When ‘new’ is really old and doesn’t get us very far – latest BIS paper

It takes a while for the mainstream organisations in economics, banking and finance to start to realise that the framework they use cannot explain the actual events in the real world, without serious revision. The problem though, is that the overall framework is flawed and the typical ‘response to anomaly’ approach, which changes a few assumptions to get ‘novel results’ is inadequate because it leaves one blind to all the possible policy solutions. The latest example is the Bank of International Settlements paper – Indebted Demand (released October 19, 2021) – which was written by three economists from Princeton, Harvard and Chicago Booth, respectively. They now recognise that rising inequality and massive household debt is a major problem for economic growth and macroeconomic stability. But, in maintaining ‘conventional’ assumptions about the government sector, they miss the vital linkages in the story, that Modern Monetary Theory (MMT) economists have been providing for the last 25 or so years. Whether these responses to anomaly represent progress or different variations in a flawed ‘chess’ strategy is a matter of opinion. My thought is they are a largely a waste of time, although marginally, they demonstrate that elements of mainstream macro theory that were considered core elements a decade ago are no longer sustainable.

The BIS paper authors think they have come up with something new, although if they had read the literature they would know that Modern Monetary Theory (MMT) economists have been talking about the phenomena they identify since the 1990s.

In attempting to reduce the hysteria about government debt that dominates the mainstream, MMT economists shift the attention to the public debt held by the currency-users (households, firms etc).

While mainstream economists, especially those who seek public attention with wild claims, come up with solvency thresholds (remember the 80 per cent threshold from the spreadsheet twins Reinhardt and Rogoff), MMT economists point out that the non-government sector balance sheets can reach a state of precarity, which then impacts back on private spending growth and output and employment levels.

We have been writing about the impacts of excessive private credit growth for decades.

It was obvious that governments could temporarily pursue austerity programs and introduce fiscal drag into the system as they chased fiscal surpluses if they could manage the politics of that anti-social policy strategy.

However, if the strategy to retrench the public sector was to avoid creating a major economic recession, then the government had to rely on an explosion of private credit growth to maintain household consumption spending as the fiscal squeeze was undermining it.

The strategy to suppress real wages growth over the last few decades also relied on credit growth sustaining household consumption spending.

Governments achieved that state through the financial market deregulations of the 1980s and 1990s and the lax prudential oversight that marked this period.

Remember Gordon Brown’s ‘light touch regulation’, which was, in fact, no oversight at all as the Financial Services Authority was compromised by the pressure placed on it to go lax.

The former chair of the FSA, Adair Turner, said on the release of the official report on the collapse of the Royal Bank of Scotland – The FSA’s report into the failure of RBS (October 16, 2012) – that:

In the years before the crisis we allowed the development of a financial system which was taking too many risks, in some cases doing activities that were socially useless, which had a set of remuneration structures that allowed people to make very large amounts of money …

These regulative lapses allowed the growth of non-government debt to provide cover for the fiscal austerity in terms of maintaining expenditure flows, but, eventually, it was the stock changes – the balance sheet effects – that would undermine the whole fiasco.

MMT economists wrote about this in the 1990s.

We pointed out that a growth strategy that was based on trying to record fiscal surpluses would ultimately squeeze non-government expenditure once the balance sheets became too precarious – loaded up with debt.

The increasing precariousness of the balance sheets meant that small changes in the economic and financial environment – such as a rise in unemployment, a rise in interest rates, or some other small shift – would trigger a sequence of defaults and bankruptcies, that would then feed into the real economy from the financial markets and cause a major recession.

The Global Financial Crisis was the demonstration of that sort of causality.

The point that MMT teaches us, which is not found in mainstream economics, is that fiscal policy is instrumental in creating the funding for the savings desires of the non-government sector.

If we decompose the non-government sector into the external sector and the private domestic sector, then for a typical nation that runs an external deficit, the only way the private domestic sector can save overall is if there is a fiscal deficit.

It is impossible for any other outcome to occur.

So the fiscal deficit creates the spending growth that the external deficit and the private domestic saving aspirations undermines.

In this way, national income can continue to grow and be compatible with the leakages from the income-expenditure system that the external deficit and the private domestic sector saving creates.

In that sense, the income growth arising from the fiscal injection, provides the ‘funding’ or ‘finance’ to permit the private domestic sector to save overall, and, reduce debt exposure.

During the GFC, many of the leading mainstream economists attempted to deny all of this.

Remember the extraordinary – Interview with Eugene Fama – with the New Yorker’s John Cassidy (January 13, 2010).

Fama is an economist at the University of Chicago and is most known for his work promoting the so-called – Efficient markets hypothesis – which asserted that financial markets are driven by individuals who on average are correct and so the market allocates resources in the most efficient pattern possible.

Fama told John Cassidy that the financial crisis was not caused by a break down in financial markets and denied that asset price bubbles exist.

He claimed that the collapse in housing prices was nothing to do with the escalation in sub-prime mortgages but rather:

What happened is we went through a big recession, people couldn’t make their mortgage payments, and, of course, the ones with the riskiest mortgages were the most likely not to be able to do it. As a consequence, we had a so-called credit crisis. It wasn’t really a credit crisis. It was an economic crisis.

Fama asserted that “the financial markets were a casualty of the recession, not a cause of it”.

The point was that the idea that financial market imbalances could generate economic recession was denied.

That was a common belief among mainstream macroeconomists.

The standard New Keynesian macroeconomic model – taught to students around the world, and dominant in policy circles – didn’t even have a financial sector specified, such was the belief in the efficient markets hypothesis.

And in the GFC, the attention was on public debt, with all the crazy predictions of impending insolvency, escalating bond yields and interest rates etc, that were common at the time.

So now we have the BIS paper – Indebted Demand (released October 19, 2021, but finalised on January 24, 2021).

The paper’s conjecture is that:

1. “Rising debt and falling rates of return have characterized advanced economies over the past 40 years” – they make no initial distinction between household and government debt.

They pose the questions: “How did the twin phenomena of high debt levels and low rates of return come to be? What are the implications of high debt levels and low rates of return for the evolution of the economy and macroeconomic policy-making?”

The fact that they ask these indicates a mainstream thought process is lying beneath the enquiry.

2. They think their paper provides a “new framework to tackle these difficult questions” – which might be “new” to mainstream thinkers but pretty common place for an MMT economist.

Their framework is based on:

… how rising income inequality and the deregulation of the financial sector can push economies into a low rate-high debt environment. Traditional macroeconomic policies such as monetary and fiscal policy turn out to be less effective over the long term in such an environment. On the other hand, less standard policies such as macro-prudential regulation, redistribution policy, and policies addressing the structural sources of high inequality are more powerful and long-lasting.

Effectively, borrowers are bigger spenders than lenders.

When “large debt levels weigh negatively on aggregate demand”, the interest payments to lenders to not lead to offsetting spending gains.

So “demand is depressed due to elevated debt levels” which the authors term “indebted demand”.

This is their so-called “new framework”.

Here is something I wrote – Balance sheet recessions and democracy (July 3, 2009) – twelve years ago.

Here is an earlier paper from 2002 – Fiscal Policy and the Job Guarantee – written with Warren Mosler and published in the Australian Journal of Labour Economics (5(2), June, 243-60).

The implications of the phenomena the BIS authors have ‘discovered’ is that:

… shifts or policies that boost demand today through debt accumulation necessarily reduce demand going forward by shifting resources from borrowers to savers; therefore, such shifts or policies actually contribute to persistently low interest rates … a rise in top income shares in the model shifts resources from borrowers to savers, pushing down interest rates due to savers’ greater desire to save.

They claim that monetary policy designed to deal with the fall in aggregate demand, create a vicious cycle of low interest rates, rising debt, and falling demand – so a “debt trap” occurs.

The income distribution and profit models of – Michał Kalecki – for examples, which were standard in the Post Keynesian literature after the 1930s, all assumed that income distribution would impact on aggregate spending.

The mainstream New Keynesian models all ignored that literature.

So it is interesting to see New Keynesian economists finally ‘discover’ it.

It is also interesting to see mainstream economists conclude that “An increase in income inequality … unambiguously reduces long-run equilibrium interest rates and raises household debt”, and, in turn, reduces aggregate spending and income generation overall.

Who would have thought?

And the BIS authors conclude that “Financial deregulation … unambiguously reduces long-run equilibrium interest rates and increases household debt”, and, in turn, reduces aggregate spending and income generation overall.

Gosh! Revelations.

The paper examines what all this means for fiscal and monetary policy.

This is where the wheels fall off.

They note that there has been a considerable rise in government debt and that:

… a rise in government debt exerts upward pressure on interest rates

I won’t detail their depiction of government in their model.

Suffice to say they “introduce a standard government sector into the economy” and “government spending is treated here as purchases of goods that are either wasted, or – which is equivalent” … a technical construct.

They claim that governments are financially constrained and issue debt to cover spending over taxation.

They incorporate the typical “crowding out” arguments to conclude that increased:

Tax-financed government spending and fiscal redistribution reallocate resources from the saver to a “spender”, which is either the government – in the case of government spending – or the borrower – in the case of redistribution. Such resource reallocation would raise aggregate demand were it not for an increase in interest rates.

So the “new framework is just the old one (“the model predicts conventional short-run effects of debt-financed fiscal stimulus programs”).

I have already mentioned how monetary policy exacerbates the situation – lowering interest rates, pushes up household debt, which then causes aggregate demand to fall, etc, etc.

The only policies they believe allows an economy to escape the ‘debt trap’ are “unconventional”:

For example, redistributive tax policies, such as wealth taxes, or structural policies that are geared towards reducing income inequality generate a sustainable increase in demand … One-time debt forgiveness policies can also lift the economy out of the debt trap, but need to be combined with other policies, such as macroprudential ones, to prevent a return to the debt trap over time.

So whether this sort of paper represents progress is moot.

One could conclude, as I do, that the authors have identified a major flaw in mainstream macroeconomics (absence of income inequality mechanisms in influencing aggregate spending) but then play with the standard mathematical gymnastics and conventional assumptions about government and households to grind out a convenient result.

And in doing so, they really get nowhere.

They cannot explain why the large expansion in fiscal deficits, variously in different countries at different times, have been associated with declining yields on the government debt.

They ignore the obvious role of central banks in controlling bond yields and hence related interest rates in the relevant ‘maturity range’, preferring to construct the low interest rates as somehow due to market responses to an excess of saving among high end lenders.

They fail to present any understanding of how the biases in fiscal policy, beginning the 1980s, towards surplus, squeezed the liquidity of the non-government sector, which was instrumental in the overall build-up in private debt stocks.

They fail to present any understanding of how wages suppression and the distribution of national income towards profits pressured households into increased indebtedness, in order to maintain household consumption expenditure growth.

If they had have constructed the government sector in MMT terms, rather than ‘conventional’ terms, the results they produce for fiscal policy would not hold.

It is true that the financial market deregulation is a causal factor in the increased household debt since the 1980s.

But, we also have to understand that in the context of flat wages growth and the fiscal surplus bias to get the whole picture, which, in turn, provides knowledge of the path out of the ‘debt trap’.

What the BIS paper doesn’t tie together is that the New Keynsian reliance on monetary policy to stabilise aggregate spending was accompanied by the obsession with fiscal surpluses.

The latter obsession created an overwhelming fiscal drag which squeezed households – the tax liability remained as government spending injections fell in relative (and sometimes absolute) terms.

So households were not only borrowing to the hilt under the new slack introduced in to the financial markets as the casino was opened up to all, but they were also being squeezed to borrow more to maintain their existing consumption expenditure, as wages growth flattened and governments were trying to run surpluses.

In that context, the reliance on monetary policy to address the downward pressures on aggregate spending, forced interest rates lower and lower until, now, we have negative short term rates in some jurisdictions.

It is all tied together, and the BIS authors do not see that because they maintain a ‘conventional’ model of government.


As the title of this post indicates – we don’t get very far with this paper.

That is enough for today!

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

This Post Has 12 Comments

  1. I expect what will happen (and seems to already be underway) is that interest rates will rise as many believe that them being so low is the primary reason the nongovernment sector is so indebted. Central banks in the West are clearly feeling the pressure and temptation to raise. And that will disrupt the whole system and we’ll replay 2018 all over again. Followed by lamentations about how “there is no way out of the debt trap” and secular stagnation.

    Also, I read “Trillions” (about the rise of the passive investments industry) over the weekend, which features Eugene Fama heavily, and it is amazing how influential a small set of Chicago economists have been in how markets today are constructed. Maybe not so much influential as having said what the finance markets wanted to hear.

    But also Fama seems to get credited with the idea that over the long run the majority of investors won’t be able to beat the market, and that gets bundled as part of efficient market theory. But isn’t that just the law of averages?

  2. The thing is Bill.

    Goldman’s top economist Jan Hatzius calls the sectoral balances the Worlds most important chart. Has understood this for well over a decade.


    They know all of this have known it for years. Therefore, the purpose of this paper is a propaganda piece for geopolitical purposes. It simply can’t be anything else.

    It is just another tool for the Empire to control the republican governess of Gual, Britania and Germania or Govener general of India. It is all about control Bill it is not a science. Pile as much $ and Euro debt onto countries as they can and control them so they don’t decide to join up with Russia and China.

  3. Noam Chomsky said that He couldn’t find a word to describe the people who strive to fill someone’s elses pockets, that are already overfilled with cash.
    Chomsky was being polite, because there is such a word.
    I can’t express it too.
    The mainstream says it’s all about “ideology”.
    But, can we call it “ideology”?
    Does “ideology” stands for some guile, like so many others (for example, Rogoff/Reinhart, or Georgieva’s spreadsheets).
    But, what does that “ideology” says, in the XXI century?
    Well, basically, it repeats the bourgeois thinking.
    The bourgeoisie was born in europe in the middle-ages.
    It took 400 years to seize power (in the French revolution, in the end of the XVIII century).
    So, why does a medieval thing still be called an “ideology”?
    Why don’t we discard it as medieval rubbish, like the spanish inquisition?
    Well, because the bourgeoisie is still in power.
    That is what needs to be changed.
    The question is: what then?
    The so-called democratic socialists (or Labour) parties failed completely and, in the end, they turn as neoliberal as the others – when they strike the motherload (oligarchs money).
    Maybe the Chinese will seize power of the world’s economy – like they intend to – and impose Chinese communism on us all.
    We are in the interregnum, as Gramsci put it.
    We are seeing aberrations, as he predicted (Brasil, the US, Turky, Poland, Hungry, etc).
    We can’t do anything but wait, but …
    …the planet is not going to wait.

  4. For me the geopolitical strategy has been very simple indeed.

    Load up European nation states with Euro debt and control them. Cause those nation states can’t issue the Euro.

    Load up other countries particularly in South America with $ debt as they can’t issue the $.

    But spend 50 years spreading propaganda that says it doesn’t work like that. That the Washington Consensus would never do such a thing. They are land of the free and home of the brave blah, blah, blah.

  5. That then leads to the question of why Monetarism was introduced in the first place ?

    Which certainly had nothing to do with improving the quality of life within a countries own borders.

    My view is once you get European nation states loaded up with Euro debt and other nations around the world loaded up with $ debt.

    Monetarism is then the perfect lever they use to control these countries. Step out of line and stray from the neoliberal globalist view point and you will be punished.

    Again create fairy tales in economic textbooks to simply hide the fact of what is happening.

    Populism is simply the product that is produced at the end of this process.

  6. At last we in Australia are blessed with a political party we can vote for with enthusiasm, in the next federal election, called ‘The New Liberals’. The name (disconcerting at first for some, because the ‘Liberal Party’ is the main center-Right party in Australia) refers back to the conservative ‘Liberal’ Menzies government of the 50’s and 60’s which ran continuous government deficits every year during its last nine years (1958-67). achieving real full employment (unemployment < 2%), low inflation and interest rates, high wages growth, and public (deficit) funding of massive nation-building infrastructure, such as the Snowy River Scheme. Bob Menzies was Australia's longest serving PM.

    [Interestingly, state premier of SA, Sir Thomas Playford, also a 'Liberal (ie a RW 'conservative' in Oz parlance) , and the longest serving of any Oz government leader (state or Federal), was also an old fashioned Keynesian in the 2 decades after WW2; he nationalized the state's electicity industry, and (on the back of cheap and abundant brown coal) supplied cheap electricity to industry, built a local car industry, and built public housing for low wage workers. His political opponent on the Left said Playford was achieving more for the the Left's constituency than he himself could; and people on Playford's own side called him "socialist'…]

    Hence the name 'TNL'; the first MMT-literate party in Oz. Hopefully it's the start of something big.

    Victor Kline (leader) is wary of getting bogged down in debates with mainstream economists about MMT; he thinks (and I agree) the above mentioned examples of successful continuous-deficit governments are a powerful argument to present to the general public who (rightly) despise 'the dismal science. Professor Steve Keen, is chief economic adviser. Meanwhile AGW climate change is emphasizing fault lines in politics and economics everywhere now; the market economy will have to be put back in its place where it belongs (ie, for producing private consumer goods). And private sector investors need a carbon tax to enable them to invest? Stuff them, we don't need them.

    So let's get to it; the Greens still refuse to face the fact their funding model requires higher taxes, which explains why their vote has plateaued at a disappointingly low level over the last three federal elections.

    Vote 1 'The New Liberals', and kill two birds with one stone; we wont have to further tolerate nonsense from mainstream economists (like the Labor Party's Andrew Leigh) saying "public money given to private companies (in the poorly designed covid rescue package) must be refunded by those companies, because the debt will be a burden on our grand-children".

  7. Eugenio Triana: “I expect what will happen (and seems to already be underway) is that interest rates will rise as many believe that them being so low is the primary reason the nongovernment sector is so indebted.”
    Can they really be so crazy as to do that in UK? I think they can. Georgists predict the land price crash in 2024. Let’s see what happens in 2022.
    My prediction of a general election in 2022 would probably prevent this from happening though.

  8. It had seemed to me the main cause of our situation was the general policy to not pay people.. what I’ve called the ‘War on Payroll’. This started in the mid 1970’s with zero wage growth. With normal inflation that meant that year after year people were less and less able to support themselves on the money they earned. The policy was to fill the gap using consumer credit – credit cards, HELOCs, all that stuff. When people had borrowed all they could under the existing rules, the rules had to be loosened to keep the system running .. deregulation.
    It seems to me that people will borrow what they have to, when they’re allowed, regardless of the rate.
    This is all in the article, but the article describes low interest rates as driving borrowing.
    With society all debted up, finance charges get passed on as a major component of all prices. At the end of the line the accumulated interest payments of produces and distributors get included in retail prices, and consumers take on debt to pay those prices. When people are borrowing money to pay debt service, then I think the natural interest rate has to be zero.

    I don’t have a theory for what triggers a crisis. Lewis Carroll wrote a cute little novel Sylvie and Bruno (not brilliant like the Alice novels, but OK.) A character there, The Professor, described how he dealt with his tailor’s bill. He would go in every year and offer to pay double a year thence instead of paying on the spot. The tailor always accepted, because what businessman will turn down a 100% yield. The bill had got pretty big, but the system worked and The Professor wasn’t inconvenienced. And why should the system not keep working? As long as the tailor didn’t run out of cloth? As long as the cloth for one Professor’s suits only amounted to a rounding error?

  9. If countries who join the EU and are immediately put on an EU convergence program were told before they joined that…..

    a) You can’t run private sector surpluses greater than 3% of GDP.

    b) You can’t have private sector saving portfolios that hold the (safest asset of all bonds) greater than 60% of GDP.

    c) We are going to Load you up with debt denominated in a currency you can’t issue.

    Voters would have never have accepted this. They would be up in arms about it.

    But because the liability sides of balance sheets are used in the selling of the EU narrative by the banking lobby instead of the asset side of the balance sheets. That the majority of households think deficits and debt are like that of a household which again this narrative was created by the bank lobbyists. They march headlong into it waving flags and singing ode to joy.

    Once in the neo!liberal club look at what they do to you if you ever threaten to leave it and try and get even a little bit of democracy back. Which is virtually impossible if you have a voting system designed not to implement any really change and that is a proportional representation (PR).

    Interesting how (PR) crept in to the Labour party conference this time around as a big issue. Just shows how the liberals have infested and taken over the Labour party. Brexit would never have happened under a (PR) system.

    A buyers beware big flashing red light should be flashing in Scotland right now. I’ve even heard independence voters saying that once Scotland gets it’s independence the SNP need a little time out of power to make it refocus. Once the realities set in of EU membership . Scotland can always leave the EU and that winning independence is the most important thing.

    Well no they can’t it would be virtually impossible to leave under a (PR) voting system which Scotland has. It would be extremely difficult win a majority in a ( PR) system which was specifically designed not to throw up majority parliaments on a promise to leave the EU.

    All that will happen is what has happened every where. Voters who want to leave the EU if Scotland joins will be forced into the arms of the far right. As there will be no where else for them to go. Which is over 35% of the Scottish electorate who voted to leave the EU.

    The so called progressives who push for EU membership will give the far right a large foothold in Scotland for the first time in hundreds of years. The dangerous thing is they can’t even see this inevitable outcome. Even though there are clear cut examples of it happening everywhere if there is nowhere else to go for voters to get a voice.

    Should be debated on the MMT podcast.

  10. @ Carol Wilcox re: can they really be so crazy as to raise interest rates? Larry Elliott in the G (Oct26th) compares the Treasury’s pre-budget messaging spin to the BofE, saying ‘nobody is really sure what the Bank now thinks, but …. financial markets have gained an impression that an increase in interest rates is highly likely at next week’s monetary policy committee meeting.’ I have my doubts that they are that crazy, but you can imagine some committee members getting a little trigger crazy in the face of pressure from the finance industry, their longing to demonstrate an independent function and the real-world sidelining of monetary policy in recent times. Small wonder they haven’t got a comminications strategy beyond giving a little (possibly false) cheer to the ‘markets’. The sooner the ‘independence’ con (introduced by Gordon Brown) ends, the better.

  11. @Patrick, I saw/heard yesterday that interest rates will not be increased this year. I also think that tomorrow RichiRish will declare that he’s found something down the back of the sofa. Talk of a rift between them over ‘the deficit’ is waffle.
    In my view Doris has promised them that he will go after he’s won his second election, which will be announced as soon as he’s secured his wedding party at Chequers in July. The tories will lose a few seats, but not that many because Labour is being very kind. They will then have secured a further 5 years (heaven help us). The tories know that at some point after 2022 people will turn against them as the chickens come home to roost. By then Doris will be happily back in the money, and probably looking for a new piece of skirt – you need serious money to dump wives.
    The only silver lining is that we get rid of Starmer – who could be worse than him?…

  12. @ Carol Wilcox. As with the Cons where it seems they can always find an even more dreadful minister, and they definitely could find a worse PM (I know it’s hard to fathom the depths of hell), so I presume with the pink-tinged Con alternative benches on the other side of the House.

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