How fiscal policy saved the world

Today I read an interview with Richard Koo from the Nomura Research Institute in Japan who is the touring the world promoting his views of why the fiscal stimulus packages are so important. His views are drawn from his extensive experience of the Japanese malaise that began in the 1990s. The interview was published in the September 11 edition of welling@weeden which is a private bi-weekly emanating from the US. I cannot link to it because you have to pay to read. Anyway, much of what he says reinforces the fundamental principles of modern monetary (MMT) and is quite antagonistic to mainstream economic thinking. It is the latter which is now mounting political pressure to cut the stimulus packages. Koo thinks this would be madness, a view I concur with.

In this blog – Balance sheet recessions and democracy – I discussed the concept of a balance sheet recession. Koo was the person who coined this term. The concept is close to a modern monetary conception of a recession that begins with a financial imbalance but quickly impacts on the real economy. There are other ways for recessions to occur, but this sequence is relevant to the current episode.

To summarise, a balance sheet recession follows this trail of cause and effect:

  • When an asset price bubble bursts a large number of private-sector balance sheets have net liabilities.
  • The exposed private sector attempts to save to repair their balance sheets – debt minimisation replaces profit maximisation as the main goal. For households, spending is constrained in favour of an increasing saving ratio.
  • There is a shortage of borrowers seeking funds as the deleveraging process continues.
  • A spending (deflationary) gap emerges and output and income contracts and saving drops in total – defeating the original purpose of the thrift.
  • Private spending will not return until the balance sheets are repaired and sustainable. In lieu, public spending has to drive the economy to allow the private saving to rise and to sustain GDP growth

Koo considers that in this type of event, “the effectiveness of monetary policy goes out the window”. No-one will borrow even at low interest rates. This is what economists called a liquidity trap.

In that situation:

… if the government did nothing to counter this situation the economy would shrink very, very rapidly … the economy will be losing demand equivalent to household savings plus corporate repayment each year … But … if the government comes in and borrows the money which now is just sitting in the banking system and puts it back into the income stream through government spending, then there’s no reason for GDP to fall.

Apart from what I consider to be a misconception of causality, this is totally consistent with MMT. There is a spending gap and it has to be filled.

The misconception arises I think from the implicit assumption that the government is revenue-constrained and utilises the private savings to facilitate spending instead of the private sector drawing on them to invest. There is a two-fold problem here.

First, it implies that the banks need deposits to lend even in good times. That is certainly not the case. Loans create deposits and reserves (where needed) are added after the fact to ensure central bank accounting rules and obligations are met within the banking system.

You might like to read this blog – Money multiplier and other myths – if you are unclear about that.

Second, the government does not “borrow” savings in the sense that there is a finite pool of saving that is sitting in the banking system waiting to be loaned out and it falls on the government to borrow those funds, and, thereby get access to dollars to spend. While it might look like that is how it happens in a causal sense that would lead to incorrect inferences.

The reality is that the government spends without requiring access to prior saving. The fact that it borrows is related to the imperatives of monetary policy to drain the reserves added by the net spending to avoid losing control over its interest rate target via competition between banks to loan their excess reserves into the interbank market overnight. You might like to read this blog – Deficit spending 101 – Part 3 – if you are unclear about that.

Further, they borrow because they are ideologically obsessed with the view that “unfunded” spending will be inflationary. So various legislative and regulative restrictions (depending on which country we are talking about) are put in place – voluntarily – to create a $-for-$ match between spending and borrowing. All of which are unnecessary.

The fact is that any spending can be inflationary under certain circumstances. The so-called funding of government spending is irrelevant and doesn’t lessen the risk of inflation.

The other way of thinking about this misconception is that if the government didn’t spend, then the saving would soon dry up as the economy contracted due to aggregate demand deficiency. So the spending actually ratifies (I use the term “finances”) the non-government decision to increase its saving ratio and reduce its debt exposure.

It is much more conceptually accurate to think of the train of events as being the government spends which creates the reserves in the banking system which it then borrows back. Without that action, there is no increase in non-government saving because GDP falls sharply.

These observations should also condition the debate we had about debt-deflation recently. As I understand Steve’s position and that of a significant number of his regular commentators (who do not regularly commentate on my blog) – debt per se is the problem – private and public. But as I pointed out sometime in my replies last week – you have to be careful what you wish for.

Under current institutional arrangemets (the ideological strait-jackets that governments put themselves in), the only way that private debt can fall as saving rises is if public debt rises (as deficits increase). You simply cannot have the first without the second.

Koo, uses this logic to warn against those who are advocating a withdrawal of the fiscal stimulus. In relation to the dangers of a double-dip, he said:

… a second collapse affects everyone, not just the bubble speculators, and it also suggests to the public that all the efforts to fight the downturn to that point – all the monetary easing, the low interest rates, quantitative easing – they all failed and even fiscal policy failed. Once that kind of mind set sets in, it becomes 10 times more difficult to get the economy going again. So the fact that Larry was talking about “temporary” fiscal stimulus had me very, very worried. The whole Larry Summers idea that one big injection of fiscal stimulus will get the U.S. out of the recession and everything will be fine thereafter probably led to President Obama saying he’s going to cut his budget deficit in half in four years … [but] … fiscal stimulus will be needed for the whole period, if you want to keep GDP from falling.

He reinforces the point that with government borrowing and spending the expenditure multiplier remains positive and that is how Japan in the 1990s kept its GDP growting. The irony for Koo is that:

It’s a complete reversal of what almost everyone alive today learned in school – that monetary policy is the way to go.

The current episode has really reinforced the failure of the mainstream teaching in this regard. The central bank can pump as many reserves into the system as it likes, but this doesn’t facilitate extra borrowing (by making it easier for banks to lend) or increase the number of credit-worthy customers seeking funds.

The only solution is for fiscal policy to plug the spending gap and to allow the balance sheet repair processes to work themselves out. This is a fundamental tenet of MMT and has been ratified, in my view, without doubt by this recession. Once more data is available (longer time series) we will be able to demonstrate this even more emphatically.

He produces a graph (titled Exhibit 12 – Americans spent $1.5trn that should have been saved) which I reproduce here. It is an interesting chart.


The graph shows total savings on the LH-axis and the saving ratio on the RH-axis. The background (white bars) are what the actual savings would be if the US actual saving volume had have maintained its average rate in in the mid-1990s (4 per cent). The shortfall is clear.

Koo says the chart:

… shows just how enormous the amounts involved are: how much savings Americans have to rebuild now.

Where I think Koo misses the point is that he fails to mention the conduct of fiscal policy prior to these events occurring. If you read this blog – Some myths about modern monetary theory and its developers – you will notice that decline in saving in the US coincides with the Clinton budget surpluses. This is no coincidence.

There hasn’t been one time in US history where a period of budget surpluses hasn’t been followed by recession. If you go back to yesterday’s blog you will see the that recessions followed budget surpluses in Australia.

So I agree that the fall in the saving ratio was associated with unsustainable increases in non-government debt positions but you cannot analyse that without also considering the liquidity dynamics that were being introduced by the conduct of fiscal policy. That conjunction is a principle distinguishing feature of MMT, which should always be emphasised.

That is another reason why I think starting with a pure credit economy without a government sector in an attempt to make sense of the actual economy is not a productive way to proceed. It is better to recognise the stock-flow implications of the government’s fiscal position on the non-government sector before you analyse the dynamics within the non-government sector (which net to zero in terms of financial assets). I am not against specialist studies of these dynamics – far from it. But they have to be properly motivated in my opinion.

Koo was asked how GDP can continue to grow if the private sector are taking “massive hits to their wealth”, which is also a common theme among the debt-deflationists – that we have to take our medicine now and excroriate the debt and allow industry to suffer widespread failure as a consquence. Some people even believe you need mass unemployment to assist in this debt elimination process.

Koo doesn’t agree (and nor do I – I actually think it is a fundamental error in debt-deflationist logic):

… Japan’s GDP grew even after the massive loss of wealth it suffered when its real estate bubble burst … That happened even though the private sector was rushing to pay down debt all during that time. And the reason is that the government’s fiscal spending kept incomes growing enough that GDP never fell below its bubble peak, in either nominal or real terms …

And this was over a period that commercial real estate prices fell by 87 per cent from their 1990 peak – and the total wealth effect amounted to “the largest loss of wealth in human history, in peace time.” GDP kept growing because the Japanese government was “highly liberal with public spending”.

Moreover, he rejects the Austrian arguments in this regard (that is, a sharp recession to clear the decks and the debt) because it would be extremely costly in human and economic terms:

… that experiment was tried from 1929 to 1933 and almost half of U.S. GDP disappeared. Unemployment rate went to 25% and bringing the economy back to full employment literally too the Japanese attack on Pearl Harbour. I don’t think that’s the way we want the world to come back to life. People who argue that zombie companies should be allow to go to hell … don’t realise that, first of all, zombie companies with no cash flow cannot pay down debt, and if they cannot pay down debt, they are actually not the source of the problem … Balance sheet recessions are caused by good companies with good cash flow paying down debt.

The problem Koo notes again is that while the first wave of Japanese fiscal injection instantly worked (building roads and bridges) they considered it a temporary measure only – “just like last year Larry Summers was saying the U.S. has to do temporary pump priming”. When the government withdrew the stimulus, the economy double-dipped.

He produced a graph to show the history of fiscal policy over this period (Exhibit 16), which I reproduce next. The graph shows government spending over the period shown relative to tax revenues and the fiscal balance (deficit).


Koo concludes that:

… what my work shows is that the total additional, or cyclical, deficit that the government created to sustain GDP during Japan’s balance sheet recession … took the fiscal deficit to about 63% of GDP. But I would argue that this 63% of GDP deficit represents the most successful fiscal stimulus in history.

His computation is based on the fact that GDP would have dived (perhaps by more than 46 per cent) if the stimulus was not provided. To be conservative, however, he assumes that GDP returns to its pre-bubble level of 1985 with no stimulus. Given the extra GDP that arose from the stimulus, he concludes that the Japanese “government bought GDP equivalent to 2,000 trillion yen with 315 trillion yen of deficit spending” (which is a “very good bargain”).

So when we are thinking we are in dire trouble with deficits around 3.5 per cent of GDP think again.

I also read during the debate last week comments like “we don’t want bridges to nowhere built” – which was aimed at my advocacy for large public infrastructure projects. This idea that government spending is wasteful is flatly rejected by Koo. He said:

… that basic assumption is just plain wrong … the lesson to be learned is that no matter how huge the asset price collapse may be, if the government takes a meaningful stimulative action from the very beginning and continues it throughout the period when balance sheets are being repaired, there is no no reason for GDP to fall .. Japan is the only country that has managed to keep growing and emerge from a balance sheet recession without fighting a war

The last point is in reference to the fact that the Great Depression really on finished with the onset of military spending (fiscal stimulus) in the late 1930s, after all the neo-classical remedies had been tried and failed.

Further, the Japanese experience supports a fundamental principle in MMT that there is no financial crisis so deep that cannot be dealt with by public spending. This was the title of a paper I wrote last year with James Juniper (the link is to the working paper version which you can get for free).

What about the question of interest rates? Doesn’t the huge deficits drive them up?

Koo offers this explanation:

… when there is no demand for borrowing from the private sector, government borrowing for fiscal stimulus does not drive up interest rates … When these points are understood by policymakers globally, then people should feel a lot better, even with asset prices collapsing, because it is possible to keep GDP from falling, meaning national income can be maintained and – as long as people can continue to pay down debt – this problem will be over at some point.

I consider this statement to once again be misleading but perhaps that is because he is not being fulsome in his explanation. If he is referring to bond yields then I agree. Under auction type bond issuance systems, which were inspired by neo-liberal thinking that net spending had to be “funded” 100 per cent by the private markets, yields vary inversely with demand for the bonds (because of the nature of treasury debt instruments).

So if there is no demand for alternative financial assets then investors will be queuing up to buy the government debt and the yields will be lower than if public debt demand falls. But, of-course, this is not the basis of crowding out theory.

That theory is based on the notion that there is a finite supply of saving and any competition for it drives up interest rates. The addition assumption is that saving and investment are equilibrated by interest rate changes. Neither of these assumptions is applicable to a modern monetary system.

Saving is a function of income and spending thus creates its own saving.

Koo was then asked about whether the Japanese experience generalises given that Japan had massive domestic saving … and didn’t have to depend on China or the Middle East like the US does. He replied:

The truth is that Japan was actually in that same precarious position, a decade ago. With Japanese government debt skyrocketing because of massive fiscal deficits, all of the ratings agencies, the IMF, the OECD – they all issued horrendous warnings against Japan. Japanese bond investors remember very well that JGBS were downgraded repeatedly, to the point where Japan’s debt was rated lower than that of Botswana, because the ratings agencies were so sure that at some point the whole thing would come crashing down and that interest rates would soar. But it never happened. And the reason is easy to understand, once you grasp the concept of a balance sheet recession. The amount of money that the government has to borrow and spend to sustain GDP is exactly equal to the amount of excess savings generated within the private sector of the economy. So that money is actually available within the private sector, even in the U.S., even in the U.K.

Again there is this reverse causality implicit in Koo’s reasoning (amount “the government has to borrow and spend”) and I must find out from him whether he intends this causality or whether it is just a recognition of the voluntary institutional arrangements that align net spending and borrowing.

It is clear in Japan’s case that this alignment was not 100 per cent because the Bank of Japan craftily borrowed less reserves than were created by the Ministry of Finance deficits and thus were able to keep the overnight interest rate at zero. In other words, they left excess reserves in the banking system and allowed the interbank competition to bid the rate to zero.

This is a good demonstration of another fundamental principle of MMT – if the central bank is not offering a return on overnight reserves, then it has to issue sufficient debt to drain the excess reserves created by the net spending to meet its interest rate target. If the target is zero, then they do not have to issue any debt. The fact they did still issue debt does not violate that principle.

Further, it demonstrates that the ratings agencies are irrelevant to public debt and yields. You might like to read this blog – Ratings agencies and higher interest rates for a discussion of this point.

But the really important point that Koo clearly advocates and understands is that the government deficit will always be equal $-for-$ to the non-government surplus. If the non-government sector is saving then the government sector has to be in deficit – “the amount of money that the government has to … spend to sustain GDP is exactly equal to the amount of excess savings generated within the private sector of the economy”.

If the government tries to buck against expanding and sustaining budget deficits at that level then the income adjustments that follow will eventually bring planned non-government saving and public net spending into line at much lower levels of activity and higher levels of unemployment. Total saving will also be lower. You simply cannot escape that in a fiat monetary system. So it is better to have “good” deficits than “bad” ones (the latter being forced on the economy by the automatic stabilisers driven by the income adjustments).

The question then came up about the need for fiscal policy caution – it should only be used in small doses “to avoid overdoing it”. Koo replied:

No, because of the political difficulty in trying to maintain fiscal stimulus when an economy is showing signs of life … Its especially fraught in Europe, where the Maastricht Treaty limits the fiscal deficits to a maximum of 3% of GDP. When those economies begin to show signs of life (because all of the European economies are putting in fiscal stimulus), the temptation to cut fiscal spending to reduce the budget deficits will be tremendous … some of the Ministers … [there are] … very pessimistic. Afraid that they are destined to have a second dip because they will cut the stimulus too early. It really is a global problem at this point – except in China, where they don’t worry about an opposition, because there is none.

So the political foibles of an adversarial system of government (driven by parties) where the opposition always has to criticise and can use the ignorance of the population to push neo-liberal arguments that sound reasonable but which, in fact, have no basis is truth. And governments themselves, caught by the same ideology and political constraints.

For MMT to be more widely accepted we need a new breed of politicians that can understand this stuff and explain that when the deficits are saving jobs it is because of x and y … then we might have better times.

In conclusion, the problem Koo notes is that:

… there is nothing in economic literature to suggest that a government should keep spending money even after an economy starts showing signs of life. Conventional wisdom would suggest that with the economy improving, the pump priming worked, so fiscal stimulus is no longer.

Sort of like this bear:


Note: cartoon by John Darkow.


While I do not agree with the way in which Koo constructs some aspects of the monetary system in general he fully understands the basic precepts of MMT and uses that understanding to conclude that even large fiscal stimulus interventions are justified if the non-government sector saving response is large.

He also provides good logic drawn from experience as to why the debt-deflation strategy of reducing all debt would be catastrophic.

The one weakness in his approach (which is also in his book) is that he fails to link the private balance sheets with the conduct of fiscal policy. Once you make that additional step (which really should be the first step) then you have more reason to argue against those neanderthals that are advocating cutting the deficits back now to avoid the destruction of the world as we know it.

Sorry … the Neanderthals were probably smarter than the average mainstream economist.

ABC PM tonight

I did an interview for the national ABC PM program tonight – Transcriptmp3

The interview was about yesterday’s Labour Force data and the RBA decision to hike rates so early. Readers of the blog will already know what I would have said.


Saturday Quiz – more difficult than ever.

This Post Has 16 Comments

  1. Many thanks Bill, I think I’m beginning to get the hang of the basic principles underlying MMT, at least within a single economy based on a Government monopoly of over its fiat currency after following your blog for a while. However I wonder if you can point me in the direction of some reading to explain how this works in a global system with many currencies and economies, each being managed with national objectives in mind but each depending on its trading and capital relationships with the others.

    For example the implication of MMT seems to be that a Government can spend entirely “unfinanced” subject to the ultimate limit being that amount of spending which starts to become inflationary. In a deflationary context like now this implies this spending be very large but in a world where a lot of what a single economy needs (resources, energy etc) comes from other nations there seems to be another limit; that of the relative value of one nation’s currency vs another.

    The elephant in the room is what Nial Ferguson called “Chimerica”; the view of China and America as one large economy, which can perhaps be seen as a single MMT system with “one currency” (albeit in two denominations) where savings, investment and spending have been split geographically between the two nations.

    The obvious consequence we’re witnessing now is the fading of the US dollar compared to most other (floating) currencies (but not the Yuan, yet).

    Clearly this seems unsustainable and I’m having trouble understanding how MMT applies in this context.

  2. I should add that one of the seriously destabilizing consequences of monetary policy in different countries being so out of phase is the carry trade which distorts the relative value of currencies in ways which have nothing to do with good economic management or any reflection of the trading relationships. It seems to me that polices based on MMT would do the same unless the entire world switched to using them in the same way.

  3. Bill,

    Like Bruce above I am curious about some of the impacts of MMT if applied in practice. On the domestic side, if I understand MMT correctly, fiscal spending would not be inflationary up to the point of “slack” in the economy where slack is essentially unemployment. So spending to support the states in the US or to create new work relief programs should not cause inflation at the moment. I am curious though as to what investors foreign and domestic might think of such a policy. It would seem that most folk who (incorrectly) believe in neoclassical thinking would probably panic at the “unfunded” spending and “money printing”.

    Is quantitative easing essentially an example of MMT? As I understand it (only a layperson, not an economist!) the governments of the UK and the US are purchasing bonds from the banks with money created by adding new balances to the governments books. This appears to be the right concept at first glance, but perhaps misguided in the sense that the money would be better put to use helping to alleviate unemployment. It does not seem that providing the banks with more money has done anything in a real sense to help grow demand.

    I am a new reader to your blog having just come over from your posting on Steve Keen’s Debtwatch. Your writings on MMT have provided me with a much better understanding of our predicament. It seems that most models and theories are unable to explain much of what Mr. Koo describes of Japan’s situation in the 90’s. I was pleasantly surprised at how well MMT “predicted” many of the policy outcomes seen in Japan. ( I have been reading your blog in parallel with Mr. Koo’s book)

    Thank you for your great work and continued efforts!


  4. Bill,

    Great post.

    To my simple mind , a way to think about this is that the most EFFICIENT way to deleverage the private sector is to convert private debt to public debt , via fiscal policy. Then , when the economy recovers , debt/gdp levels will decline so long as the rate of new debt added is less than the rate of gdp growth.

    Without having the figures in front of me , I believe if you looked at total debt/gdp levels pre- and post-crisis in Japan , and in the Great Depression in the US ( using the post-WWII period as post-crisis ) , you would see that “X” level of private debt/gdp ended up being replaced by “less than X” level of gov’t debt/gdp. This , I suspect , is a function of several factors , including lower interest paid on gov’t debt , GDP stabilization or growth that would not have occurred in the absence of fiscal inputs , and outright writeoffs of some private debts that provided greater economic growth effects because they benefitted lower-income debtors ( aka spenders ) even while hurting higher-income creditors ( aka savers ).

    Here in the US , it’s been common practice to criticize Japan for their ‘lost decade’ , ‘roads to nowhere’ , etc . , and I’m sure they could have handled things differently to better effect , but I’d be happy if the next decade in the US turns out like the lost decade in Japan , because there are much worse alternatives that could ensue.

  5. MMT should seize the high ground on balance sheet recessions. It’s nice that Koo understands the net saving idea, but getting the accounting and causality right is essential.

    On the issue of erroneous inverted causality, we’ve hit the trifecta in the last few days – Krugman, Koo, and Lacy Hunt.

    Lacy Hunt:

    Steve Keen noted on the above interview:

    “Mind you, there’s lots of stuff toward the 2/3rds point (about 8-9 minutes in) which will annoy the Chartalists-it’s a fairly straight “crowding out” argument. But the opening focus on private debt … is very solid.”

  6. Goldilocksisableachblond-

    I’ve been playing with Japan’s debt data and the results surprised me in that the government added substantial debt relative to the deleveraging of the private sector! The private sector’s nominal debt level was still slightly higher in 2007 than its 1989 level (it kept rising through 1997 before starting to fall), while the government debt in 2007 was 3.5 times its 1989 level! [graph]. Debt-to-GDP tells a slightly different story [graph], but the private sector only managed to reduce from 385% to 349% (1989 to 2007) while the government debt increased from 64% to 182%. Not even close to a one-to-one conversion of private debt to public debt!

    It’s possible my derivation of the data is flawed, but I have been able to match up all the 1990 sector debt levels except financial to third party published data points. So my conclusion so far is that yes, government deficits kept GDP growing and averted a depression (and resulting low interest rates kept the debt serviceable)… but I’m still trying to work out the implications and whether modern monetary theory leaves out any consequences (despite the basic theory making sense). For example Japan’s currency fell dramatically in the late 1990s [graph] — if government spending had not been accompanied by government debt issuance (since MMT says the latter is optional when the overnight interest rate target is zero), would the currency have fallen more severely/harmfully, and also impacted commodity prices, asset prices, etc? I have more MMT reading (and thinking) to do in my quest for answers.

  7. JKH,

    Nice video. I mean scary what people think – good was only for me getting to watch the video.

    The spending mutliplier effect Lacy Hunt gets is a complete static analysis (and stock flow inconsistent as well). Its funny that in the debate last week with Steve and Bill, MMT was called just a static analysis. In fact it is just the opposite! Economists who learn Keynes’s multiplier stop at the one period fiscal mutliplier to analyse things. However a 1-period analysis is so static! When one analyses it more ‘dynamically’, one gets the multiplier effect more prominently. The studies Lucy Hunt refers to do not study it that way surely.

    In other words, right now the propensity to consume of households has come down (very natural – people want to save more) and hence the multiplier effect will be obviously be less. However this has to be analysed for multi-periods. More stimuli next many quarters and we see the multiplier. The phrase ‘Stock-flow consistency’ shouts “I’m dynamic”.

    The important thing is that neoclassical economists do not seem to be able to do multi-factor analysis. The US yield curve is at low levels and there is obviously no crowding out. The demand-supply argument for crowding out ignores accumulated wealth and preferences of investors. Increase in accumulated wealth crowds in and liquidity preferences can do either. If investors move from government debt to corporate debt or emerging markets – it is obviously not crowding out. Plus as Bill says the auction sytem is neoclassical by construction

    Having said that in the last many years there has been no crowding out. Even neoliberal Paul Krugman accepts that

  8. Ramanan,


    I had exactly the same reaction to the static/dynamic argument, but for a slightly different reason.

    The accounting identities that are central to the integrity of MMT are continuously in play. That’s the perfection of double entry book keeping.

    It seems to me that perfect continuity over time is pretty dynamic.

    In fact, Krugman bashed the fresh water (Chicago) types for not understanding this, and making the error of interpreting a dynamic accounting reality as a static accounting constraint.

    Krugman has moments of quasi-PK insight. Here’s the important one that was picked up by both Bill (Why am I telling you this? You commented there.) and Scott Fullwiler (where I commented with annoying obstreperousness and where Scott demonstrated his usual strength of supreme patience):

  9. JKH – good to fight it all out in the spirit of the debate.

    Scott reminded Steve of your ” .. alarm bells are raised …” comment from the debates a couple of weeks back here

  10. JKH . . . you give me far too much credit. I’m glad I can at least sometimes present the illusion of supreme patience via my online persona (though I’m well aware that even then it’s a short-lived illusion). Thanks to you I also learned a new word today (after I looked up the meaning, of course!).

    Ramanan . . . yes, they are having trouble understanding the points being made by you all here (and there), so I thought I’d try a different route to get at these same points and see where that led. Not expecting a tremendous breakthrough, though.


  11. Scott, Ramanan,

    That word I used sounds a lot better than it looks, I think.

    I’m not sure where Steve is going with his model, but I’m reminded of something related. I would position Warren Mosler and Steve Keen as somewhat opposite in their approach to the “empirical” validation of how bank reserves work in a fiat system. Warren knows and interprets how they work (I’m guessing) largely with the benefit of having worked at the New York Fed (I believe) along with a lot of follow up work later on. But he pretty well knew what the accounting entries were from experience (again I’m guessing). Once you know that sort of thing from experience, it’s easy to pick up on the critically relevant data points that confirm it. The most succinct and revealing data series I’ve always thought is the long history of the incredibly steady (until the crisis) average excess reserve position as published by the Federal Reserve. Anybody looking for sufficient evidence of empirical proof as to how the reserve system actually works would look up that series and say “Ah ha. That’s completely consistent with a central bank that manages actual interest rates against policy target by tweaking the excess position, and that provides required reserves fairly continuously in response to system deposit expansion.” Steve on the other hand adopts a more complicated and no doubt thorough empirical study from the top-down. This was quite evident to me in his “Roving Cavaliers” post. I’m closer to the Mosler mode in my approach, in that I have some relevant experience also. But I’m also extremely lazy when it comes to the very idea of undertaking statistical studies that are designed to confirm what I believe to be indisputable engineering facts about how the world works. I single Mosler out here only because of what I gather his experience has been, and how he has written about these things. My sense is that Scott and Bill are probably closer to the Mosler mode along the “empirical evidence” continuum than to Steve’s end. But all that said, I’ve probably misrepresented stuff including the value of empirical work per se. Still, it makes we wonder philosophically about what that word “empirical” really means in this case.

    P.S. I prefer also to think that double entry book keeping is pretty compatible with differential equation type of thinking. That also may be somewhat loose, but I happen to be in a demure (as opposed to obstreperous) mood today.

  12. JKH, Ramanan

    As far as I know, Warren never worked at the NY Fed, but the rest of JKH’s story is probably at least close, as Warren’s put this all together from his experience as a bonds and derivatives trader.

    My own approach is both/and, not either/or. I think Bill’s is, too. Just a quick perusal of CofFEE working papers will show that Bill and his colleagues at Newcastle can be as technical, mathematical, statistical, etc., as anyone would want to be. I’ve similarly studied large-scale macro models about as much as I’ve studied anything. The key is using the appropriate analytical tool for the given context (that’s how I’d personally aproach the difference vs. differential equation debate, as well).

    I’ve personally been heavily influenced by a particular school of Institutionalist thought that integrates system theory, modeling, and very careful qualitative analysis. The question for me isn’t “which approach is more scientific?” as some like to put it, as the problem there is most that say that have little understanding of the can of worms they are opening there, given the large literature regarding methodology and philosophy of science in the social sciences. Instead, I always ask myself . . . “how do I know that I know something?” The answer sometimes requires statistical work, sometimes modeling, and sometimes careful analysis of how a process actually “works” in the real world (including accounting identities). There’s a sizeable literature on how to approach the latter that has again influenced me greatly. And then there are obviously standards of judgment for each of these fields (modeling, statistics, accounting, qualtitative analysis, etc.) that must be adhered to.

    Hope that makes some sense.


  13. Thanks for correcting the bio info, Scott. Not sure how I dreamed that up. The rest makes sense also.

  14. JKH, Scott,

    Great points.

    It sometimes happens that a lot can be learned by something which seems like a ‘technicality’ and in the case of MMT – reserve accounting. I really liked Scott’s point how do I know that I know something?. James Clerk Maxwell discovered Electromagnetic waves, and the fact that light is an electromagnetic wave by studying some technical puzzling aspects of capacitors. Similarly it seems to me that Bill, Scott, Warren, Randy and Co. found the true nature of money by looking at reserve accounting very carefully and then learning from that as well as from the works of Keynes and Kalecki and applying it to the whole of Macro with double entry accounting as the framework. I was commenting as superpoincare (somehow not able to change my name) in Steve’s blog and it seems to be that some of the people didn’t seem to want to look at reserve accounting and national accounts and thought is was just a bunch of numbers in spite of my telling them that there is a lot of juice in there.

    And as far as Steve is concerned – borrowing words from JKH – I can just say that he is believes in reincarnation and is calling a “dead parrot” alive

    As far as systematics/formality are concerned I like formal methods developed by Wynne Godley and Marc Lavoie. I have been continuously reminding Steve of that work. I also had a small exchange of notes with Warren Mosler on his blog post Godley letter to FT about making it more Chartalist than what it is.

    Btw, I also wanted to mention how I came across Bill’s blog. Early this year around January I was a bit uncomfortable with the consensus that Wall Street caused the crisis. So I started dabbling with a bit of Macro, looking at some Fed sites and trying to analyze numbers from the BEA website. However this Reuters article drove me nuts initially RPT-UPDATE 1-India call rates rise as advance taxes squeeze cash. A Google search for some 2-3 hours got me into Billy Blog!

  15. Dear Ramanan

    You might have saved time by typing in billy blog!

    I am glad you found it at any rate. The Reuters article that drove you across the threshold doesn’t seem that offensive.

    best wishes

  16. Hi Bill,

    Yeah the Reuters article is great – that is what I meant. I felt uncomfortable initially that taxes were going nowhere. This thrill that “there is something there” made me land into your blog. And after spending time at your blog, it seems to make perfect sense – taxes go to the recycle bin!

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