The IMF is all at sea, stuck in its ways, and sending conflicting signals

Last week, I wrote about how the IMF is presenting a somewhat nuanced view these days. See – IMF now claiming continued inequality risks opening a “social and political seismic crack” (April 21, 2021). But, there was a warning for those who might think this suggests the institution is leaving its mainstream macroeconomics past behind them though. Rather, I think what is going on is a series of ad hoc responses to the growing anomalies that the institution faces between the observed reality and the sort of predictions it has been making based on its core paradigmatic approach. We are observing a specific form of dissonance in many of the current contributions coming out of mainstream economics. This takes two forms: (a) an incomplete response to the current situation (pandemic, GFC aftermath, climate change) where there are conflicting signals being sent; and (b) a tortured attempt to absorb pragmatic narratives within a theoretical structure that cannot consistently accept that absorption. The IMF’s latest blog post (April 20, 2021) – A Future with High Public Debt: Low-for-Long Is Not Low Forever – is a good example of both forms of this dissonance.

The reality that the IMF blog authors observe is now obvious to all:

1. Rising and in some cases relatively large fiscal deficits with capitalism on government life support.

2. Given the institutional practice of issuing public debt to match the fiscal deficits, which most people still, erroneously believe is a funding operation, the rising fiscal deficits have meant rising public debt levels.

3. Interest rates and government bond yields are near zero or negative in most nations. We have seen negative bond yields for long-term debt.

The other reality, that the IMF refrains from recognising, helps us understand why this agreed reality tells us that the mainstream macroeconomics is incapable of explaining these trends and their causal associations.

4. Central banks around the world are buying government debt in massive volumes using their unlimited currency issuing capacity. This has had two consequences: (a) it has demonstrated that the government (via its central bank) can set the yields on its debt at whatever level they chose and they can sustain those levels indefinitely; (b) there are no evident inflationary consequences arising from doing that.

Which has a third consequence of breaking the taboo that mainstream economists have placed on such behaviour.

Taken together we now know that rising fiscal deficits do not drive up interest rates, a proposition that every student enrolled in mainstream macroeconomics courses is forced to rote learn under the ‘crowding out’ fallacy.

Students are also forced to rote learn that such bond-buying by central banks will accelerate the inflation rate. There is no evidence of that happening despite central banks in some nations funding most of the increases in deficits since the pandemic began.

Of course, Japan provides a three decade case study negating the mainstream predictions. Now many of the leading central banks are repeating the lesson.

Why the IMF would ignore the role of the central banks in its analysis is pretty clear. It would interrupt (undermine) their convenient narrative.

The basic argument advanced by the IMF blog post is that eventually the higher public debt exposure of governments will cause them grief.

The part of the pragmatic narrative that the IMF has embraced (the reality) is that:

… countries … [should] … spend as much as they can to protect the vulnerable and limit long-lasting damage to economies … countries should not run larger budget surpluses to bring down the debt, but should instead allow growth to bring down debt-to-GDP ratios organically.

So there is more or less a consensus organising around those propositions now.

It would be unthinkable for any economist to be advocating anything less than this fiscal activism in this period of our history.

That ‘consensus’ is also leading to a rejection of the rigid fiscal rules that economists have imposed on policy makers in various ways, formal or informal, over the last several decades.

The IMF now says that:

More recently, the IMF has stressed the need to rethink fiscal anchors-rules and frameworks-to take account of historically low interest rates. Some have suggested that borrowing costs-even if they move up-will do so only gradually, leaving time to contend with any fallout.

You will note that this ‘rethink’ is highly conditional (on low interest rates).

It is thus based on a misunderstanding of why the fiscal rules, that are based on a premise that a government can become insolvent if private bond investors stop buying the government’s debt or force yields up so high that the situation becomes impossible for the government to proceed, are flawed.

The fiscal rules are not inappropriate because governments have more “fiscal space” as a result of low interest rates.

The fiscal rules are irrelevant because they assume that government is financially constrained in its spending.

The only fiscal rules that make sense must be based on a recognition of real resource limits (such as full employment of labour).

Please read my blog post – The full employment fiscal deficit condition (April 13, 2011) – for more discussion on this point.

Which highlights the central point – that mainstream economists are trying to walk the pragmatic walk at present (because the reality is staring them in the face) but they cannot put all the pieces together into a coherent whole (story) because their underlying framework is incapable of doing that.

So you get this sort of piecemeal approach which is they then try to render comprehensible by absorbing insights back into a flawed theoretical framework.

And in doing so, they miss the point and end up sending conflicting signals.

So to motivate their ‘fiscal space/low interest rates’ narrative but still bring the story back to an austerity bias they have to claim that interest rates (yields) will rise at some point – and by force of their own logic – bring the mainstream story about deficits, debt and austerity – back into the main frame.

The authors ask:

… will borrowing remain cheap for the entire horizon relevant for fiscal planning? Since that horizon seems to be the indefinite future, our answer here would be “no.” … History gives numerous episodes of abrupt upticks in borrowing costs once market expectations shift … Limits to how much can be borrowed have not disappeared, and the need to stay well clear of them is even sharper in a world where interest rates and growth are uncertain.

First, the narrative is conflicting. Deficits are necessary for the “indefinite future” but then they will be unsustainable of this time frame because of the possibility of “abrupt upticks in borrowing costs”.

Second, you can now see why they had to leave the central bank role out of the picture.

The point is that central banks can keep rates and yields low or at whatever level they choose.

Shifts in “market expectations” cannot alter that reality. The participants in the primary bond auctions can seek higher yields if they choose but, ultimately, the central bank has infinite fire power to override those aspirations, even if the bank stays out of the primary issue, which is not guaranteed.

That means that the treasury can always just allow the central bank to buy up all the auction issue, which would render higher yield bids from the priviate bond market investors irrelevant.

But, even if the central bank just limits its activity to the secondary markets, after the auction is completed and the public debt is freely tradable, its purchasing power would soon snuff out high yield auction bids as private investors appreciate the rising demand for public debt would deliver them capital gains anyway.

The IMF blog post continues the Armageddon story:

Theory and history suggest that, when investors begin to worry that fiscal space may run out, they penalize countries quickly. Market-driven adjustments are not necessarily gradual, nor do markets only ratchet up the cost of borrowing once healthy growth returns-indeed, just the opposite seems plausible.

There can be no market-driven adjustments if the government chooses to take the yield dynamics out of the hands of the private investors.

The theory that suggests otherwise is incorrect as history has shown.

The IMF is also still rehearsing the ‘dangerous debt threshold’ argument.

They claim that:

… debt is getting closer to levels that were previously considered dangerous …

And we are confronted with a graph entitled “Dwindling fiscal space”.

I won’t reproduce this piece of propaganda but suffice to say on the horizontal axis is Canada, Germany, France, Great Britain, Italy and the USA.

My edX MOOC students would immediately score a fail for the IMF in this regard.

Regular readers here would immediately score a fail for the IMF in this regard.

Anytime you read an economics article that conflates currency-using governments with currency-issuing governments, you can conclude the content is not worth the time taken to read it.

Germany, France and Italy use a foreign currency – the euro. They are beholden to taxpayers and bond investors to get the euros that they then can spend.

Canada, Great Britain and the USA are currency issuers and are not beholden on anyone for their spending capacity.

Moreoever, you can again see why the central bank activity was not mentioned in the blog post.

Even in the case of the Eurozone Member States mentioned, the massive government bond buying programs run by the ECB, which accelerated last week, are making the private bond markets irrelevant.

The 19 Member States have unlimited spending capacity at present because the currency-issuer in their system, the ECB, is actively funding their deficits, at least to the point, that keeps yields at low and zero levels.

So any analysis of “fiscal space” in this regard that assumes the bond investors call the shots is deeply flawed.

The real politik is clear.

The ECB knows, as well as I know, that if it stops funding the deficits then insolvency issues will arise rather quickly – Italy would probably lead the way.

I cannot construct any situation where the ECB will allow that to happen, now or over the indefinite future.

That is a consequence of the poor choices they made in the 1990s about the fiscal architecture of the monetary union.

As for Canada, the USA, the UK or most nearly all the currency-issuing nations, insolvency or dangerous debt considerations are totally inapplicable.


It is quite interesting to see the machinations of mainstream economists at present.

They are really caught on the hop.

Major parts of their framework have been obliterated by the policy responses of governments around the world, first, during the GFC, but then, definitely, during the pandemic

They cannot deny what is happening.

But they also do not seem to be able to jettison the framework they use to ‘understand’ the world (being kind) or mislead the public so the government can serve vested interests (more likely).

I understand why they cannot do that, which just makes their interventions look pale and inconsistent.

More people are starting to get it.

And then their own ambitions – aspirations, goals, missions etc – will start to receive more airplay.

And it is the Right that is moving faster in this direction while the Left continues to be the Left.

It is time they woke up.

That is enough for today!

(c) Copyright 2021 William Mitchell. All Rights Reserved.

This Post Has 15 Comments

  1. This is a really good essay that points out so many of the flaws and contradictions of standard economics. I could even get used to “paradigmatic” as a word- even if I would rather not.

  2. Apologies for off-topic but Bill may find this interesting (assuming he isn’t aware already).

    Erika Altmann from the University of Tasmania has charged that she suspects the Australian federal government of attempting to suppress the true unemployment number ahead of the upcoming federal budget by making changes to certain mutual obligations for Jobseeker recipients over a certain age.

    As I interpret it at least, she is saying that if a percentage of those on Jobseeker are relieved of the requirement to search for any particular number of jobs per month, they will no longer be considered to be actively looking for work and therefore not unemployed.

    I’m uncertain of the accuracy of any of this but her comment (the first in the comments section) and links to her credentials can be found beneath this article published by Roger Wilkins of HILDA at The Conversation.

    It would not surprise me at all if the Morrison government would use such sleight-of-hand as a justification for fiscal cuts in the upcoming May budget.

  3. “… countries should not run larger budget surpluses to bring down the debt, but should instead allow growth to bring down debt-to-GDP ratios organically.” This is the narrative of the UK Labour Party. On a mission to change this.

  4. This post, and the one from a few days ago on the Bundesverfassyngsgericht (had to cut and paste that one!) raise a few questions for me.

    Firstly, if central banks are buying government bonds why on earth would “free markets” want to destroy the capital value of the bonds they hold by bidding up yields?

    Second, while the Bundesverfassyngsgericht says Germany should not countenance any EU debt that it might have to “pay for”, what if the EU is not raising any debt? The current program of buying bonds of EU members is not, or should not, be raising any debt – it is eating debt. Are the owners of capital about to seek an injunction prohibiting the ECB from issuing euros to buy debt? I don’t think so, who else is going to buy back all those bonds they’re holding for more than they paid?

    The whole idea that “the market” is going to punish governments for this makes no sense. At worst, traders will opportunistically pick off some weak governments if they think they can make a buck by shorting their currency, but if central banks are buying bonds for more than face value they won’t be able to short that.

    All this leads me to an idea, which might solve 2 problems.

    1. Neo-liberals happily use the dis-trust in government (that they encouraged) to claim that MMT will never work, because governments will become addicted to spending and can’t control themselves

    2. Eurozone governments are stuffed because they don’t have a sovereign currency

    What if central banks had a mandate to buy government bonds until full employment? It would work for the Eurozone, if they could ever get consensus on the formula (possibly more far-fetched than this idea); for sovereign states it would also get around the arguments about untrustworthy governments. Of course some will argue that there is nothing to constrain governments from cutting taxes excessively, but that would only make them more dependent on the central bank.

    There would need to be some accountability mechanism of course, maybe the board is answerable to parliament (as opposed to the government).

    Anyway, I’m just throwing the idea out there to test it. If MMT is just a framework, then it’s time we started designing some economic models based on that framework to see what happens – and turn the theory into something more tangible for people who don’t think too hard about this stuff.

    I’m a designer, not an economist, but that is a skill set that economics could use.

  5. Paul Johnson, director of the UK Institute for Fiscal Studies, gave an odd interview on the BBC Today program on 23rd April at 07.14.
    He went on at excessive length on the size of government borrowing. The estimate of government borrowing in financial year 2020-21 is £303 billion, which is the highest on record since WWII. In financial year 2021-2022 borrowing will likely be 2nd highest on record.
    He was then asked will the cost of government borrowing change anytime soon.
    He replied that the cost of borrowing is lowest since records began but since the debt is mainly held by the Bank of England (BoE) if base rates go up there will be an immediate increase in the cost of government debt.
    This was presented as a real sting in the tail of the fact that the debt was owned by the BoE and not the private sector.
    Katy Austin, the BBC interviewer, did not point out that since the government owns the BoE then interest paid by the government to the BoE was effectively interest paid to itself.
    In an MMT aware world, surely, the IFS becomes a complete irrelevance.

  6. “What if central banks had a mandate to buy government bonds until full employment?”

    I think the problem there is that if central banks bought bonds, but no-one took steps to hire people, then the CBs would be buying bonds forever. It’s a neoliberal fallacy to think that economic considerations really effect policy. At most they dictate a lack of policy, which is acceptable to the beneficiaries of neoliberalism. The monetary approach of easing money to reach full employment, never did reach full employment.
    Also, governments have lots of responsibilities besides full employment. A government ought to maintain lots of common infrastructure — e.g. roads, education, public order, public health — that smooth everyday life and reduce costs of doing business. All that needs to be funded too.
    It’s starting to look as though public finance is a bit of necessary common infrastructure that we’re still missing.

  7. @Martin D re: ‘the IFS becomes a complete irrelevance’. Yes, with every pronouncement made, the IFS prove they have nothing to further any understanding of macroeconomics. The BBC unfortunately, despite Andy Verity letting slip a few weeks ago that government borrowing was not like household borrowing, still haven’t yet reached an understanding to report truth, or else they are under instruction that truth is too dangerous in the hands of the public (following Samuelson).

  8. @Bradley Scott @Mel re: “What if central banks had a mandate to buy government bonds until full employment?” I think the point to be made is that government bonds do not fund the spending of a currency issuing government, (spending by means of the Central Bank computer interaction with private banks). And there are responsibilities besides full employment: employment should be on things useful to society (of which giving someone social interaction and a living wage is just one), many of which aren’t delivered if left to the private sector, or delivered inefficiently (few people employed and profit going to the bank accounts or gratuitous assets of the already wealthy). Employment and providing society with useful things go together, and the limit to what can be provided at any time is decided by whether there are any workers still idle, but willing to take a job (maybe initially involving some training).

  9. The bottom line IMHO, which Bill lays out much more intelligently and diplomatically, is that our global neoliberal economy–the way of life which juxtaposes ever-increasing money made from money (for the elite), with ever-decreasing money not yet siphoned off to the elite (for the rest of us)–is OVER for three interrelated reasons: the GFC, Covid, and climate change. When the elite see what the rest of us see, at least those of us hip to MMT (and recent Davos rhetoric is somewhat encouraging here), then we’ll move out of the stage of denial, confusion, and mixed signals into serious exploration of concrete proposals for a post-Bretton Woods world. At its best, this is what the Great Reset is all about (or should be), and thus it’s both a terribly frustrating and incredibly exciting time to be alive, especially for a geezer 60s-holdout like me. “Seize the time!” we said back then; “Reclaim the State!” we say now. Old or young, it’s the only game in town, at least the only one worth playing.

  10. “…. ever-increasing money made from money”. My old dad was a simple soul, but he had a saying: money makes money – he was right about that.

  11. This co-design process has picked a flaw in my idea already! What happens at zero – if government has a jobs guarantee then unemployment is effectively zero, central bank clams up, model falls apart. Not sure if it would work any better using another metric. The bond-buying process is just an accounting mechanism, it could be just a direct allocation but I’m trying to make it fit the Eurozone.

    Re the money makes money discussion, investment in money itself is not productive so interest rates should remain at zero to discourage that. Land is the same. Investment in land is not productive, it is the use and development of it that creates the value.

    The neo-liberal model currently seems to reward the extraction of value more than its creation, from rents and monopolies. The one who owns the asset gets to extract the value, the one who creates the value in the first place only gets paid for the time they spent creating it – that’s certainly how the design industry works but it applies across all types of property. It’s ultimately not sustainable.

    It seems the micro must go with the macro for a model to work. That would be why, since 2008, the combination of loose central banks and government austerity has only inflated assets and not helped the real economy to the degree those asset prices should indicate. So, the government spending program, zero rates, taxation of rents to make them relatively less attractive, and the central bank idea would all need to go together for this to work.

    Chances of the Eurozone ever getting all that together?

  12. On another site I wrote this n replu to “A guy”.

    A guy wrote:
    [quote]The way inflation is managed is through taxation. My understanding is MMT requires a flexible tax rate. When inflation goes up, taxes go up to suck up excess money supply which should reign in inflation. This is the sticking point that I think why MMT will never take off.

    Companies and people do not like the idea of ever changing taxes. Even if it’s for their own good.

    I think MMT is sound, but I don’t believe it is practical.[/quote]

    My reply was =>
    The obvious solution (which is possible in many nations, like the UK) is to have it set up so that the Central Bank can adjust a percentage “surtax” on some tax final bills or rates.
    . . . This may be unconstitutional in the US. But, his can be worked around or changed with an amendment.
    Examples of the taxes effected are =>
    1] The VAT tax rate can be changed.
    . . . Increased or decreased.
    2] The income tax final bill can be increased or decreased.
    . . . IMHO, the surtax rate would be set at 5% normally, to provide room to decrease it.

    I’m suggesting giving this power to the Central Bank, because economists have already tasked them with this duty. They just give the Central Banks an ineffecive tool (monetary policy) to do it with.

  13. ” My understanding is MMT requires a flexible tax rate. ”

    Regrettably that belief is taking root – because of the way MMT is currently being presented in the USA.

    Of course as we know that isn’t the proposal MMT usually puts forward. The obsession with taxation is peculiar to a particular political philosophy.

    You set the tax rate to release the resources required by the political programme, and the tax amount then varies based upon activity. That tax rate is sufficiently tight to ensure that it always releases resources even at the peak of the business cycle. The business cycle variation is then taken up by the automatic stabilisers – primarily a job guarantee.

    Varying tax rates fails for the same reason that varying interest rates fails. Humans are incapable of making those sort of decisions in a timely manner. And nobody likes paying variable costs that aren’t known up front.

    The MMT approach will fail if it gets associated with taxation. Everybody likes the idea of taxation. And everybody thinks it should be somebody else paying the tax, not them.

  14. There’ve been clear indications that the ECB will never allow interest rates to spin out of control since its former president Mario Draghi famously declared that they’ll do whatever it takes to save the euro.

  15. Martin D,

    The IFS should be closed down.

    Paul Johnson is one of the most dangerous men in the UK.

    Gets a knighthood for protecting vested interests.

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