When I was in London recently, I was repeatedly assailed with the idea that the…
On October 13, 2019, the Bank of International Settlements published a paper – Exiting low inflation traps by “consensus”: nominal wages and price stability – (which was based on a speech one of the authors was to make in late November at a conference in Colombia). The reason I cite this paper is because it talks about Modern Monetary Theory (MMT) – in pejorative terms, without really knowing what MMT is. But the most interesting aspect of it was the admission that the mainstream theory that they use to set up the ‘straw person’ they tear down cannot explain real world events. The BIS unwittingly admits that the mainstream macroeconomics really is adrift and the analytical frameworks that arise from it (DSGE etc) are incapable of explaining real world developments. So I thought that was worth documenting.
How to discuss MMT without discussing it – BIS style
The paper is about how nations that are trapped in what they call “the low inflation trap” (who would have thought!) can escape that state and push up inflation rates to the levels targetted by central banks.
If you think about it, the logic demonstrates how far removed from anything reasonable the mainstream narrative has become.
We have a situation these days, where central banks set some arbitrary level of inflation that that defines their policy target.
Then because governments run such contractionary fiscal stances, which combine with the institutional realities that governments set in place through legislation and regulation to suppress the capacity of workers to enjoy real wage rises (such as, attacks on trade unions), to suppress any inflationary pressures, the central banks start getting antsy that their ‘targets’ are not being met.
What they should be railing against is the labour wastage that all this is causing, the rising poverty rates, the precarious work, the ‘gig’ economy, the lack of action on climate change, the degraded public services and infrastructure, and all the rest of it.
But all they seem to want is to meet their inflation target.
And when you think that the austerity and real resource wastage is justified by the mainstream because they claim that fiscal policy excesses have cause inflationary biases which have to be rooted out of the system.
But now they want inflation rates to rise.
A very confused lot operating within a very confused and defunct paradigm.
The BIS paper is another input into the dialogue that is recognising that the mainstream reliance on monetary policy as the counter-stabilising policy tool has not worked – as was obvious to anyone who understands the way the system operates from day one.
But the resistance to recognising paradigmic failure is intense among mainstream economists so they have had to work out a way to save face while slowly jettisoning their rigid views about monetary and fiscal policy.
Some refuse to acknowledge failure.
The BIS paper, though, reflects the shift going on in the profession, that is motivated by a desire to stay on the right line of history.
An unkind rendering of what is going on is summarised by the ‘rats deserting the sinking ship’ syndrome.
The basic contention of the BIS paper is that:
As of today, monetary policy has been more or less left to stabilise inflation on its own. Central banks have put in place an extremely accommodative stance for an extended period of time. As political economy conditions evolve, this role should be progressively substituted by rebalancing the macro policy mix with a more expansionary fiscal policy. More importantly, social partners and governments control an extremely powerful lever, ie the setting of wages at least in the public sector and potentially in the private sector, to re-anchor inflation expectations near 2%.
Which, of course, represents a major shift from the New Keynesian consensus that has dominated economic policy over the last 30 or 40 years.
Effectively, the BIS is now advocating pushing up business costs via money wage increases so that firms then pass the increasing costs on via price rises so that the inflation rate rises to their target levels.
They also claim this process is “less uncertain than alternatives … reversible … [and] … seems preferable to … modern monetary theory (MMT) that has been proposed recently.”
Okay, so what is this MMT “that has been proposed recently”?
The BIS writes that:
Given the likely side effects of keeping low interest rates for too long on financial stability, and the chances that these effects will have diminishing returns, some old and new proposals to lift inflation have emerged.
That is the case, for example, with modern monetary theory.
Well, as one of the original developers, this doesn’t resonate at all.
Our work has never been about developing policies “to lift inflation”.
Even the underpinning or implicit motivation in that ambition is antithetical to our work. The BIS is clearly stuck in paradigm that privileges the idea an inflation target above the current low inflation rates is the major aim of policy and anything that can be brought to bear now that forces a convergence between these targets and the actual rate are to be entertained.
And, further, the claim that MMT is a set of “proposals” that would impact on the price dynamics in different nations is not remotely descriptive of what our work represents.
This is what the BIS say about MMT:
MMT sees currency as a public monopoly for any government, irrespective of issues of credibility and confidence. Following that reasoning, the sovereign could use money creation to achieve full employment through a straightforward financing of economic activity. The obvious risk of inflation can be addressed subsequently by raising taxes and issuing bonds to remove excess liquidity from the system. The major underlying assumption is that of “seignorage without limits”. A government that issues its own money cannot be forced to default on debt denominated in its own currency. As commentators have pointed out (Summers (2019), Krugman (since 2011, but more recently 2019)), MMT poses significant problems. It would undermine the complex set of institutional and contractual arrangements that have maintained price and financial stability in our societies. Moreover, numerous experiments in the history of hyperinflation in AEs and mostly in developing countries show that, while outright default in a country’s own central bank currency might be avoided, the value of domestic assets including money could be reduced to almost zero.
1. It is fact, that for a currency-issuing government the “currency is a public monopoly”. Only the US government issues US dollars and so on.
2. Whether there is “credibility and confidence” does not alter that fact.
3. Government spending always involves “money creation” – every day, every month, every year. When a government procures a large military contract it is creating ‘money’ (although I prefer not to use that term because it leads to ambiguities).
When a government pays a public sector worker each week it is creating ‘money’.
4. There is an inflation risk involved when any component of aggregate expenditure – household consumption, private business investment, export revenue, and government spending – increases.
There is nothing particularly unique about the inflation risk associated with government spending.
If any component of spending drives total spending growth faster than the productive side of the economy can absorb – which means produce real goods and services in response – then there will be price pressures.
That absorbtion capacity in the economy is not binary – it doesn’t just go from being able to absorb to not being able to absorb.
Different sectors in the economy might reach full capacity at different points in time and depending on how significant they are for movements in the overall price level, demand-pull inflation could start to accelerate before full capacity in all sectors occurs.
So to hold out that there is an “obvious risk of inflation” arising from government spending is a biased rendition of what MMT is about.
5. MMT never says that “issing bonds to remove excess liquidity” would be a possible solution to an accelerating inflation.
It is clear that the BIS authors have not the slightest grasp of what MMT is about.
When they say MMT is “seignorage without limits” they are trying to reduce and absorb our work back into the flawed mainstream framework.
The concept of seignorage goes back to medieval times times and is often tied in with the so-called “Great Debasement”, which referred to the period after the ascension of Henry VIII in 1509 when the silver metal content of the currency (coins) was steadily reduced over the next 50 years to create metal ‘wealth’ for the monarch.
The debasement strategy was also deployed by French monarchs.
The way it worked was outlined in the 1997 paper from the Federal Reserve Bank of Minneapolis – The Debasement Puzzle: An Essay on Medieval Monetary History.
Essentially, valuable metals (silver and gold) were brought to the mints, which were “under direct control of the sovereign” but “run as businesses by private entrepreneurs”, by sellers, and “the mint retained a fraction of the metal – a charge known as seignorage.”
By increasing the so-called “minting volumes”, the sovereign could increase the revenue they personally enjoyed from creating the gap between the cost of producing the coins and their legal tender value.
This process thus describes a situation where “the difference between the value of money and the cost to produce and distribute it” (Source).
The concept of “monetary seigniorage” stems from these early insights applicable to commodity currencies.
The 1992 paper from the Federal Reserve Bank of St. Louis – Seigniorage in the United States: How Much Does the U.S. Government Make from Money Production? – explains how mainstream economists attempt to extend the medieval concept to apply to a fiat monetary economy.
… the revenue from money creation is called “seigniorage.” Unfortunately, this term has been subject to a variety of interpretations in the literature.
A study this area, quickly concludes that there is no easy translation from the ‘revenue’ sovereigns took as part of the conversion of valuable metals into coins to what might apply to a fiat currency system with private banks creating ‘money’ as credit.
The 1992 paper confines the concept to “the revenue accruing to the government and, therefore, on the creation of monetary base rather than the creation of deposits by private depository institutions.”
The reason mainstream monetary economists wish to continue using the concept is because it is central to their claims that government deficits are inflationary, especially if there are no bonds issued.
The idea reflects the flawed view that somehow the government is financially constrained in its spending and must impose an ‘inflation tax’ on the non-government sector if it chooses to deficit spend without raising funds from bond sales to the non-government sector.
The ‘tax’ arises because of the alleged link between expansion of the monetary base and the acceleration of prices, all linked causally via the monetary multiplier.
None of the mechanisms that are invoked to support the causal ideation are applicable to a fiat-currency issuing government.
I have written many blog posts that untangle each of the alleged causal steps.
Please go to the blog posts under the category – Debriefing 101 – for more detail.
MMT does not claim that there are limitless opportunities for a currency-issuing government to transfer ‘real’ value (embedded in the goods and services it buys) from the non-government sector to the government sector.
Everytime the government credits a bank account in the non-government sector as part of a procurement contract or a direct employment arrangement it is transferring ‘real’ value.
If the spending pushes up the price of the goods and services being sought for public use then the real value per dollar spent declines.
That is no different to a household buying goods and services as it seeks to transfer ‘real’ value from a shop owner to the household. It can also create a decline in ‘real’ value.
That is the point about there being inflation risk in all spending.
There is a ‘real’ limit to spending. That is core MMT.
The BIS has clearly not understood that and is thus content to produce a gross misrepresentation of what our work is about.
Which is scandalous really given its status as a major public institution funded by national central banks.
The BIS claim that “MMT poses significant problems” follows their reading of two Op Ed articles (Summers and Krugman).
All the alleged problems are related to the erroneous claim that government deficits are inflationary. That is the only card they think they have to play in these situations.
There is a massive dissonance in their paper – they start by acknowledging that the massive expansion of central bank balance sheets following the on-going QE purchases have not created any inflation impetus.
But then move on to criticise MMT as being inflationary – in the sense that they associate MMT with governments spending via central banks buying up the governments’ bonds.
It is a tough gig to make sense of that contradiction.
They rightly acknowledge that a “government that issues its own money cannot be forced to default on debt denominated in its own currency” but still claim that that doesn’t stop hyperinflation.
Well the two are not linked.
Hyperinflation is typically related to supply-side constraints.
In, say, Zimbabwe’s case, Mugabe could have been running fiscal surpluses and the hyperinflation would have occurred.
Please read my blog post – Zimbabwe for hyperventilators 101 (July 29, 2009) – for more discussion on this point.
And if governments choose to run deficits without matching them with bond-issuance, then the inflation risk of the spending does not fall.
The bond purchase decision is rarely a choice between spending the funds on consumption or other goods and services or buying the bond.
It is typically and overwhelmingly a portfolio choice about how best to manage wealth.
So selling bonds does not typically impact on non-government spending although the subsequent interest payments might given they are non-government income.
Hyperinflation would only occur of the government continued to drive spending growth beyond the capacity of the economy to absorb by producing goods and services.
That continued violation of the real constraint would have to be massive and maintained for some time for hyperinflation to arise.
No responsible government acts like that.
I checked the reference list provided at the end of the BIS paper and there is not one source that has been published by an MMT economist mentioned.
Their sole account of the huge body of MMT literature – both academic and Op Ed/Social Media – is the spurious attacks in the media written by Larry Summers and Paul Krugman, who can hardly hold their heads up high in the light of the some of the rubbish they have written and said over the course of their careers.
But the point is often made. If one wants to write a critique of something then it is only reasonable to actually see if what is claimed to be the body of work matches what the authors of that body of work actually write.
The BIS rendition of MMT is thus a massive fail.
But the BIS do trash mainstream macroeconomics – unwittingly
There was something interesting in the paper that they seem to have glossed over or not realised was massive damaging to the macroeconomics that they were using to criticise MMT.
The BIS paper discusses a number of instances where policy makers have been able to alter the course of inflation.
After discussing an Israel case, they write:
This notion of mental and institutional roots of inflation strongly echoes the “low inflation mindset” that the Bank of Japan invokes to explain why Japanese inflation does not respond to slack in the labour market as it would in “orthodox” models of inflation (Kuroda (2018)). The argument runs that the mindset of Japanese households and firms has developed over several years of very low inflation and deflation. This would explain why the qualitative and quantitative (QQE) monetary policy adopted in 2013 succeeded only in lifting Japan out of deflation, but fell short of bringing inflation to its 2% target.
Notice the “this would explain” reference.
The ‘this’ in this case is not a variable that would appear in any New Keynesian macroeconomic model (DSGE or otherwise).
Think about that for a moment.
All the claims in the paper against MMT – which are about how government deficits not matched by bond-issuance would lead to hyperinflation – are based on economic models that do not include variables capturing “the mindset of … households and firms”.
They are based on a priori assumptions of human behaviour that no psychologist or sociologist would recognise.
They are based on frameworks that do not recognise ‘culture’ and ‘practice’ or habits etc, which arguably, drive our individual and collective behaviour significantly.
So in the Japanese case, the mainstream theory (used in the MMT critique by the BIS) always predicts hyperinflation given the scale of the QQE program conducted by the Bank of Japan.
But that hasn’t happened.
And they cannot accept it is because the economic theory is incorrect and inapplicable.
So they have to dodge by claiming some special case mitigates the situation – an ad hoc anomaly.
The import of all that is that their theory cannot be relied on. Every case might become ‘special’.
The whole ‘box-and-dice’ has no applicability and should be disregarded.
The BIS paper is a classic example of ‘straw person’ argument.
But the most interesting aspect of it was the admission that the mainstream theory that they use to set up the ‘straw person’ cannot explain real world events.
I will write more about ‘culture’ in further blog posts.
That is enough for today!
(c) Copyright 2019 William Mitchell. All Rights Reserved.