When you’ve got friends like this … Part 2

… who needs enemies. Today’s blog is Part 2 in a series I am running about the propensity of self-proclaimed progressive commentators and writers to advance arguments about the monetary system (and government balances) which could easily have been written by any neo-liberal commentator. The former always use guarded rhetoric to establish their “progressive” credentials but they rehearse the same conservative message – the US has dangerously high deficits and unsustainable debt levels and an exit plan is urgently required to take the fiscal position of the government bank into balance. In doing so, they not only damage the progressive cause but also perpetuate myths and lies about how the monetary system operates and the options available to a currency-issuing national government.

I have been reading some of the articles and essays put out by the Center for American Progress lately, which describes itself as follows:

The Center for American Progress is a think tank dedicated to improving the lives of Americans through ideas and action. We combine bold policy ideas with a modern communications platform to help shape the national debate, expose the hollowness of conservative governing philosophy, and challenge the media to cover the issues that truly matter.

On their About Us page they the prolific use of the word “progressive” (or plural forms) to describe themselves stands out. It is run by former Clinton hack John Podesta and George Soros is one of its benefactors. They are very well connected in Democrat political circles and arguably have strong influence in the Obama camp.

They tell us that:

Our ability to develop thoughtful policy proposals and engage in the war of ideas with conservatives is unique and effective.

So with unemployment at around 10 percent and housing foreclosures still rising (especially among the poor) and with a major attack on the US government coming from the “conservatives” based on spurious understandings of how the monetary system operates, you would think that the centre would want to push a strong case for expanding the US government deficit and also to disabuse Americans of the central propositions that the deficit terrorists lambast the public with on a daily basis.

You would be very wrong if you thought that. These guys are as conservative as they come even though the Austrian school zealots and the mainstreamers from the Chicago school tradition hate them.

A recent publication (January 20, 2010) from the Center caught by eye. It was entitled – How to Spot a Deficit Peacock – and was written by one Micheal Linden, who is the “Associate Director for Tax and Budget Policy” at the Center and he has authored several publications on deficits and debts all of which could have referenced Mankiw’s macroeconomics textbook as a primary source.

Anyway, in “How to Spot a Deficit Peacock” we see how non-progressive this organisation really is. The best thing about the article is the beautifully coloured image presented at the outset. My peacock image here is also lovely. Should soothe us while we take this agonising journey together!

Linden notes that when the US President releases his 2011 budget proposal (he did this on Monday, February 1) the “fiscal future it projects is sure to be troubling”.

From a the perspective of modern monetary theory (MMT) you wouldn’t talk about a “troubling” fiscal position. You would, instead focus on the rate of unemployment, the rate of employment growth, the rate of real GDP growth, the inflation rate, and things like that which actually influence the opportunities that people have for work and income. They can all be troubling or not depending on your aims.

But a fiscal position can only be described as providing enough or not enough stimulution.

Linden then gets a bit ornithological stating that this “troubling” fiscal outcome “will set off another chorus of concerned pundits and lawmakers who will loudly insist that they are true deficit hawks and want to reduce the deficit”. But then the lesson in ornithology begins:

Deficit hawks come in a variety of breeds. There are those who believe that the long-term deficits pose serious risks, but that short-term deficits are necessary and wise during a recession. There are those who believe that deficits are always risky and should be avoided at all costs. Both kinds of hawks are genuine in their concern over our nation’s finances and are sincerely committed to working toward a more sustainable federal budget.

And then there is another species of deficit bird all together: the deficit peacock. Deficit peacocks like to preen and call attention to themselves, but are not sincerely interested in taking the difficult but necessary steps toward a balanced budget. Peacocks prefer scoring political points to solving problems.

How can you tell the difference between deficit hawks, those who are serious about the dangers posed by persistent, large deficits and deficit peacocks, those who only use those dangers to preen and score political points? It’s actually fairly simple. Here are four easy ways to tell when someone isn’t taking our budget problems seriously.

I wondered about his avian taxonomy. There is, of-course another winged species of misguided deficit commentators – the well-known species of “Progressivina Deficit-Dove” (Source). They fit Linden’s description of those “hawks” that “who believe that the long-term deficits pose serious risks, but that short-term deficits are necessary and wise during a recession”. This species claims it is progressive but also pushes the “balanced budget” over the business cycle ambition which is clearly dim-witted as a stand-alone goal and unprogressive in philosophy. Linden slots into this category perfectly.

So how can you tell a “peacock”?

First, Linden says “(t)hey never mention revenues” and:

There are two sides to every balance sheet, and the federal budget is no exception. Deficits occur when spending is too high, but they also happen when revenue levels are too low. The budget deficit in FY 2009 was a whopping 9.9 percent of GDP, the highest it has been since World War II. And that enormous deficit was caused as much by a dramatic decline in tax revenues as it was by an increase in spending. In fact, the size of the revenue decline was four times larger than all of the new spending initiatives started since President Obama took office. Tax revenues in 2009 were at their lowest levels since 1950. When revenues decline by 17 percent, as they did last year, deficits skyrocket.

In an accounting sense, the use of the term balance sheet (which measures stocks – “balances”) to describe a budget (which describes a flow of funds) is worrying. But a minor point. Commentators who claim to be experts often mis-use terminology that they know will not be finely understood by their readers or listeners but which discloses their own less than complete understanding of the matters at hand.

Further, the federal budget is a very special “flow of funds” not like that of a private company or household at all. So to lump the national budget into the same category as “every balance sheet” (meaning private and public – state and federal) is plainly incorrect and fails to acknowledge the “special” nature of the financial capacity of a sovereign currency-issuing government.

There is no meaning in the statement that “deficits occur when spending is too high” or “revenue levels are too low”. The obvious question – in relation to what? Deficits occur in an accounting sense when spending is greater than revenue – that is all you can really say. A deficit can occur when “spending is too low” when you consider the net position in relation to the non-government spending gap (nominal aggregate demand being below that necessary to full employ the productive capacity available at any point in time).

The juxtaposition of nominal demand and real output capacity is the benchmark you have to assess a net budget position.

Linden then says that:

Increasing revenues is going to have to be part of the solution for meeting the fiscal challenge. Any suggestion that we can solve this problem solely by cutting spending reveals an utter misunderstanding or ignorance of the budget numbers. Balancing the budget without raising any additional revenue 10 years from now would require cutting every program in the entire budget by more than 25 percent …

He who calls the kettle black! (that is, making accusations about “ignorance of the budget numbers”).

First, the revenues that he says were lost in the earlier quotation (“the dramatic decline in tax revenues”) will all come flowing back as soon as employment growth is strong enough. That is the nature of the automatic stabilisers.

Second, why is “balancing the budget” being mentioned in this context? I know that his organisation – that fearless progressive defender of American liberty – believes that a balanced budget over the cycle is desirable but they never explain why or what that would mean for other sectors of the economy.

No progressive position – which I define as one which desires an environmentally-sustainable economy producing full employment and price stability with strong equity programs to ensure equal opportunity and zero corporate welfare – would accept a balanced budget as a goal independent of other knowledge.

Possibly, if you had a strong net exports position and you desired less public involvement in the economy you might be able to achieve the progressive goals with a balanced budget over the cycle. A net export surplus over the cycle could allow the private domestic sector to net save on average over the cycle (equivalent to the average external surplus) in this situation.

But this cannot be a standard prescription because by definition (of the accounting relationships between nations – that is, the Balance of Payments) all countries cannot be in external surplus.

For the US and Australia, long-standing external deficits are apparent. So a balanced budget over the cycle target will ensure that the private domestic sector dis-saves (overall) on average equal to that external deficit if the government sector was to achieve balanced budgets over the same cycle.

Does Mr Linden understand that? I don’t detect an understanding from his writing.

So a hawk (or a dove) is “sincerely in favor of balancing the budget necessitates being in favor of raising more revenue” and that awful posturing peacock wants to savage “Social Security, Medicare, and everything else, or else he is just posturing”. From this gender-specific description I concluded all peacocks were males. That about all I could make sense of.

Linden says the second way you can tell a Peacock is that “(t)hey offer easy answers”:

Beware anyone offering easy answers. We face a very large budget gap over the coming decade, and the scale of the problem is such that no one solution is going to solve it all. It is going to take a mix of increased revenues, spending reductions, and improved government efficiency to get our fiscal house in order. Those who claim that we could get the budget back to sustainability if we only cut out earmarks, or say that the solution is to simply freeze discretionary spending, are just peddling fiscal snake oil.

So no ornothology meet herpetology.

The term “budget gap” conveys no meaningful content. In relation to what? A gap usually means a shortfall. So a spending gap is clear – it is defined as nominal aggregate demand being below what is necessary to sustain full employment.

What is a “budget gap”? What is a fiscal house that is in order look like? When is the budget back to sustainability? What does that mean?

To find out what fiscal sustainabilty means in the context of a fiat currency system please read my three-part series – Fiscal sustainability 101 – Part 1Fiscal sustainability 101 – Part 2 – and Fiscal sustainability 101.

You will find nothing there that corresponds with anything that Linden is saying.

He instead lists absolute sizes of net spending – “the budget deficit is likely to average about $900 billion per year over the next five years” – whereas the absolute size is meaningless as a standalone entity. In relation to what? – is the question you always have to ask.

Clearly, if there has been a collapse of private spending and net public spending has filled the gap (or is partially doing so) then as private spending recovers the government has to back off its stimulus. This assumes that the pre-recession balance between private and public is politically desirable. This is one of the reasons I prefer fiscal initiatives to be built into the automatic stabilisers because they are easire to unwind (politically) and need less planning.

I agree that US government spending will probably have to be pared back in some areas once the economy has recovered. But how much is probably a lot less than Linden and the rest of the deficit-terrorists think. They are aiming for a balanced budget whereas on-going deficits are going to be required in the US to support demand and strong employment growth.

So the US government will have to make some cut-backs to accommodate the renewed private spending but how much is uncertain and they should allow the automatic stabilisers to make the initial adjustments anyway so as not to endanger the fiscal support that is currently there (although in decline).

Linden says the third way you can tell a peacock is that “(t)hey support policies that make the long-term deficit problem worse”:

This one seems like it should be obvious, but you might be surprised by the number of people who now claim to be concerned about our fiscal future even though they recently supported massive budget-busting legislation. Congress voted repeatedly over the past eight years to make huge tax cuts and create new spending programs without offsetting any of those costs. Many of the very same members of Congress who voted for those policies are now loudly urging the president to clean up the mess that they themselves made.

This is more balanced budget rhetoric. Clearly, some of the fiscal decisions made in the past might have been ineffective in terms of advancing public purpose and ensuring jobs were available for all. Those spending programs should be deleted immediately.

But the notion new spending decisions “without offsetting any of those costs” is pure conservative or mainstream thinking. What costs are we talking about? The only “costs” that matter when the government decides to spend are the real resources that are used up by the spending. Are they being put to good use? Is the spending straining the supply of real resources? Are there real resources (for example, labour) that could be utilised? They are all sound questions that a fiscal authority has to ask when designing a spending strategy.

But to think that it also has to “offset” its nominal outlays with nominal revenues collections is crazy and misunderstands the macroeconomic role that the spending plays and the way that it creates net financial assets in the non-government sector.

Finally, the fourth way you can apparently identify a peacock is that “(t)hey think our budget woes appeared suddenly in January 2009”:

President Bush inherited a record budget surplus when he took office. Yet he managed to turn that surplus into a massive deficit after repeatedly cutting taxes while prosecuting two wars and enacting billions of dollars worth of new spending programs without paying for any of them. By the time President Obama took office in January 2009, the Congressional Budget Office was projecting a budget deficit of $1.2 trillion for the year. The dramatic decline from record surplus to record deficit under President Bush resulted in a nearly $3 trillion increase in publicly held debt, the largest debt expansion in American history.

Not only did President Obama inherit the least balanced balance sheet in 60 years, he also took office in the midst of the deepest, most dangerous recession since the Great Depression. Running a large budget deficit is both necessary and wise during a recession. The extra spending and reduced taxes that produce big budget deficits help counter the downward recessionary spiral and blunt its negative effects. Yet eight years of fiscal damage left the country in a much weaker position from which to respond to the economic conditions, and left President Obama with far less fiscal room to maneuver.

Yes, President Bush inherited the destructive Clinton surpluses which not only squeezed the private sector of liquidity and set in place the rising private indebtedness but ultimately pushed the US economy into recession in 2001 on the back of the fiscal drag. So he inherited a mess which is exactly the opposite to what Linden is claiming.

Bush did spend freely on stupid wars and tax cuts which were all the neo-liberal rage at the time. But if you consider the macroeconomic state of the economy there is no sense that you can say these deficits were excessive. Unemployment and underemployment were still above the full employment levels and the average inflation rate between 2001 and the end of 2008 was around 2.8 per cent per annum. The latter rose a bit after the 2001 recession but then fell back to low levels in 2006 only to rise again on the back of oil price rises (that is, nothing to do with the budget position) in late 2007 and into 2008.

So I wouldn’t refer to Bush’s time as “fiscal damage”. He had a very poor set of spending priorities – clearly. A terrible approach to lobby groups seeking corporate welfare – definitely. Bush’s regime damaged the US standing in the World by lying about WMD and all the rest of it. But the overall fiscal balance was not a disaster because of its “size”.

Further, the fiscal position from a previous period does not financially lessen or increase the capacity of the government in the present to net spend. It is true that some spending choices or tax changes from a previous regime or period are undesirable in the current period and politically these might be hard to unwind. Politics always overlays the underlying economic opportunities and capacities.

So here we have a progressive think-tank running the conservative line and attacking those weak-kneed, posturing peacocks. Presumably they are differentiating themselves from the peacocks to let people know they are tough policy commentators who know what the game is about.

Peacocks, hawks, doves – anyone who advocates balancing a national government budget without telling you what the sectoral implications would be under what circumstances – are all in the same misguided camp.

Linden went on to push the conservative “twin deficits” argument which I will write about separately. He also tried to maintain support for Obama (after inferring his “spending freeze” was the strut of the peacock”) by saying Bush as mostly to blame.

Anyway, he closes by suggesting we pose the four questions to anyway who is talking about the deficit and if they answer yes to any of them then “you’ve identified a deficit peacock”. I think the only thing we can conclude from this is that Linden is a turkey.

Paul Krugman also wrote about the peacock-hawk story on January 28, 2010 in his March of the Peacocks article.

He described Linden’s piece as an “acerbic essay” and says that Obama’s suggestion to do “the deficit-peacock strut” (meaning his proposed freeze on spending which he announced in the SOU address) is “such a dumb policy idea” and “an indication of the extent to which we’re failing to come to grips with our economic and fiscal problems”.

Certainly we can agree with that assessment.

Krugman then reminds us of the real issues:

The nature of America’s troubles is easy to state. We’re in the aftermath of a severe financial crisis, which has led to mass job destruction. The only thing that’s keeping us from sliding into a second Great Depression is deficit spending. And right now we need more of that deficit spending because millions of American lives are being blighted by high unemployment, and the government should be doing everything it can to bring unemployment down.

Ain’t that the truth. The primary responsibility of a national currency-issuing government is to ensure that there is sufficient aggregate demand which, in turn, maintains high levels of employment. Poverty is primarily caused by unemployment. Governments should do other things as well but from a macroeconomics perspective they are deficient in their duty if they don’t keep demand growth high.

They have several tools that they can deploy to do that and by far the most effective is fiscal policy. If you want to contract fiscal policy when you have a serious demand deficiency then you are arguing for high unemployment, high income losses, higher poverty rates and, ultimately, slower future growth (given that capacity atrophies when investment slows down).

After that, Krugman immediately loses the plot:

In the long run, however, even the U.S. government has to pay its way. And the long-run budget outlook was dire even before the recent surge in the deficit, mainly because of inexorably rising health care costs. Looking ahead, we’re going to have to find a way to run smaller, not larger, deficits.

Whatever the long run is the US government doesn’t have to “pay its way” in any sense that we understand from our own household experience. All households have to “pay their way” in one way or another but the US government could if it wanted to stop issuing debt (if it thought that was a problem) and keep spending the currency it issues.

At some point this might debase the currency through accelerating inflation but then why would a sensible government choose to do that. There is no such thing as a dire budget (refer back to my comments above on the “troubled” budget). These adjectives have no descriptive content when considering what a fiscal position represents.

If it is true that rising health care investments (I prefer that concept to “costs”) may absorb an ever-increasing proportion of the government spending. Every generation can choose its won spending composition and its own tax regime. It may be that Americans become collectively enlightened as some of the real resource choices start to bite – like do we invade country X or provide better health care given the real resources available?

But as long as there are real resources available for sale in US dollars then the US national government will be able to purchase them with US dollars. If it needed to cut its net spending because the economy was inflating (and it desired to maintain the private command of “full employment” resource-usage) then it could unwind its destructive military complex as a good starting point. That would quickly reduce nominal aggregate demand and probably make the World a safer place.

As noted above, when private spending collapses and net public spending steps up to fill the gap (through a mix of automatic stabilisers and discretionary policy changes), then the latter has to back off as the private spending recovers. This assumes that the pre-recession balance between private and public is politically desirable. Politics can surely get in the way of this process and my understanding of US politics at present (as an outsider) is that the system is basically dysfunctional.

This is one of the reasons I prefer fiscal initiatives to be built into the automatic stabilisers because they are easire to unwind (politically) and need less planning.

So the Job Guarantee approach exemplifies that. The government offers a minimum wage job to anyone who wants one and allows the pool to fluctuate up and down with private demand. That sort of program – based on a buffer stock – is always counter-cyclical (as is desired) and allows deficit spending to contract when required by the strength of private demand.

On this theme, Krugman says:

How can this apparent conflict between short-run needs and long-run responsibilities be resolved? Intellectually, it’s not hard at all. We should combine actions that create jobs now with other actions that will reduce deficits later … The sad truth, however, is that our political system doesn’t seem capable of doing what’s necessary.

This comment reflects that fact that the initial Obama stimulus “wasn’t nearly big enough” and as it fades, the US will still be facing “years of mass unemployment”. However, “there is little sentiment in Congress for any major new job-creation efforts”.

I agree with this point – the politics are the problem. That is a totally different way of understanding the problem. It directs us away from an obsession with an imagined “fiscal problem”.


Neither the Center for American Progress or Paul Krugman’s ideas on government budgets represent a progressive position at all. The former are just mouthpieces for the deficit-terrorist cause.

That is enough for today!

Other blogs in this series

=> When you’ve got friends like this … Part 1

=> The enemies from within

This Post Has 24 Comments

  1. Bill, while I understand that MMT under a fiat currency regime makes deficits less relevant, I disagree on the desirability of increasing the govt share of the consumption pie in order to maximize some generic employment component of the economy (employment digging ditches in not productive while employment working in a biotech lab may be, even if it takes an extra few months of searching in order to utilize the human capital).

    But that being said, allow me to better understand the MMT view on deficits and interest rates. Your view is that deficits don’t matter because the govt essentially creates that money by crediting accounts of the recipients of spending; those $’s have to go somewhere and so they end up financing the deficit (after they have circulated throughout the economy). Essentially the deficit finances itself because the money created needs to eventually end up in a financial asset of some maturity (cash being the shortest duration while 30 year bond the longest).

    But what is the reason for the spread in LT vs. ST interest rates- pure inflationary expectations? If that is the explanation would one not be justified to expect that higher current deficits in order to incite “growth” will lead to inflation? Thus, are not higher interest rates the indirect result of deficits? And don’t higher interest rates impact investment decisions? I believe your answer to this last question is: NO but I would have to disagree because whenever I have contemplated an investment I have compared it to the return on capital I would get from a risk free investment (treasuries) to see if I am being sufficiently compensated for the risk. Curious your views on this matter. Thx.

  2. Yossarian, I disagree on the desirability of increasing the govt share of the consumption pie

    This is a political question. MMT’ers don’t all agree about this division but they do agree on the principles underlying now the monetary system works in relation to the economy. The understanding makes various options possible. For example, Warren Mosler takes a generally more conservative position that Bill. However, both agree that that a job guarantee is a good idea based on the economics, politics aside. Why, because it grows the pie. A lot of things that government can do with its monetary authority involve wise investments that increase the pie. The idea that government must take from the pie when it disburses funds that it creates through currency issuance is just not reality-based.

    Warren observes that government should be of the right size to do what it needs to do to meet public purpose, in the US, to “promote the general welfare” (Preamble). It is a vacuous presumption that “small government” is to be preferred over “big government,” whatever that means. We need the right size government to do what the people decide through their elected representatives they want it to do. That is a political decision, which if taken through informed deliberation, requires a sound understanding of reality-based monetary economics along with other essentials for proper understanding.

    “Efficiency is doing things right; effectiveness is doing the right things.” Peter F. Drucker

  3. Yossarian, I’ll leave it to an economist to address you concern about deficits and inflationary expectations. However, I will point out that this is at the basis of the political kertuffle in the US at the moment. Bond holders want inflationary expectations controlled, so they and their cohort are all talking “fiscal responsibility” even at a time when the output gap is still wide and unemployment has not yet even turned around.

    Why should there be concern about controlling “inflationary expectations” that are not even materializing, and when there are not any signs that inflation will soon materialize other than theoretical, especially when a large portion of the populace is suffering miserably, and another large portion living in fear that they will be soon be in the same boat?

    Not mention the huge economic cost in foregone opportunity owing to the wide output gap and the cost in idle human capital and deteriorating human resources.

    Do you see any difference in proportionality here between this and your investment concerns?

  4. Tom, forget our disagreement on the virtues of govt involvement in the economy and let’s focus on interest rates. Since $’s are the shortest term financial assets and the govt can essentially create $”s (or $ credits in an accounting ledger) by running deficits then those fiat financial assets must always exist- the only question is: in what form? Mind you I am not making a statement here- it is more of a question so that I can think through the MMT.

    Since the deficit is self-financing (money created is equal to the demand for US govt debt assets) the only question seems to be: in what US govt financial product will the new money be held? That is: T-Bills, 2yr, 10yr, TIPS, 30yr, etc. Inevitably that is the only option as the money will always end up in some bank account and be put to use. So the deficit spending will always be financed- that is a constant as long as the govt fiat is respected- but the shape of the yield curve is the variable?

    I know this is the simplified version because it ignores the fact that banks create money through credit (bank lending causes money growth and not vice versa) and also destroy it when they (along with reluctant potential borrowers) contract credit. So if govt is creating money through deficit spending but the financial system is still contracting the money supply then there is less net demand for us govt financial products (an investor has to keep more cash on hand in order to buy the same quantity of Treasuries) and interest rates rise depending on the preferred duration. So I guess interest rates are the result of inflationary expectations combined with credit conditions (perceived risk of lending/borrowing).

    Thus higher spending that is deemed inflationary will lead to higher rates but higher spending that expands productivity and is thus non-inflationary will not lead to higher rates. Different people with different views on the productivity of incremental deficit spending will consequently have different interest rate expectations. Furthermore, one with an optimistic view of real growth and the cash flows that result from it will have lower interest rate expectations (for Treasuries) because they would expect increased credit growth to bring about money supply growth and thus more demand for Treasury products.

    Make sense?

  5. Here’s how to abolish the deficit without reducing AD.

    Assuming no deficit, government spends $x per annum and collects $x in tax pa.

    Assume total govt spending is still £x pa, and that govt starts to run a deficit of $y pa. This involves printing $y pa (instead of collecting the relevance chunk of money in tax) and inducing citizens to buy $y pa of govt debt: that effectively stops citizens spending the $y.

    AD remains the same and living standards remain the same.

    Now for the $64,000,000 question: how do we reverse the process? Personally I can’t see the problem.

    The solution is simply to raise taxes by $y pa, stop printing $y pa, and stop issuing $y pa of govt debt / Treasuries or whatever you want to call them.

    Note that I have two simplifying assumptions. First I’ve ignored any deficit that is totally unfunded. This equates to the annual rise in the monetary base. This averages roughly 5% of the monetary base pa, though this figure was much larger, quite rightly, in 2009.

    Second, I have assumed that Keynsian “borrow and spend” is totally ineffective because any stimulatory effect of this policy is totally negated by crowding out.

    No apologies are offered for the simplifying assumptions because when you are trying to solve a problem, always start with the simplest possible case of the problem. Then gradually introduce complexities.

    How much out of ten do I get for that?

  6. Yossarian, I agree, a lot of scenarios “make sense” in terms of inflationary expectations, including the absolute size of the deficit and national debt, depending on what “makes sense” means for them. One can construct a rationale for just about anything, either out of ignorance or disingenuously to “talk one’s book” in a self-serving way.

    Assuming “makes sense” in terms of what MMT says about how the monetary system actually works, there are a lot of factors involved, including commercial bank lending, which controls the (bank) money supply and is interest-rate sensitive because bank money is created by lending. Commercial bank lending is pretty much beyond the direct control of the government, but governmment does have some levers that work in normal circumstances, chiefly controlling the overnight interbank rate. However, with commercial lending pretty much out of the picture now, the focus is on government action. This says something very important about a realistic assessment of inflationary expectations, since inflation generally results from commercial lending at the height of a boom, and this lending contracts in the following bust, as now. Reasonable people would see the consequent government action as an attempt in extremis to restore nominal aggregate demand and prevent deflation from spiraling. Some are confident that this has happened already. I am not one of them.

    Regarding government action and MMT, as I said, I’ll let one of the economists deal with the details. But the general MMT principle is that deficits create reserves as assets of commercial banks when the Treasury’s checks clear, and excess reserves depress the interest rate in the interbank overnight market, driving it toward zero, unless the Fed takes steps to drain the excess reserves through OMO if the Treasury would not issue corresponding Treasury securities or the Fed does not offer a support rate for the excess reserves instead. However, in the US the current law requires a debt offset. These securities issued in offset exactly equal the amount of deficit by law, and their sale drains the exact amount of reserves created by the deficit disbursements, allowing the Fed to hit its target rate with minimal OMO, even when the Treasury is injecting substantial funds into the economy. The Treasury/Fed decide the composition of the securities issued in terms of different rates and maturities. Note that this issuance of securities is subsequent to the disbursements and is not needed to “finance” the deficit.

    The government is able to influence the yield curve by the several means, e.g., the proportion of LT and ST securities issued. The government can roll over its debt with ST T-bills if it choses, for instance. The Fed can also purchase LT securities to flatten the LT curve as it wishes, as it has been doing to keep mortgage rates low in order to facilitate housing sales and support housing prices. In extremis, like now, it can also purchase securities other than Treasuries, and this influences the bond market also. While this is a called “Quantitative Easing,” it doesn’t add NFA, since it is just the switch of one asset (bond) for another (corresponding bank reserve). It’s a liquidity operation. But government bond purchases do affect bond rates in that sector. A lot of the talk about inflationary expectations has been gas because it has been based on theory that makes perfect sense but was just wrong.

    As über-bond guru Bill Gross said, “Follow the government.” PIMCO has made a lot of money doing just that, knowing that the government would act to keep rates low, thereby raising bond prices. Of course, as the government perceives recovery developing, it will change this policy, and interest rates will rise somewhat, e.g., as the Fed winds down QE and starts draining some of the liquidity it created in extremis. However, this rise will not be due to true “inflationary expectations,” but rather a return in the direction of normalcy. But as Gross says, it’s anyone’s guess as to what the “new normal” will be, with most economists foreseeing weak demand, increased consumer propensity to save, and chronic structural unemployment ahead for some time to come. Doesn’t sound very inflationary to me.

    A further point about inflationary expectations and being disingenuous. Military spending and especially war are inflationary because they generate government disbursements that create reserves, which are not offset by domestic production or exports. This injects huge sums into the economy that don’t have any corresponding goods and services to buy to exports to sell, increasing NAD in relation to real output for purchase. No one makes a peep about this. But when it comes to government “spending” on social programs, the howls arise about looming hyperinflation, even when those programs are designed to increase NAD in the face of deflation, recession, and rising unemployment. Purely ideological and without basis in fact.

  7. Real quick because I’m strapped for time and can discuss this all day:

    -Open Mkt Operations are no longer necessary to set the Fed Funds Rate as The Fed now pays interest on reserves (the new mechanism)

    -if you redistribute capital away from those who add to the productivity of an economy and towards those who aren’t nearly as productive (which happens more often than not in my view, not your’s) then you end up with higher demand and lower supply (bad inflation).

    -I agree that some of the defense spending may fall in the unproductive category, just as breaking windows and then fixing them, digging ditches, building pyramids, and paying people to paint murals on buildings would. But as far as defense spending legitimately adds to security and allows for free trade (which the dominance of the US Navy has certainly done successfully) it is productive. This is a complex issue of national security and an entirely different debate. I tend to be more non-interventionist than most but I can see both sides and don’t have strong opinions on this matter the way I do with domestic policy issues.

  8. Apparently, It’s “a no brainer”

    “Deficits are like putting dynamite in the hands of children,” Taleb said in an interview with Bloomberg Television. “They can get out of control very quickly.”

    Should be hyperjailed !

  9. Yossarian: -Open Mkt Operations are no longer necessary to set the Fed Funds Rate as The Fed now pays interest on reserves (the new mechanism)

    Some time ago, Randy Wray proposed that the Congress not raise the debt limit, since it isn’t necessary financially to issue debt to “finance” deficits. The same monetary operation that debt issuing achieves can be accomplished by paying a support rate on reserves, as the Fed is now doing.


    -if you redistribute capital away from those who add to the productivity of an economy and towards those who aren’t nearly as productive (which happens more often than not in my view, not your’s) then you end up with higher demand and lower supply (bad inflation).

    No need to redistribute, since taxes don’t fund deficits under the present fiat system. You seem to be presuming that there is a fixed stock of money as was the case under the convertible fixed rate currency. This is no longer the case. The government simply issues currency to reimburse the labor it hires to do productive work for the commons comparable to the WPA and CCC. The government is not competing with anyone since these are people who want to work when no one wants to hire them. The government is neither competing with the private sector, nor offering a better deal. Where’s the redistribution here? More paid service jobs are created that add to NAD but they also create corresponding value, and I would bet that the value the WPA and CCC created was a lot more than the wages paid. In many cases, this investment is still paying off, if you watched the Ken Burns PBS magnum opus on the development of the national parks.

    -I agree that some of the defense spending may fall in the unproductive category, just as breaking windows and then fixing them, digging ditches, building pyramids, and paying people to paint murals on buildings would. But as far as defense spending legitimately adds to security and allows for free trade (which the dominance of the US Navy has certainly done successfully) it is productive. This is a complex issue of national security and an entirely different debate. I tend to be more non-interventionist than most but I can see both sides and don’t have strong opinions on this matter the way I do with domestic policy issues.

    The strongest argument for the contribution of defense spending is the technological advances that are the by-product. Technically speaking, the interstate highway system begun under Ike was justified as a contribution to national defense. Look how that investment paid off.

    But my point in bringing up defense is that the fiscal scolds are only concerned about the supposed inflationary effects of social spending, even though defense spending is manifestly inflationary. This is disingenuous. Of course, they would argue that defense is necessary and social spending is discretionary. I and many others would disagree and provide good reasons for for holding that necessary social spending is mandated by the Constitution as much as national defense, as well as being good economics. Redistribution arguments against social spending generally depend on there being a fixed stock of money, when we are no longer there.

  10. > Taleb Says `Every Human’ Should Short U.S. Treasuries

    How practical is that? There are 7 Billions humans. Of those, how many know what a US Treasury is, let alone what it means to short it, and actually have access to a sophisticated brokerage account. E-ve-ry human I tell you, spread the word!

  11. Cityislander,

    It is impossible! Even if a small fraction of the market decides to short Treasuries, the rest of the market would not allow it to do so! The repurchase market (not the one involving the Federal Reserve) is what one can use to short Treasuries. Usually, this market is used to borrow “cash” and the security is just a collateral. However, if the security is the one which is demanded, the repo is said to be on special. The interest paid on the “cash” is lower than the highest repo rate in the market because the lender of the Treasury will want to invest the cash somewhere else and earn a rent. It is better to think of a repo rate for each security than one single number for the market. A sudden increase in the demand to borrow Treasuries, in order to short sell will send the repo rates deeply into the negative territory. Since it is less likely to happen that Treasuries’ prices fall, it will create a rally in the market when the shorts try to cover their positions. There are rules for fails on the repo and they have been tightened since the fall of Lehman. Any attempt to go short is highly dangerous!

    Taleb has been trying to fear-monger since a long time. I think he is heavily short on Treasuries and has lost a lot I would imagine. This seems like a desperate attempt to recover his losses.

    Here’s another article which came out in June 2009. http://seekingalpha.com/article/141286-julian-robertson-bets-the-farm-on-inflation

  12. With unemployment at around 10% in the USA, why isn’t the idea of fewer workers instead of more jobs discussed more?

  13. With unemployment at around 10% in the USA, why isn’t the idea of fewer workers instead of more jobs discussed more?

    Business and Wall Street are quite happy with this arrangement, since productivity and corporate profits are up due to layoffs and declining wages. More jobs are becoming superfluous as companies trim, automate and offshore. Moreover, capital is fleeing the developed countries for emerging nations, where growth is faster paced and investment opportunities better.

    The question now is what to do with the labor “surplus” building up in developed countries and turning into a glut, resulting in structural unemployment and creating conditions approaching what has previously been the case only in underdeveloped countries. At least guard labor is booming, as would be expected, with the have’s increasingly feeling the need to isolate and protect themselves from the have-not’s.

    President Obama has recognized this problem and is addressing it to some degree, although not to the degree necessary, owing in no small part to political resistance to government action. There is also a lack of understanding of how the monetary system operates, and so many options are excluded by the prevailing idea that government must “finance” its spending. A great deal of the problem is just bad economics, as Bill has been pointing out relentlessly. Evolutionary biologist David Sloan Wilson takes a look at it from his perspective in Economics and Evolution as Different Paradigms III: The Case of Norms. Are we at an evolutionary plateau, about to become a dead end of history, or can we adapt? It’s now a tug of war between those who want to return to the 19th century and relive Dickensian times, expecting a different outcome this time, and those who want to enter the 21st and create an environmentally sustainable economy that fosters national prosperity and progress in an equitable way.

  14. > I and many others would disagree and provide good reasons for for holding that necessary social spending is mandated by the Constitution as much as national defense, as well as being good economics.

    Didn’t NZ give up its air force a few years ago? and Costa Rica the entire armed forces altogether in favor of education and other social programs? I can think a few culinary-clueless (and rainy?) countries that therefore don’t risk jealousy from external forces who should do the same ;-).

  15. I read both of Talebs books last summer and learned a whole lot about uncertainty and randomness from both of them. I have found him to be extremely bright and he understood the nature of our crisis well I believe. He is definitely a high grade thinker but it sounds like he is stuck in the wrong paradigm in our current currency regime. Peter Schiff is the same way. He knew there was a problem but he had the wrong prescription. Good diagnosticians may not know the best treatment.

    Is part of the problem with our world currencies that some are pegged, some are free floating while some are commodity backed? Would we be better off if ALL sovereigns issued their own free floating fiat currency? Not at all suggesting a one world currency but a one method of valuation.

  16. Greg,

    As you probably know, NT’s big thing is that people underprice Black-Swans, i.e. large and rare events, due to a variety of cognitive or institutional biases that underestimate the chaotic nature of the world that surrounds us. But I haven’t seen much cogent macro-economic analysis coming from him. So where does his prediction of hyper-inflation come from, a gut feeling?

  17. I cant say where his prediction comes from. I’ve never heard him make that statement. Every time Ive seen him talk its been about his book and our cognitive biases regarding risk assessment. Again I think he knows that subject well, but macroeconomics is not his area of expertise. He has predicted that without significant changes to the way we think about risk we will have repeat of ’07-’08 down the road. I dont think he is wrong here.
    He advocates boring banks and significant oversight of our financial institutions, nothing whacko there.

    Lots of people have been screaming hyperinflation, we’ll just add his voice to the pile. He should still be listened to in other areas though.

  18. Greg,

    I agree that we should listen to him and dissenting voices in general, but critically, which is different from dismissing them.

    For example, he takes great pain at refuting criticism such as when told that there are counter-example to his claim (in his book) that nobody predicted the fall of the USSR, that, well, it proves his point because it’s not statistically significant. Let’s see :

    In 1975, Emmanuel Todd predicted the decline and fall of the Soviet Union, drawing on research from cultural anthropology and demography as well as economics. At the time his findings challenged a conventional wisdom that saw in the Communist world a dynamic and growing challenge to the West. Generations of Kremlinologists may not have known much, but they knew that Todd was wrong – until 1989, that is, when conventional wisdom retired hurt.

    The number of scientists may be statistically insignificant, but what matters is whether or not the content of the above thesis is significant, because one of the premise of the Black Swan (the book) is that they (rare & large events) simply cannot be predicted. But let’s stick to the not statistically significant line of thought : E.Todd is an outlier. Now, here’s what he tells Tyler Cowen :

    The results Cowen refers to may hold solely in a very narrow subset of index options (not stock options), which requires excluding the crash of 1987, and ignoring the impact of the errors

    Double standards? He would probably argue that E.Todd was a rare but not large event, whereas 1987 was a rare and large event. But what if the institutions that govern us could be trained to correct their biases listen to the E.Todd’s of the world, then recognition of the impending fall of the USSR would have changed the course of history (one benefit is that it would have spared us the star wars propaganda).

    But let’s get back to hyper-inflation. His claim is that we don’t see the non-linearities i.e. when hyper-inflation kicks in, it will be too late to do anything about it, exactly the opposite -I hope I’m paraphrasing correctly- of what Bill claims for non-revenue constrained nations. For now I see that Bill has a theory about it, not Taleb. So it’s going to be very interesting to see how the future unfolds.

  19. Hi Bill –
    I’m trying to understand the key points of MMT. I thought one of them was this, from above:

    “Whatever the long run is the US government doesn’t have to “pay its way” in any sense that we understand from our own household experience. All households have to “pay their way” in one way or another but the US government could if it wanted to stop issuing debt (if it thought that was a problem) and keep spending the currency it issues.”

    there is a repeated hammering that government debt is different from household debt, and that the government doesn’t need to “fund” its spending – fine. Ok – I understand that. The alternative is for the government to just create more money and spend it…. In the line following the quote I just excerpted, though, you continue:

    “At some point this might debase the currency through accelerating inflation but then why would a sensible government choose to do that.” -ok – now this is the fear of non-understanders (like me) – creation of more money –> inflation.

    what i don’t get is that you seemed to have just argued “if it would cause inflation, then any sensible government wouldn’t do it.”

    what if we (“we” being the government) don’t have a choice? what if, to take it back to the real world – China wants their money back – instead of rolling their debt holdings, they decide to reduce them. We might “just create more money and spend,” right, and then “debase the currency through accelerating inflation,” right? and when i say “we might” i really mean “we WILL.”

    thanks in advance.

  20. i have one more question while I’m at it regarding full employment. I believe it was mentioned that a goal of MMT/CoFFEE is full employment (which is admirable – no one would really argue that full employment would be bad!). Doesn’t employment have to be “economically” efficient – whatever that means? Said differently, I read on another one of your pages that you advocate a jobs pool which would guarantee a minimum wage job to anyone who wanted one. If minimum wage jobs are good, then wouldn’t DOUBLE minimum wage jobs be better? (i hope the answer is as simple as “no, because that would result in all private sector minimum wage job earners leaving their jobs for Federal double-minimum wage jobs)….. ok – so hopefully that was an easy question… now the next one:

    if the government provides guaranteed jobs for people, and these jobs are digging holes and filling them back in (in other words – NON productive jobs) – is that still good by your model? If so, why bother to even make them dig the holes? why not just pay them the money to NOT dig the holes (never mind the fact that this sounds a lot like unemployment insurance!)

    i think it’s an important point because any job the government creates, while hopefully not being as unproductive as digging holes and filling them back in, is almost CERTAIN to have some degree of non-productivity or non-efficiency or non-economicallity (or whatever we want to call it) to it.

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