In the spirit of debate … my reply Part 3

The debate seems to be slowing down which means this might be my last response although we will see. But in general the debate has raised a lot of interesting perspectives and I hope it has stimulated interested parties to read more of our work. I also think that while (as in any debate) “battle lines” appear to be drawn, I repeat my initial point some days ago. Steve and I saw this as a chance to focus on the common enemy – the mainstream (neoclassical) macroeconomics. That (failed) paradigm has nothing to say about the world we live in. The work of Steve and the modern monetary theory I work on both have lots to say and should not be seen as being mutually exclusive. Indeed, Steve operates in what we call the horizontal dimension of modern money.

Just as an aside I am glad I don’t live in the UK at present – its government clearly operating under false perceptions of how its monetary system operates has announced a scorch the earth type approach to managing the recession.

The Times reported that the government in a desperate effort to get reelected will:

… halve Britain’s deficit with spending cuts and asset sales worth £75 billion without resorting to further tax rises … Senior ministers are demanding that the pay of judges, top civil servants and NHS managers be frozen within weeks as the cuts package begins to bite. The remaining five million public sector workers can expect only minimal rises, union leaders have been warned privately … shelve or scrap capital projects to pay for new equipment for troops in Afghanistan … Cabinet ministers are also being pressed for a list of possible privatisations. They believe that sell-offs, particularly of property, could significantly reduce the deficit.

So all of this going on while unemployment sky-rockets and the domestic economy needs every dollar (sorry pound) of aggregate demand that it can get its hands on to stop further employment losses.

Employment issues

One commentator introduced the matter of employment which I find significant because it brings us more directly to the human dimension of the debate. A lot of the shazam about financial assets etc really ignores the fact that a substantial proportion of the activities in financial markets involves gambling between various parties and adds zero value to the real economy.

Anyway, this point was raised (and I fixed up spelling in the original):

… Is it the contention of chartalism that 1. The government can secure full employment such that potential output gaps are removed. 2. when 1 occurs, the loanable funds IS-LM model will finally be a valid construct. If so, what can be said about interest rates (I believe you guys have a ‘natural rate is 0’ concept)?

The initial objections that are already forming in my mind are that:

A. the government must secure full employment at a wage which does not compete with the private sector, otherwise I think private sector wages will rise to a point where there are no profits to be made.

B. if A is true, then an arbitrage in the labour market is being deliberately perpetuated, so that actualyl IS-LM model is still not reliable.

First, it has never been the contention that the loanable funds IS-LM model is valid. For a start, the loanable-funds model is not part of the IS-LM model. The loanable funds model sees the rate of interest as a real variable mediating real investment and saving. The IS-LM model posits that the interest rate is a nominal variable determined in the money market through the intersection of money demand (a function of interest rates and income) and money supply (exogenously controlled by the central bank).

Neither model has any place to play in modern monetary theory and I would only ever teach them in courses of history of economic thought – never in a course on macroeconomics.

To understand our view about the setting of short-term interest rates I refer you to this blog – The natural rate of interest is zero. It provides a full account of what is implied by modern monetary theory and the dynamics that are explained (for example, budget deficits put downward pressure on overnight rates) are not remotely those that are demonstrated either by loanable funds theory of IS-LM models (with usual assumptions).

Second, an understanding of modern monetary theory immediately demonstrates that the government can use fiscal policy to ensure full employment. It can do this in a number of ways including: (a) increasing net spending via purchasing goods and services and/or labour at market prices (old fashioned Keynesian approach); and/or (b) using its currency issuance power to provide a fixed-wage job to all those who are unable to find a job elsewhere. This employment buffer stock approach is termed the Job Guarantee.

What modern monetary tells you is that there is no financial constraint on taking either of these routes. However, the consequences of each strategy are different and need to be understood. It is likely that the preferred option will be some combination of the three but in the first place, (c) should be introduced because it provides a nominal anchor on the price level.

This is why we call it the “loose” full employment option. Option (a) which most progressive ost Keynesians advocate involves a generalised fiscal and monetary expansion perhaps mediated by incomes policy and controlled investment as a solution to unemployment

They see the government having control of a steering wheel and exogenously increasing aggregate spending when a private spending gap manifests.

However (indiscriminate) expansion in isolation is unlikely to lead to employment opportunities for the most disadvantaged members of society and does not incorporate an explicit counter-inflation mechanism. It also fails to address spatial (regional) labour market disparities. For example, how can we be sure that the investment will provide jobs in failing regions? Upon what basis are the most disadvantaged workers with skills that are unlikely to match those required by new technologies going to be included in the ‘generalised expansion’? Where is the inflation anchor?

What an understanding of modern monetary theory will demonstrate is that the JG is an effective strategy for a fiat-currency issuing government to pursue to ensure that work is available at a liveable wage to all who wish to work but who cannot find market sector employment (including regular public sector).

The government would provide a buffer stock of jobs that are available upon demand. The JG differs from a Keynesian expansion because it represents the minimum stimulus (the cost of hiring unemployed workers) required to achieve full employment rather than relying on market spending and multipliers. The JG also provides an inherent inflation anchor missing in the generalised Keynesian approach.

Clearly, and emphatically, a mixture of Option (a) and (b) is likely to be optimal although (a) alone is not preferred.

The JG is juxtaposed with what the NAIRU approach which accompanied a regime shift in macroeconomic policy in the 1970s. The NAIRU approach is exemplified by
tight monetary policy that targets low inflation, using unemployment as a policy tool rather than a target. The countries that avoided high unemployment in the 1970s maintained employment buffer sectors which generally allowed low skill workers to maintain their jobs when the private labour market contracted.

The JG absorbs and hence minimises the real costs of private sector demand swings. When private employment declines (expands) the JG pool automatically increases (decreases) and full employment is retained. The JG wage rate set at minimum award levels does not interfere with the private wage structure.

Critics sometimes focus on government consumption of low-skilled services by JG advocates. They claim the leading sectors rely on information, knowledge, communications and networking. They advocate a boost to public infrastructure investment which enhances the profitability of private sector investment, in addition to contributing to aggregate demand and employment.

Clearly, if a political will exists to construct public infrastructure then employment levels will rise subject to real resource availability. This is independent of the need for a JG. Yet, the JG should be accompanied by social wage spending to increase employment in education, health care and the like.

But, sole reliance on public sector investment to achieve full employment, would create considerable economic inflexibility. The ebb and flow of the private sector would not be readily accommodated and an increasing likelihood of inflation would result.

Crucially, public investment is unlikely to benefit the most disadvantaged workers in the economy. The JG is designed to explicitly provide opportunities for them. By way of example, during the golden age in Australia (1945-1975) when public capital formation and social wage expenditure was strong, full employment was only achieved because the public sector (implicitly) provided a JG for low skilled workers. This experience is shared across all advanced economies.

Further, the JG does not replace social security payments to persons unable to work because of illness, disability, or parenting and caring responsibilities.

Critics also claim the low-wage service JG employment produce skills which are of little benefit to the private sector. They allege that in a tightening labour market with structural unemployment, firms drive up wages to retain skilled staff, thereby maintaining unemployment in the context of wage/wage inflation.

But structural unemployment is itself a loaded term because it ignores the fact that firms adjust hiring standards across the business cycle and offer training slots as part of their recruitment strategies when labour markets tighten. Certain individuals are excluded from job/training offers by discriminating firms because they are deemed to possess “undesirable” personal characteristics although discrimination reduces as activity increases. But progressives should question why these discriminative practices occur rather than perpetuating the idea that there are “structural” labour market impediments.

The JG redresses this discrimination that many wrongly call structural unemployment. Further, via regionally-based job creation programs, the JG can also productively employ all workers who cannot find a private employer. The JG also does not preclude training initiatives. Appropriately structured training within a paid employment context helps overcome the “churning” of unemployed through training programs, workfare and other schemes under current neo-liberal policies. Specific skills are usually more efficiently taught on the job.

The JG is thus designed to ensure that the lowest skilled and experienced workers are able to find employment. The JG is a full employment policy and should be judged on those terms. It does not presume that JG jobs will suit all skills. For some skilled workers who become unemployed in a downturn the income loss implied would be significant. It is clear (if you do the modelling) that a fully employed economy with the JG workers paid minimum wages represents a Pareto improvement, when compared to the current unemployment.

What about the claim that in a low wage regime, government employers may choose to replace some current public sector employees with those paid at the minimum wage, thereby reducing their costs of employment. These cost-minimising strategies are not specific to a JG implementation and are available for most employers. They can be easily stopped with regulation if it is the will of the government to do so.

While environmental constraints militate against generalised Keynesian expansion, JG proponents emphasise the regional dispersion of unemployment. Higher output levels are required to increase employment, but the composition of output remains a pivotal policy issue. JG jobs would be designed to support local community development and advance environmental sustainability.

JG workers could participate in many community-based, socially beneficial activities that have intergenerational payoffs, including urban renewal projects, community and personal care, and environmental schemes such as reforestation, sand dune stabilisation, and river valley and erosion control. Most of this labour intensive work requires very little capital equipment and training.

I have called this form of spatially targeted employment policy as Spatial Keynesianism, in contrast to the bluntness of orthodox Keynesian tools which fail to account for the spatial distribution of social disadvantage.

I urge all those who are interested in finding out more about the employment guarantee approach to price stabilisation to read our major Report (released in December 2008) called Creating effective local labour markets: a new framework for regional employment policy. Further, I have written many academic journal articles and sections in my books about this topic. I don’t want to be disengenous but I have heard all these criticisms and a lot more over the last 31 years (I first conceived of a Job Guarantee in 1978) and have responded to them in depth.

So that is the best way to understand the concept. If you just want to rail about forced slavery and that sort of approach without reading the works then why waste your time – this is a debate not a slanging match.

Another commentator said said that of the Job Guarantee policy:

… Please tell me I’m not in fairy tale land here. Like I said in a previous post; does the government jobs entail one person digging a hole and another filling it in. How about paying the unemployed enough so that they can live reasonably but not enough to be comfortable. In this way they will have incentive to get an education and maybe open a business themselves …

You might be in fairy tale land – but how would we know? But your conception of the Job Guarantee indicates that you have a limited imagination and have not thought very deeply about what constitutes productive work. I see millions of jobs that will add value to communities and to the environment everywhere I go and they are not being done because no-one will fund them.

You might say they are not being done because they are not productive. But productive is not confined to contributing to the profit bottom-line of a capitalist enterprise. There are many things that deliver social returns that will never spin a private profit. Even mainstream economics says optimality should be defined in terms of social costs and benefits. It is just that they never get to that level and slip back always into the private returns mould.

So if there are millions of productive jobs that are out there but will not be attractive to private-profit seeking employers then they are ideal vehicles for public sector job creation. Which will benefit all of us and help repair our natural environment.

Our research has generated an inventory of hundreds of thousands of these type of jobs in Australia alone and we barely scratched the surface.

I also note the interventions here in the debate by Anthony (and this one, this one, and this one, plus others) which have been excellent. Thanks for the clarity.

It also seems that conservatives in the US are starting to take to modern monetary theory. My colleague Warren Mosler has been giving modern monetary talks to the arch-conservatives in the US at the Tea Party meetings. The link will take you to some videos of a recent Tea Party talk he gave. He reports that once the conservatives understand the policy implications of modern monetary analysis they stop shouting slogans about command economies and the like. He thinks that stable employment with rising incomes is a common thread across the ideological divide.

Other issues

Another commentator offered this:

From my initial readings, it would seem that Chartalism posits that governments can/do control the money supply and that they can use this control to influence unemployment … my main beef with Chartalism is that, even though it may account for every dollar in the asset and liability columns, the split between “government” and “non-government” sectors is a false one. With the advent of the credit-money system, the tail now wags the dog. To me, one of the assumptions of Charalism is that governments / central banks can control the money supply. I think it’s fair to say that Steve has demonstrated in previous posts that not only does credit-money totally dwarf government fiat money (i.e. M3 >> M0), it is in fact created first with fiat money then created many months later to meet reserve requirements. Let’s face it, the banks and other financial institutions control the money supply and there’s bugger all the government can do about it without drastically changing the rules (as if the banks would ever let that happen).

This is not what modern monetary theory says. The government has no real control over the money supply. It can control the short-term interest rate only.

But what modern monetary theory demonstrates is that the government does choose the unemployment level by its spending decisions. It can always offer a job and pay a fixed wage to anyone who wants it.

Further, last time I looked there was an easily (and legally) definable split between government and non-government in every country from the point of economic transactions. It is definitely not a false construction and has deep meaning in terms of understanding how net financial assets denominated in the currency of issue enter and exit the non-government sector and the consequences for non-government leverage activity of particular net positions taken by the government.

As to who wags which tail – I covered this question yesterday. Clearly the commercial banks have the capacity to make loans at will and the central bank will always have to ensure the banks have the required reserves if it wants financial stability to remain.

Further, the private sector can influence the government’s net fiscal position via its saving plans. If the private sector thinks the public deficit is too large then it can simply spend more itself (increase investment and/consumption) and allow the automatic stabilisers to drive the public deficit down.

But then if the non-government desires to save more then it will be thwarted by income contractions unless the government “finances” that desire with increased deficits.

So I find it pointless to determine who is in control.

The same commentator then asked a question:

“How can monetary policy or any other economic tool prevent the boom bust cycle without taking into account non-productive debt and the corresponding speculative asset bubbles that inevitably result???” I would like Chartalism a lot more if it divided the monetary system along the lines of originators of finance/money and users of finance/money. What I mean to say is that in terms of monetary policy, banks are a sort of quasi-government given that they originate most of the money and it would be interesting to analyse the monetary system with them included with the government. Chartalism seems to ignore private debt because it occurs within the non-government sector and cancels out to zero. If Steve’s blog has taught me anything it is that DEBT MATTERS. If you’re going to try and set monetary policy then I believe that you need to consider and have direct control over the originators of ALL finance/money/whatever you want to call it. I don’t think it’s possible to enforce effective centralised monetary policy without getting rid of fractional reserve (zero reserve?!) lending across the whole economy and that’s just not going to happen.

First, some of the modern monetary theory writers (Randy Wray for one) have dealt with the leveraging aspects of the non-government sector in detail. You cannot judge the millions of words we have written over the years by a short 1000-word precis that I gave to Steve to get the debate started.

Second, the banks are not quasi-government institutions in the way you mean because all their transactions net to zero whereas all government transactions with the non-government sector change net financial asset positions. That is an important distinction that has to be grasped (including the implications of it) if one is to understand how the fiat monetary system operates.

Third, I agree that (private) debt matters in some situations. However, there is nothing intrinsically destabilising about the credit creating capacities of the banks. That capacity has not caused the financial crisis.

In terms of how a modern monetary economist would deal with the banking system I am going to write a separate blog on that. But I would advocate that banks be regulated into going to back to being banks and outlawed from being merely commission recipients for securatised package deals etc.

I would prevent banks from doing anything other than taking deposits and making loans. All the rest of the behaviour that the banks have been involved in would be outlawed. Anyway, I will write in more detail about this in a coming blog. It will be the partner blog to this one – Operational design arising from modern monetary theory where I deal with the operations of the central bank and treasuries.

Then I read this interesting comment which is representative of many similar comments:

… How feasible the policy implications are in the real world with fallible people in positions of power and with limited realtime macroeconomic measurement abilities …

One aspect of modern monetary theory that is important to understand is that it promotes broadening the automatic stablisers (for example, the introduction of a Job Guarantee is exactly that).

In that context, the government will know immediately when it has to put another worker on the payroll – when he/she turns up looking for a job. They would also know when to stop putting people on the JG payroll – when no-one else walked through the door looking for a job. So the limits of the expansion are automatic – and expand and contract in a timely manner as the need arises.

The informational requirements for this policy to be effective are thus in-built.

The same commentator then said:

… Using chartalist policy prescriptions as I understand them during a debt crisis such as this almost seems (to this non-expert observer) “too good to be true” and I’m trying to figure out what implication or cost might be missing if anything … Two aspects of this:

a) Stepping back to look at the big picture, we’ve had massive asset bubbles bursting. People developed irrational expectations of the future value of earnings (with respect to the actual economic growth potential), especially via housing and stocks, and as such wealth was artificially inflated. That has partially corrected … which is one reason desired non-government savings has been rising. Does this imply a higher than “natural” non-government savings rate is likely now to compensate for past under-saving, and could this require an unsustainable (in some way) application of chartalist prescriptions?

b) By supplementing income through unsustainable growth in debt, the non-government sector has artificially boosted demand and therefore also aggregate income / GDP over the last several decades (is this a false understanding?). Does chartalism propose that either this level of aggregate income or this growth rate of aggregate income (I know the two are different) can now be sustained via government deficit spending that targets the demand gap? IF there is some need for income to realign to fundamental trends in demographics and productivity (the only two actual drivers of inflation-adjusted growth, as I understand it) while following chartalist prescriptions, then that could still result in a debt deflation as warned about by Steve, right? (Unless for example Steve’s prescriptions along the lines of debt jubilee are followed). Or is this misalignment of aggregate income with potential growth untrue or irrelevant, e.g., with private sector debt only having been used to compensate for increased income inequality within the aggregate income measure?

First, on point (a) your depiction would concur with my perception and the increasing household saving ratio once again shows we have been in a very atypical period of history. But this period was also marked by fiscal austerity and in Australia’s case 10 out of 11 years of budget surpluses bleeding the capacity of the non-government sector to spend. But this tells me that we need to get back to the situation where the non-government sector overall saves and this saving has to be “financed” by equivalent net government spending if we want the economy to continue to grow in line with capacity.

Otherwise, the saving ratio increases will cause contracting income and we will all be worse off. The best chance the non-government has of reducing its debt burdens (and I agree it has to do that) is for the government sector to fill the spending gap and keep employment growth strong.

Modern money theorists have been writing about this for at least 15 years (since the debt build-up began).

Second, on point (b) it is clear that the only way, for example, the Australian economy kept growing as the government was increasing the fiscal brake via the surpluses was via the financial engineers loading the household sector up with debt. That was always an unsustainable strategy and had to come to an end sooner or later as the private balance sheets became more precarious.

An understanding of modern monetary theory will clearly tell you that fiscal policy can always fill the spending gap left by non-government saving and maintain high levels of employment. How it does that is the issue and I refer you, in part, to the discussion above on employment guarantees.

I also recommend you read this blog – Origins of the economic crisis where I also outline changes in the income distribution that will be required to get us back onto a sustainable growth path. I think the fact that the outcomes in Australia even have not lived up to any of our expectations (Steve is planning to walk to the mountains I believe because house prices are still growing) is indicative of the early fiscal intervention.

But much more fiscal work needs to be done until the non-government sector has delevered enough to be back in safe territory. I think this little discussion also addresses the good point made by Mahaish.

Finally, I am not advocating growth at all costs. I am green in outlook and think we need to significantly change the composition of economic growth towards more sustainable income generating activities.

I also read this comment about modern monetary theory:

Yes it’s all ideological in origin. The ideology is political stability, which is perhaps mostly a by-product of economic stability, which is saying that the rich stay rich and the poor stay poor. Which is saying that we cannot have a meritocracy, in which you might become rich through accomplishment and effort.

Which is socialism, or a caste system resembling the worst aspect of medieval India or decadent Europe.

Statement 1: 1 + 1 = 2 doesn’t appear to be an ideological statement at the level you are referring to.

Statement 1: I hate/feel compassion for the unemployed does appear to be an ideological statement at that level.

Modern monetary theory is ground on stock-flow consistency of the type embodied in Statement 1. The policy design that might follow from understanding how the monetary system works is where values and ideology enters. I think JKH’s comment was excellent in that regard.

In a theoretical sense, understanding the monetary system could lead to policies that heavily taxed the rich and built mansions for the poor. It could lead to policies opposite to this.

The split between market and non-market is also ideological and not derived from modern monetary theory. So please stop imputing that we are left-wing socialists. We might be. But you cannot learn that from our demonstration that we understanding how the actual monetary system we live in works.

Whenever, was Europe decadent? Gosh!

There was also some movement (finally) on the inflation front:

How does Chartalism explain Zimbawe’s hyperinflationary meltdown when the government there had assumed all power with a compliant central bank and judiciary to implement any policies they liked by creating deficits and printing money? They tried ignoring repaying debt and look where that led.

Please read this blog – Zimbabwe for hyperventilators 101, which will show you that your construction of what happened in that country is probably amiss. That is not to say it wasn’t an example of total government failure. But it was a supply side problem not a deficit problem.

Mahaish raised a good point:

… the chartilists may understand how government spending actually works, the problem is for chartilists to be understood by the people shuffling in and out of the shadow cabinet room, supermarkets and buses of this land, its akin to getting the rest of us flat earthers to step aboard the nina and the pinta to set sail for the new world

i’m going to corner joe hocky or tony abbott one of these days and run some of your ideas by them …

The interface between what is knowledge and the political process is important. Other commentators have alluded to this point as well. For a theory to be useful it has to have policy applications. I agree that once you enter into the world of judgement (resonating JKH here) you are expressing values and ideology. That is clear.

But I think it is better to do that from an informed understanding of the mechanics of the system than raving on without understanding how the monetary system operates.

I have firm views about things political (see my Political Compass chart but I can separate them my operational understandings of the macroeconomy. Unless you want to pull the post modernist ploy and argue that even using terms such as the monetary system is ideological. In a sense it is, but then we may as well curl up on the floor and gargle for what progress we would ever make under those rules.

So I do think ultimately politicians have to be influenced and I try to do that all the time. But that is beyond the realm of my role as a theorist.

Models again …

Once again I noted that a lot of commentators on Steve’s blog were enamoured by the Mathcad modelling Steve does as part of his academic work. It seems as though the commentators considered this added “science” to the analysis in some way.

I do not decry formal modelling … I do it myself. But I know it for what it is and I am always aware of the garbage-in-garbage out danger. Further, while I am technocratic in outlook I also have deep sympathy with the view that most of the “insights” that come from formal modelling can be achieved through good grammar and well-written prose.

But I would make one further point and this in no way is a comment on whether Steve does his modelling well or not. The fact is that his model is of a pure credit economy. Whether his accounting conventions are adrift from widely accepted practices (they are!) is also not the point I am making here.

The pure credit economy has no government. So whatever the model delivers by way of dynamics assumes away any government influence. As a modern monetary theorist who understands that only government to non-government transactions create or destroy net financial assets I would not want to make that assumption about the way non-government entities interact.

I think it leaves you short of an understanding of the way the non-government markets and institutions function. That is why modern monetary theory starts with an understanding of the vertical relationships in the economy (government to non-government) then drills down into what we call the horizontal leverage level where we break the non-government sector up into its constituent parts (banks, firms, households, foreign sector etc) and analyse the consequences of that behavioural level, all the time, maintaining stock-flow consistency and sound national accounting practices.

Further, because Steve’s pure credit model, has no goverment in the model anything that the model says cannot be used to provide authority for comments or conclusions about the behaviour of government or the consequences of particular government action.

So whenever Steve says anything about fiscal policy, for example, he is making those comments without the authority of his models. That is, they are his opinion.

Conversely, whenever I make statements about fiscal policy they reflect: (a) my opinion; and (b) my understanding of the way a modern monetary economy operates where the government – non-government interactions are intrinsic to that understanding. And (b) heavily conditions (a). I think that is a major difference between our approaches.

I also think when Steve integrates his pure credit economy into a stock-flow consistent model with all the sectors specified he will be better placed to make statements about fiscal policy.

So all of the commentators who see virtue in Steve’s models, don’t think for one minute they justify anything you are saying about the consequences of government behaviour. You have a better chance of understanding those consequences if you come to terms with modern monetary theory.

Conclusion

After all that I have the Havanna (sic) Journal (http://havanajournal.com/) to look forward to tonight courtesy of one of the more informed commentators on Steve’s blog.