Scottish-born economist - Angus Deaton - recently published his new book - An Immigrant Economist…
As indicated yesterday, Steve Keen and I agreed to foster a debate about where modern monetary theory sits with his work on debt-deflation. So yesterday his blog carried the following post, which included a 1000-odd word precis written by me describing what I see as the essential characteristics of modern monetary theory. The discussion is on-going on that site and I invite you to follow it if you are interested. Rather than comment on all the comments over on Steve’s site, I decided to collate them here (in part) and help develop the understanding that way. That is what follows today.
My narrative does not repeat all the comments verbatim and may take things a bit out of order. Nothing implied by that. Some of the comments were at the non-end of decent debate and appeared to be just negative railings against government, akin to the hysteria that is going on in the US at present about Obama’s health reform proposals (I will write about these in due course). I have responded to those type of comments if the rebuttal provides insights. Otherwise I just ignore them.
But many of the comments were well intended and worthy of response.
This comment seems to be representative of a lot of misunderstanding:
Bear with me if I don’t come up all the proper economic names and terms. But as a layperson, what’s one of the most frustrating things about the Global Depression? This delusion that endlessly running up the debt won’t cause a problem. All we need to do is throw enough money at the problem. And then life will be wonderful.
I am not sure who is being delusional but I guess it was aimed at modern monetary theory. In that vein, what is being said? First, debt is the way business firms grow and households accumulate assets such as housing (which in the case of most families/households represents the most significant component of their wealth at career end). The private sector is revenue constrained and as such has to obey certain budgetary principles when making decisions to accumulate debt. the most obvious one being that they have to pay it back and to do that they have to save from their incomes.
The government sector is entirely different in this regard because in a fiat monetary system it is not revenue constrained (as the monopoly issuer of the currency). So for it accumulating debt has a different implication. Yes, it has to be paid back and yes, it has to be serviced. But these actions occur at the stroke of a pen by crediting bank accounts.
For the household, paying back debt means they have to sacrifice current consumption (spending). For the government, no such financial constraint is imposed. Its ability to spend now is independent of how much debt it holds and what is spending was yesterday. That situation can never apply to a household or business firm.
Further, in thinking about private debt much is made of so-called toxic debt. But toxic debt today was good debt yesterday in most cases. The difference is today the holder of the debt has just lost their job and can no longer maintain payments. The real problem in this case is not the debt but the lost job. Governments can always maintain higher levels of employment (up to full employment) if they choose to create enough jobs (either directly in the public sector or indirectly via targetted spending in the non-government sector).
This is not to say that some of the “toxic debt” wasn’t based on dishonest assessments of the asset values or incomes of the applicants (by mortgage brokers seeking commisssions and knowing that the debt would be bundled and on-sold as securitised products that some hedge fund would buy.
Of-course, saying that there is no financial constraint on government is not the same thing as saying there are no economic constraints. I am ignoring the political constraints here – these are the constraints that require the government to impose voluntary chains around itself which has it issuing debt in the first place when clearly it doesn’t need to do that – please read Operational design arising from modern monetary theory
The economic constraints are that the government can only purchase what is available for sale. So nominal aggregate spending growth can only run up to the real capacity of the economy to absorb it after which inflation becomes the problem.
If the net spending involved in servicing the government’s debt and maintaining its social program pushed nominal spending growth beyond the inflation barrier then the government has two broad choices – cut some of its program or reduce the capacity of the private sector to spend (via taxation changes).
Another way of looking at this is that the government must fill the spending gap left by the decision to save of the non-government sector for output to remain unchanged and at full employment. Beyond that inflation becomes certain.
So “all we need to do is throw enough money at the problem” depends on what the aim of the government is. I note the terminology “throw” is emotional. Governments spend by crediting bank accounts (adding reserves in the commercial banking sector). If the government wants to achieve and sustain full employment then it has the capacity to do that by closing the spending gap.
This means its deficit will have to equal the non-government sector’s net saving. That will be enough spending. Beyond that – as above – inflation becomes the problem.
I also note that solvency is never a problem for government in its pursuit of full employment – only inflation is the potential problem.
Someone said that:
The Chartalist ideas as depicted by Dr. Mitchell appear idiotic on their face to this noneconomist. The idea that issuing or authorizing fiat currency is “spending” is wrong. Then, the idea that government deficits equals private savings is wrong. It’s very easy to consider a situation in which the government has outstanding a stable money supply with a stable population, and the government administers a system of courts and a small army and navy, collecting import taxes to support this government. At the same time, the private sector is productive and sells its goods internally and overseas, garnering monies from foreign countries (either their fiat currencies or gold) as the savings.
Even trained economists find modern monetary theory difficult to grasp at first because they are so conditioned by their own gold standard training. The general public is even more baffled because they have been so conditioned by 30-second grabs on TV and radio and the experts they read in the newspapers who cannot see that 1 + 1 = 2, by all the rules of commutation that we learn in primary school.
How does the government which is the monopoly supplier of the fiat currency issue it? Well by spending.
The exact statement that was made in the summary on Steve Keen’s blog is that “As a matter of national accounting, the federal government deficit (surplus) equals the non-government surplus (deficit). In aggregate, there can be no net savings of financial assets of the non-government sector without cumulative government deficit spending.”
I don’t see the words “private” included. Government deficits do equal private savings if the external sector is in exact balance always. Not likely.
So the recommendations I make when trying to understand something is to first assume it is correct – that is, not jump into the fray looking for errors. Second, with your “eyes open” make sure you understand every nuance of the language being used and not substitute things you have learned from other paradigms or from the TV news. Third, ask questions if you are unsure to make certain that you have captured the essence of the argument being made. Fourth, make some assessments based on known methods of determining knowledge.
Which brings me to another comment that appears to be in that spirit:
I’m having a hard time getting my head around Chartalism. Is the argument that we are already in a de facto Chartalist system, and the central banks’ machinations are just adding an unnecessary layer of complexity?
By this explanation, “taxation acts to withdraw spending power from the private sector but does not provide any extra financial capacity for public spending”, is the argument that taxation is just a means of soaking up excess liquidity due to the previous spending? In that case, couldn’t government debt be seen as soaking up excess liquidity by taxing future taxpayers?
We are certainly operating in a fiat monetary system (excluding the individual Eurozone countries and certain other small nations) where the government is sovereign in its own non-convertible currency and relies on its capacity to impose taxes/fines to ensure that the non-government sector has a requirement to get hold of that (otherwise worthless) currency.
The central bank is part of government irrespective of what the political or ideological rhetoric might tell us. The so-called independence is a chimera.
The way we know it is an intrinsic part of the consolidated government sector is because its transactions with the non-government sector can create or destroy net financial assets. Transactions between non-government entities can never do that. More about which later. But you might like to read or re-read the following trilogy of blogs – Deficit spending 101 – Part 1 – Deficit spending 101 – Part 2 – Deficit spending 101 – Part 3.
Taxation initially functions to generate a demand for the otherwise worthless currency. The ability to force the non-government sector to get hold of the government’s currency allows the latter to conduct its socio-economic program (by spending). In addition, taxation is a way to destroy net financial assets held in the non-government sector if the government wants that sector to have less purchasing power. For example, to reduce inflationary pressures.
Now what about public debt issuance. First, the funds that are used to buy the debt were created by government spending in the first place. So the idea that government borrowing is using up funds that were accumulating previously by non-governmetn saving misses the mark badly.
Second, debt issuance just swaps bank reserves for a piece of paper (the government bond) but in doing so drains the reserves from the banking system.
Third, issuing debt today has no intrinsic implications for future taxpayers. I guess the point being made is that the debt has to be paid back and that will require tax increases in the future. Not at all. The government has the capacity to spend at any time irrespective of what it spent yesterday. Paying back debt is just the same process that the government uses in all its spending activities – bank accounts are credited and bank reserves increase. The sovereign government is not revenue-constrained.
It might increase taxes in the future because it wants the non-government sector to have less purchasing power. But that will not be inevitably related to its past debt issuance and never related to a need to accumulate funds to pay the past debt issues back.
So this discussion should allow us to see why this comment misses the point:
Certainly an interesting read. Mitchell presents some very controversial arguments. I’m not sure how he can so confidently assert that government debt (surplus) balances out private-sector surplus (debt). Are Australians somehow not allowed to transact with people from other nations? …
As an aside, my 1000 or so word primer on modern monetary theory is not what I would consider to be “very controversial”. It was mostly a statement of essential accounting rules and behaviours that follow from those stock-flow constraints.
Anyway, I covered the point about the national accounting identity above. But I did like this comment from fellow modern monetary traveller, Professor Scott Fullwiler:
A few have already questioned the government debt = non-govt surplus point made by Bill, so allow me to elaborate.
To begin, this is an accounting identity. Disagreeing with it is akin to disagreeing with gravity. That it seems so foreign to so many has more to do with the paucity of understanding of basic accounting that persists among economists, the financial press, and those that follow the writings of both groups.
Another common misconception is that modern monetary theory is inconsistent with endogenous monetary theory (which Steve Keen writes about among others). So there was a comment:
As a non-economist, the biggest difference I see between your analysis and this summary of chartalism is private credit creation. The chartalist view assumes that only the government can create money so this would imply a full-reserve banking system. Your analysis accepts the current regime of private credit creation being the dominant source of currency and determines the likely behaviour of such a system.
Personally, I find myself drawn to the Chartalist’s view of the world and support the idea that fractional reserve banking should be abolished. Money should be created, not borrowed, by the government.
It would help to read this blog – Deficit spending 101 – Part 3 – where a detailed analysis of what modern monetary theorists refer to as the horizontal relations in a monetary system is presented. We distinguish the horizontal dimension (which entails all transactions between entities in the non-government sector) from the vertical dimension (which entails all transactions between the government and non-government sector).
In simple terms, the horizontal dimension is equivalent (totally consistent) with the (properly accounted for) circuit theory and endogenous money models.
The leveraging of credit activity by commercial banks, business firms, and households (including foreigners), which many economists in the Post Keynesian tradition consider to be endogenous circuits of money, occur in private credit markets. The crucial distinction is that the horizontal transactions do not create net financial assets – all assets created are matched by a liability of equivalent magnitude so all transactions net to zero – always.
The other important point is that private leveraging activity, which nets to zero, is not an operative part of the stores of currency, reserves or government bonds. The commercial banks do not need reserves to generate credit, contrary to the popular representation in standard textbooks.
So whenever we are analysing horizontal transactions we always have to find an asset to match with a liability. In the vertical dimension, net financial assets can be created and destroyed by government. That is a fundamental difference between the sectors.
You can also see this in terms of stock-flow consistent macroeconomic models – see this blog to learn about this type of model.
To fully understand what the non-government sector is doing you have to ensure you fully specify the economy (at the sectoral level) to be stock-flow consistent using the accounting rules that govern stocks and flows that we all accept. If you leave out the government sector from the model when you are missing a “row” in the stock-flow matrix and so you will miss essential dynamics that exist between the sectors.
A properly specified model will show you emphatically that the horizontal transactions between household, firms, banks and foreigners (which is the domain of circuit theory) have to net to zero even if asset portfolios are changing in composition. For every asset created there will be a corresponding liability created at the same time.
The model will also show you that once all stocks and flows are reconciled as consistent then only the government transactions with the broad non-government sector create or destroy financial assets.
Modern monetary theory emphasises that you should start your learning journey at that point to fully understand what happens elsewhere in the economy – say at the credit money – bank leveraging domain.
We don’t say that all models have to introduce all element all the time. It is legitimate to study endogenous credit money creation at the non-government (horizontal level). But you will make errors if there is not an explicit understanding that in an accounting (stock-flow) consistent sense all these transaction will net to zero. In adopting this understanding you might abstract from analysing the vertical transactions that introduced the high-powered money in the first place, but never deny its importance in setting the scene for the horizontal transactions to occur.
Which means I totally agree with a comment that followed:
For what it’s worth, my sense is that Steve’s endogenous money model should be totally compatible with the Chartalist operational model. There are some wrinkles related to Steve’s interesting accounting for loan repayments, but I don’t think they contradict anything fundamental about the operational foundations for the modern monetary theory.
As long as Steve operates within conventional accounting traditions and is stock-flow consistent then endogenous money theory is fully captured in the horizontal dimension of modern monetary theory. But in saying that I think Steve has “invented” some accounting rules which would not be normally accepted (by anyone else). More later.
Then there was this interesting comment (partly reproduced):
… Would it be true to say then, that banks are directly in competition with governments to ‘own’ the money supply – issuing loans (whereby the banks transform credit into gambling stakes and real assets) vs. government money creation? Government may spend first but banks loan a lot more? This would explain the malficient stranglehold Wall St. has on the US government – another mechanism that should be serialised on national TV?
There is no competition because the government is the monopoly issuer of the currency. By loans creating deposits, banks certainly create credit which can be used for any number of things. This is not a struggle over control of the money supply. It is clear that the government cannot control the money supply as the mainstream macroeconomic text books claim. This fact is one of the essential insights of endogenous money theory, which is the area of research that Steve is active.
The essential point – explained above is to understand the difference between vertical transactions between the government and non-government sector, which create/destroy net financial asset positions in the non-government sector; and, horizontal transactions within the non-government sector which have to net to zero.
Bank loans create deposits but the loan is an asset to the bank just as the deposit is a liability to the bank. Nothing net has been created.
Then Steve Keen himself entered the debate to clarify a few matters. He said (partially quoted):
I don’t question the accounting identity Scott,
In the spirit of n8r0n’s comments though, what I do question is its relevance to the data.
In a flow sense, a government deficit in a given time period corresponds to the net accumulation of private sector monetary assets in that period, if there is no other source of money or if those other sources create a balance of money and debt. Of course there is another source of money – money endogenously created by the private banking system – and on the data, there is not a balance of money and debt creation there (so that the two net to zero) but a surplus of debt creation over money, so that the two sum to a substantial negative.
Yet the system functions (albeit it’s c#cking up now): our actual monetary system appears to function with net negative financial assets. Using the broadest measure of money the USA ever published (does it rile you that the Fed has stopped recording M3? Sure annoys me!), total debt was 2.25 times M3 in the 1950s, and was 4.3 times M3 when the data collection stopped in 2006 (the ratios of only private debt to M3 were respectively 1.25 and 3.3). So even at a time when Minsky described the USA as financially robust, debt exceeded money: the system functioned well with net negative financial assets.
It therefore appears to me that what we need to explain is how a monetary economy can function with net negative financial assets – or more strictly, with monetary debts substantially exceeding money holdings.
I’ve done that with my Circuit models, in which debt exceeds money (when defined to exclude the banking sector’s own transaction accounts). I also have an extension I haven’t yet published where I have a non-bank financial sector, which creates debt without creating money.
I would like to know how the Chartalist perspective handles the empirical fact of net negative financial assets in a monetary economy.
From my point of view, one of the things the government does when it runs a deficit is reduce the excess of debt over money, which is an important policy measure to reduce financial fragility. But I don’t see the fact that only the government can create net financial assets as a crucial argument for the importance of a Chartalist perspective, because our system always seems to function with net negative financial assets – and it has occasionally secured full employment without government deficits as well.
So from Steve’s perspective he is asserting that the non-government sector can alter net financial asset positions independent of any government involvement. The fact is that it cannot – categorically – do that. Let me explain. I also had some input on this from Warren Mosler.
So we would agree that “in a flow sense, a government deficit in a given time period corresponds to the net accumulation of private sector monetary assets in that period” as long as we include residents and non-residents in the “private sector”. Modern monetary theory uses the aggregation – non-government sector to eliminate confusion about whether the private sector is resident or more general. This is important because foreign governments are equivalent to “domestic private” from the perspective of the home economy in that they cannot create or destroy net financial assets in the home currency of issue.
But Steve wants to add the caveat to this statement – that is, it holds “if there is no other source of money or if those other sources create a balance of money and debt”. We have to be very careful in using the term money as I will explain.
Steve then seeks to explain his position by noting that there is another “source of money” which is “endogenously created by the private banking system – and on the data”. He believes that “there is not a balance of money and debt creation … but a surplus of debt creation over money, so the two sum to a substantial negative”.
Well this might exist in Steve’s models but it is impossible in the real world where accounting principles rule. Why? Because bank loans create equal deposits as a matter of accounting (identities).
The bank has an asset (loan) and an equal liability (deposit). The borrower has an asset (deposit) and an equal liability (loan). If we consolidate over the entire non-government banking system then the sum of loans and the sum of deposits cancel out even though there is more “money” in the private sector hands as a result of the bank bank balance sheet expansion.
There can never be a substantial net negative upon consolidation. What this tells me is that either the usual (double-entry) accounting definitions are not being followed or the stock-flow model is not consistent (or both).
The point loans create deposits certainly but net out to zero. Only cumulative government deficit spending adds net finanical assets to the non-government sectors, just as budget surpluses destroy them.
Steve then invokes some data.
He says that “total debt was 2.25 times M3 in the 1950s, and was 4.3 times M3 when the data collection stopped in 2006 (the ratios of only private debt to M3 were respectively 1.25 and 3.3). So even at a time when Minsky described the USA as financially robust, debt exceeded money: the system functioned well with net negative financial assets”.
This also cannot be correct. All the dollar debt (always) has a corresponding dollar financial asset held by the borrower. You need to dig below the surface of the numbers to the conceptual level to fully understand the situation. This is the danger of taking a particular view of what money is.
Steve then says that his latest unpublished work has “a non-bank financial sector, which creates debt without creating money”. Once again this could not be the case if the usual accounting rules were followed and a fully-specified stock-flow consistent macroeconomic model was used.
Non-bank (corporate) debt creates non-bank financial assets, such as commercial paper, corporate bonds and the like. So dollar-denominated net financial asets cannot be altered by private sector activity. Only the government can add or subtract net dollar financial assets to the non-government sector.
But appealing to empirics like those above can only establish the “empirical fact of net negative financial assets in a monetary economy” if you use a definition of money that doesn’t include all the financial assets created by debt. Once you adopt the usual accounting rules to map out all these non-government transactions then it will never be the case that they create net negative (or positive) positions.
Steve finishes this comment by arguing that “I don’t see the fact that only the government can create net financial assets as a crucial argument for the importance of a Chartalist perspective, because our system always seems to function with net negative financial assets – and it has occasionally secured full employment without government deficits as well”.
All of the above reasoning should give you confidence that the government is the only entity than can create net positions in the non-government sector. Moreover, it is true that the non-government sector can operate – for a time – with negative financial assets (but then the government sector will be in surplus).
The non-government sector can achieve this state – negative financial assets if for that period of time there is a desire to reduce net financial assets by going into debt to pay taxes to a government running a surplus. But as we have seen, and Steve has shown categorically – this is an unsustainable growth strategy – the non-government sector cannot dis-save indefinitely and accumulate ever increasing levels of debt.
This reasoning should then tell us why the following comment also violates basic accounting sense (Steve also agreed with this example as a vindication of his position):
Steve, surely net debt greater than money is easily understood by:
bank A creates and loans 100$ to NBFI B at 2%.
NBFI B loans the 100$ to C at 3%.
Now the money in the economy is $100, but debt is $200. Why is this a problem? In fact it seems to me (apart from the issue of counterparty risk), that the above is equivalent to simply A lending to C at 3%.
To understand the net position you have to trace the assets and liabilities created here.
Bank A creates loan of $100 – it has an asset of $100 (loan) and a liability of $100 (deposit). NBFI B has an asset of $100 (deposit) and a liability of $100 (loan). Nothing net created there.
NBFI B then loans and creates a deposit worth $100 to entity C. B has an asset worth $100 (loan) and a liability to C of $100 (deposit). C has an asset of $100 (deposit) and a liability of $100 (loan). Nothing net created there.
How you account for this depends on what you assume about NBFI B – does it lend by creating a deposit for C or just withdraw the $100 from its deposit at A and hand the cash over? You can imagine the latter if B was just a person as was C but the former if B is a NBFI. I have assumed the former (so the deposit B has with A remains at $100 and a new asset – liability to C (deposit) arises. If you assumed the latter then the B’s deposit at A goes to zero and no new deposit is created for C in B (an unrealistic example that reeks of money multiplier implications. Whichever way you account for it, all the transactions create a net position in financial assets of zero.
When all is paid back there will be an corresponding extinguishing of the assets and liabilities and again nothing net will be created. The problem again is not counting everything on both sides of the ledger (taking an narrow view of money as opposed to financial assets).
In this regard, I think Scott Fullwiler’s intervention was excellent:
… using the term “money” often confuses things. “Money” is always someone’s liability, so better to be precise about whose liabilities we are talking about than saying “money.” This also helps because some people consider “money” to be deposits only, and others consider it to be more broadly defined. You’ll notice perhaps that most of the chartalists have over time stopped using the word “money” as much as possible and refer to specific entries/changes to balance sheets.
If the government increases its liabilities, this is a net increase in financial assets for the non-government sector.
The non-govt sector actors can certainly increase the quantity of credit amongst themselves. Whether or not it increases someone’s definition of “money” 1 for 1 with loans, it DOES BY ACCOUNTING DEFINITION increase the quantity of financial assets and financial liabilities 1 for 1 in the non-govt sector. So, with private credit, there is BY DEFINITION no NET increase in private sector financial assets created.
The bank example commentator then said that “We need to distinguish between debt, and leverage. In my example the $100 created by the bank A is leverage. B is intermediating and spreading risk but has not created extra leverage/money. There is only one liability here belonging to C. If C defaults the liability passes to B. Still only one liability, not two.”
But Scott’s reply is spot on – “Leverage is defined as debt in the academic field of finance (that is, debt is a leveraging of equity). Otherwise, you’re making up your own definitions.” Clearly Bank B has a liability to A that is not extinguished by lending to C. If C pays up and extinguishes its liability to B, then B destroy the asset (loan to C) and can use the funds to extinguish its liability to A which, in turn, wipes out the asset it holds against the loan to B. Again, nothing net is created here.
I think JKH, who is a regular commentator on my blog as well summed it up well in a couple of comments which I conflate (in part):
I have a visceral negative reaction to the apparent econo-blogosphere virus of making up definitions that conflict with standardized double entry book keeping definitions that the creators of those conflicting definitions actually rely on in order to source the data that supports their new creation …
Moreover, the monetary system as a whole does not have negative net financial assets. That is logically incorrect. Every financial obligation is mirrored by a corresponding financial asset. This holds for money, debt, and equity. This is double entry book keeping …
If the common ground between Circuitism and Chartalism is that both camps understand how the monetary system works, that would be enormous common ground. I’m absolutely convinced that the Chartalists understand it, and that understanding is provable by operational fact and pure accounting logic. The accounting paradigm as between government and non government financial balance is absolutely indisputable in that sense. Conversely, if the primary distinction between Chartalists and the neo-classicals is on the same point, that is enormously important. It is enormously important because there is no way you can understand economics if you don’t understand how the monetary system works. It is a necessary condition. Otherwise, it would be like monkeys typing Shakespeare for the neo-classicals to get it right.
Then someone said:
As far as I’m concern it’s all nonsense. A different view of what is clearly wrong (neoclassical) could also be wrong.
Yes, a rival paradigm could be as wrong as the mainstream. But you need to be able to demonstrate why it is wrong by first of all understanding the assumptions and mechanics of the model in question. That would be better than dismissing rival work or any work as nonsense from the outset. We move on.
Another commentator expressed some problems understanding modern monetary theory (as depicted in my 1000 words precis on Steve’s blog). They said:
I’m still trying to get to grips with this stuff and (literally) don’t understand the following:
1. Bill Mitchell: “The modern monetary system is characterised by a floating exchange rate (so monetary policy is freed from the need to defend foreign exchange reserves) and the monopoly provision of fiat currency.”
Surely in a globalized world economy “the” monetary system(s) gyrating around floating exchange rates is a symptom of instability rather than a cure for it. Things haven’t got more stable since the US defaulted on its gold exchange rate in the 1970s?
How the economy has played out since the collapse of Bretton Woods is not the point of how the modern monetary system is characterised. The fact is that under a flexible exchange rate, monetary policy no longer has to defend the fixed parity and so fiscal policy does not have to get into self-defeating stop-go growth paths characteristic of external deficit countries under Bretton Woods. This constraint was one of the major reasons why the convertible currency system collapsed.
Then the commentary went into the modern monetary theory = communism nexus. When in doubt bring in the furphy that everyone will get emotional about.
Chartalism as I read it is pretty much what we have now; some may also refer to our current system as crony capitalism or socialism for the uber rich. All this searching for alternative systems plays into the hands of the controlling banking elite. Left wing pundits seem unable to understand that the scraps being thrown by way of stimulus is a smoke screen to mask the bailing out the banks by way of money printing.
Some of the phrases from the Chartalism discussion is scary in its simplicity; ones like: “Modern monetary theory provides a sound basis for understanding the intrinsic opportunities available to governments” – Wow, so the government should be given opportunities; why don’t they just do their job and enforce the rule of law by locking up the fraudsters.
Modern monetary theory is not left-wing just as much as it is not right-wing. It is an operationally-based characterisation of the way the monetary system operates and the way that the government sector interacts with the non-government sector. It is a stock-flow consistent framework.
The reality is that whatever the government does (using its opportunities) – big or small, surplus or deficit, whatever – will have implications for what the non-government sector does. If they run surpluses then the non-government sector runs deficits. We have to get down to that level of understanding and acceptance before we can discuss other matters that might reflect our values.
Then, what you do with this understanding by way of policy design reflects your ideological slant.
The same commentator continued:
… “In the absence of government spending, unemployment arises when the private sector, in aggregate, desires to spend less of the monetary unit of account than it earns.” – NO, in the absence of government people are industrious. Only when government gets involved does the system fall apart. The job of government is to uphold the law and lock up the fraudsters.
“The only danger with fiscal policy is inflation which would arise if the government pushed nominal spending growth above the real capacity of the economy to absorb it”. At least inflation is mentioned; however it should have been defined for what it is – a TAX.
The debate on the whole is centred around those who think that printed money creates the type of productive that is sustainable. Sure giving printed money to failed car companies enables them to make more cars but this is still fraud. We will continue to waste resources at the maximum possible rate so long as we don’t have a sound currency (and I’m not talking gold). It’s like giving fishermen printed money to fish when the fish stocks are depleted; it’s asinine. We need tough love and we need it badly.
There can be no unemployment in a non-monetary system. But in a state system (fiat currency) if the non-government sector desires to net save in that currency then unless the government sector fills that spending gap, unemployment will result. Sorry to disappoint but until you find an alternative to the monetary system that will be the reality. An emotional dislike of government will not help. That is just denial.
Further, the “at least inflation is mentioned” comment implies that we should always think inflation is the most important issue. Inflation can occur under the conditions specified but we should not get obsessed with it. It remains something that governments have to consider in their fiscal design. But it is neither inevitable or just around the corner.
References to “printing money” will ring out to regular readers of my blog. Governments do not spend by printing money. They credit bank accounts and create new bank reserves.
But being generous to the commentator – it is true that if the fisherman are the economy and the fish stocks are available productive capacity, then any further nominal spending (aggregate demand) by any spending source (government, consumption, investment, net exports) will be unable to be met by real production. Then inflation results. We are so far from that situation now that I wouldn’t be losing any sleep over it.
And finally, for me today, there was this comment, which takes us back to where we started:
Left leaning politicians must adore chartalist dogma. After all, it places Govt at the very center of all economic activity and outcomes. Which would not be a problem were Govts entirely transparent, ruthlessly efficient and entirely apolitical. But to me this just sounds like the rule of negative selection at work. Where well connected political hacks get to run pretty much my entire life and make choices about my wealth limitations behind closed doors.
Modern monetary theory does start with the broad sectors – government and non-government – because you cannot understand what goes inside the non-government sector (which includes foreigners, households, business firms and commercial banks) without first understanding how the government and non-government sector interacts.
Why is that necessary? Simply because the government is the monopoly supplier of fiat currency which is required by the non-government sector to pay its tax liabilities. You cannot assume that away because it motivates non-government activity and outcomes.
Further, the accounting statement the government surplus (deficit) is exactly equal to the non-government deficit (surplus) has behavioural underpinnings and so you have to understand that if the government is in surplus in any period, the non-government sector has to be in deficit. Then the question is what activities, decisions etc are manifest in that non-government deficit.
For a country like Australia that typically runs an external deficit then this accounting statement tells us another fact. If the government is in surplus then the private sector in Australia has to be in deficit – that is, running down its savings, selling previously accumulated assets, or, ultimately, as a sector, becoming increasingly indebted.
So to understand the dynamics of private indebtedness you cannot ignore the government balances.
Further, to make statements like “the solution is that the private sector saves more” one has to also make statements about what the government sector has to do (given that the external sector in Australia is typically in deficit). An understanding of the fiat monetary system leads you to the indisputable conclusion that the private sector (under these circumstances) can only save and reduce its indebtedness if the government sector “finances” that saving via deficits.
In the absence of this the private attempts to save will be thwarted by income adjustments (downwards as aggregate demand falls) as output and employment falls. The only way that the non-government sector can save and national income keep rising is for the government sector to fill the spending gap left by the saving – that means running a deficit.
So in relation to this comment, it is not a matter of liking or “adoring” modern monetary theory (neo-chartalism). What the electorate allows the government to do, or what the government does on its own bat – transparently or otherwise – fairly or otherwise – is a separate matter. That sort of consideration is the realm of political science. Modern monetary theory tells you (predicts) what will be the tendencies of any particular government or non-government behaviour.
You can establish the most libertarian society you can think off – getting rid of those “well connected political hacks” – but as long as the government that is in place issues the currency as a monopolist and taxes (fines) exclusively in that currency then your economy will be bound by the dynamics laid out in modern monetary theory.
I think the differences between Steve’s models and modern monetary theory are two-fold.
First, I do not think that Steve’s model is stock-flow consistent across all sectors. By leaving out the government sector (even implicitly) essential insights are lost that would avoid conclusions that do not obey basic and accepted national accounting (and financial accounting) rules. This extends to how we define money.
Second, I think Steve uses accounting in a different way to that which is broadly accepted. It might be that for mathematical nicety or otherwise this is the chosen strategy but you cannot then claim that your models are ground in the operational reality of the fiat monetary system we live in. I have no problem with abstract modelling. But modern monetary theory is firmly ground in the operational reality and is totally stock-flow consistent across all sectors.
If we used the same definitions and rendered Steve’s model stock-flow consistent in the same way as modern monetary theory then Steve’s endogenous money circuits would come up with exactly the same results as the horizontal dimensions in modern monetary theory. His results might look a bit different in accounting terms but most of the message he wishes to portray about the dangers of Ponzi stages in the private debt accumulation process would still hold.
After all, these insights are at the basis of modern monetary theory also and were written about by the leading exponents of that approach including myself at least 15 years ago.
Tomorrow: the G-20 hands over legitimacy to the IMF.