something needed to spend and collateral to possibly use for loans. As before, this government “equity” does nothing for government’s ability to spend at will. Your definition. Functionally, nothing has changed regarding government’s financial position, as above. Government never “has” or “doesn’t have” it’s own currency any more than a football stadium has or doesn’t have points to put on the scoreboard.
Once again we need to keep this point in the perspective of the analogy that mainstream macroeconomics draws between the household and the sovereign government. That is the context in which I make the points about a government saving.
Scott F notes:
Scott F: Regarding accounting and saving, we use the term ‘net saving,’ which isn’t the same as ‘saving’ since the latter usually includes private capital spending (and in that case, the ‘saving’ offset is only the accounting record of the capital spending). And by accounting identity, the non-government sector cannot ‘net save’ unless the government runs a deficit. Again, nobody said the government can’t save in the accounting sense … but rather that it is nonsensical to think that when it does, it enables more spending now or later . . . any other interpretation of Bill’s quote seems to me to be off and conflating ‘accounting’ with ‘operational.’ Certainly, there is a difference between surpluses and deficits in terms of the ‘constraint’ of inflation, but we’ve always acknowledged this.
JKH then moves onto public surpluses:
JKH: This government surplus position creates a net non-government deficit in the sense of the Kansas City sector financial balances model. The SFB model is defined relative to netting out investment from the non-government sector balance sheet. So the government surplus in this case serves as an offset and partial match for investment, equivalent to the shortfall in non-government saving. (I’m afraid to use the word ‘funding’ here, for fear of being excoriated for false causality. That’s another unfortunate perception problem I won’t get into here – the idea that words previously associated with an improper operational model retain a patina of ineptitude if not criminality when used in association with the correct operational model.) That partial offset to investment again proves the existence of saving.
A red herring threatens beneath all this. It doesn’t matter at all that the government acquisition in this case is a stock (i.e. existing asset) as opposed to a flow (i.e. real GDP component) purchase. I.e. it doesn’t matter that it is simply an exchange of newly created money (or bonds asset) for an existing real or financial asset. All that matters is that I have created the capacity for a government balance sheet equity position, and I’ve even done so by remaining “in paradigm”
First, the language issue. Paradigms reinforce themselves with a particular language set and the cogniscenti imbue themselves with “understanding” each time they use the terminology. A professor once said to me that the process of university education is to take an otherwise bright person with common sense and intuition and turn them into a confused, jargon-babbling ideologue. The more serious point is that if you are desirous of breaking away from a dominant paradigm then you should avoid using their terms. They are loaded.
Maybe not quite as you are assuming there is some operational further purpose to this entry you call ‘equity’
JKH: I.e. The acquisition of assets has created its own (money) finance, and taxation has withdrawn money and reserves from the system, in the process creating the actual equity position. And finally we can ignore from an economic perspective the fact that governments tend to misclassify outlays as between expenditures and investments or financial assets. Such misclassification is a non-issue in terms of the true economics, and the true identification of government saving or dissaving.
Moreover, all this has absolutely nothing to do operationally with the fact that the government issues its own currency when it spends. To be sure, the issuance of currency allows expenditures and deficits to be offset operationally with money creation. But money creation doesn’t require deficits. Just look at my example again where the central bank creates money by acquiring non-government assets and the government
acquires additional non-government assets in generating an ultimate surplus. Similarly, when the government runs a budget surplus and pays down pre-existing debt (representing cumulative prior deficits), it saves.
Once again saving to a household reduces current consumption and increases future consumption within an intertemporal household budget constraint. This constraint is not relevant to the sovereign government and so the terminology is not applicable.
Warren repeats this point:
Warren: By your definition, which is fine. just that there are no operational consequences from this entry.
Scott F has another point here:
Scott F: Regarding the point that ‘money creation doesn’t require deficits’ … none of us ever said otherwise. We are endogenous money proponents, after all. First, best to get rid of the term “money” altogether when we discuss this stuff in such detail. “Money” is always someone’s liability, so best to just say whose liability you are talking about to avoid confusion. Anyway, what we say is that private sector credit creation (which creates deposits or other “near monies” on private balance sheets) is effectively a short position in or leveraging of government liabilities. But the amount of “shorts” that can be privately created are obviously never limited by the quantity of government liabilities.
JKH: The fact that somebody has a net liability position has nothing to do with whether or not it’s possible for them operationally to save. The fact that governments tend to run chronic net liability positions similarly has nothing to do with their operational capacity to save. From a policy perspective, that saving affects a governments ability to borrow in the future. There is less debt on the balance sheet, and less debt servicing interest costs. Obviously this isn’t the case from an operational perspective, which is your ongoing point.
A past surplus has never improved the government’s ability to borrow in the future. Further while lower debt levels mean lower interest servicing costs that doesn’t have any operational implications for the sovereign government.
Another point I made was that “There is no storage shed in Canberra or Washington or anywhere else where the surpluses are saved up and available for the government to drive a truck down and pick up some dollars to spend.” To which JKH replied:
JKH: Neither is there when I save to pay down my credit card debt.
Warren: Yes there is, in the sense that operationally you are more able to spend when you have savings and/or credit etc. The governmnet is never more or less able in any case.
To understand why JKH is in error here you have to go back to the analogy between the revenue-constrained household and the sovereign government. If the household (you and I) pay down our credit card we now have more “revenue-capacity” than we had previously. This is functionally equivalent to saving. Paying down our cards means we are consuming less now to allow us to spend more in the future. So the conception of putting more “spending capacity” into the shed for the household is apt. But it is never so for a sovereign government.
Scott F says:
Scott F: Bill’s statement about the storage shed refers to the fact that most think there is something like this. Again, he wasn’t suggesting otherwise > for the non-government sector, but merely critiquing those who think that government revenues enables more government spending the way that income enables more private sector spending.
Another fundamental proposition of MMT is that:
Surpluses destroy financial assets that were previously in the hands of the non-government sector and these assets are gone forever.
In reply, JKH then says:
JKH: (With all due respect) so what? The same goes for my credit card company when I save to pay down my balance. Is this an operational point, a policy point, both, or neither? It appears to be a truism operationally, and from a policy perspective what’s the problem with paying down a little debt once in a while?
Well we are generally respectful here! And my reaction to the point depends on the state of the business cycle, the state of the external sector, and the extent of underutilised labour resources. If you are at full employment (2 per cent official unemployment, zero hidden unemployment and zero underemployment) then you might want to run surpluses if net exports are strong enough to fund the domestic saving desires.
You would not want to run a surplus if the non-government sector was desiring to save and you were not at full employment.
Warren: There is nothing wrong with paying down debt, if you are trying to cool aggregate demand. But there is a lot wrong with it if there’s a shortage of agg demand
Scott F offered this insight:
Scott F: Regarding surpluses destroying non-govt financial assets, you’ve missed the point again. When you pay down your credit card, there is no net change for the non-govt sector in terms of net financial assets … the asset and liability were privately held and are both destroyed. But when the goverment pays down its debt, the private sector asset is destroyed, but no private sector liability is destroyed. It’s an accounting point, but it also counters the fact that most think paying off the national debt increases the private sector’s ability to finance capital, when in fact (by accounting definition) it reduces net financial wealth of the non-government sector. Of course, this doesn’t affect the “operational” ability of the non-government sector to finance more capital, but the likelihood of this could be greater with more net financial wealth than with less. The operational ability to finance private capital isn’t the point, though, but rather the facts that with a surplus (1) there is less net financial wealth for the non-government sector, (2) there is certainly no more ability for the private sector to finance capital spending than before the surplus, and (3) most in the policy debates think the reality for (1) and (2) is the opposite.
JKH then says:
JKH: And from a policy perspective, where’s the logical and mathematical dividing line between running a deficit that is less than infinity and running one that is occasionally less than zero? Who made up that rule and exactly what is it?
That is very clear. At all times the public purpose role of fiscal policy should be to ensure that aggregate demand is sufficient to generate output that will create enough jobs to fully employ the labour force. If a budget surplus can do that then fine (for exammple, when there is a low domestic saving desire and significant net exports). But typically the fiscal drag coming from a budget surplus will undermine full employment. It is also unlikely that an infinite (close to it) deficit will be required.
Policy is about balance – but at least we should set the goals correctly and make unemployment a policy target again rather than a policy instrument as it has become under the neo-liberal obsession with surpluses and inflation-first monetary policy.
Scott F says:
Scott F: Our concern about surpluses has to do with two things. First, they reduce net financial assets of the non-govt sector, and in a Minskyan sense, this is ultimately problematic since the non-govt sector is obviously not the currency issuer. Second, because the non-govt sector is a currency user and not the issuer, the non-govt sector will over time (not necessarily every year, but on average) want to net save. Persistent surpluses, paying off the national debt, or basic “sound” fiscal policy that we hear about in the policy debates are all inconsistent with these points. Note that I haven’t even mentioned “operational capacity”, which you seem to think is the overarching foundation for our argument here.
Long comments invoke long responses. Exhausted!