It is going to be brief today – it is a holiday in Australia. Queen’s Birthday no less. Can you believe that we are still under the yoke of our colonial masters? Anyway, a winter’s holiday – pouring rain and cold. But I read a couple of things today which I thought were worth interrupting other work to write about as they establish some general principles relevant to understanding Modern Monetary Theory (MMT). The discussion also highlights the recurrent nature of the prophecies of doom – that come from the likes of the Peter G. Peterson foundation now but others in the past. We were told in the 1930s that profligate governments would go bankrupt. They didn’t but when they cut back there economies went broke. The Japanese government was predicted to become insolvent in the 1990s along with hyperinflation and skyrocketing interest rates. Nothing happened other than the fiscal austerity that was imposed as a result of the political pressure arising from these predictions sent the economy back into recession. Same as now … fiscal austerity – imposed because allegedly budgets are unsustainable – will drive economies back towards and into recession. When will we ever learn?

Several readers have written to me asking me to comment on a recent paper that the New York Federal Reserve released as a Staff Report (May 2011) – A Note on Bank Lending in Times of Large Bank Reserves. Apparently, there is an impression that the federal reserve economists might be seeing the light a bit about the banking system and the way economists think about it. The reason that some readers have concluded that is because the substantive conclusion of the paper is that credit expansion is independent of the level of banking reserves held at the central bank. This conclusion is totally consistent with Modern Monetary Theory (MMT) but is at odds with the standard mainstream macroeconomic view (as taught in textbooks) that relies on the money multiplier to draw a (spurious) connection between bank reserves and the money supply. As you will see – my advice is to be very careful when reading such papers – they are not what they seem. The FRNY paper reaches the correct conclusion using erroneous theory which they partition as a special case arising from the extreme circumstances surrounding the crisis. Even in defining their “model” as a special case, they employ flawed logic. It is a case of being beware of the wolf in sheep’s clothing.

Some years ago – I did not have sexual relations with that woman – were the famous words that seemed to redefine everything we had come to think of sexual relations between two consenting partners. Suddenly we could have sexual relations without having them. The same person has come up with a new conclusion – the US never ran “permanent structural deficits of any size before 1981”. Hmm, you mean that for 84 per cent of those years from 1930 when the US federal government ran deficits they were just cyclical events indicating deteriorating economic conditions? Maybe the former president might say a structural deficit equivalent to 3 per cent of GDP was not of “any size”. My conclusion is different – that this statement like the previous one was another case of a former US president making things up.

The US press was awash with claims over the weekend that the US was “living beyond” its “means” and that “will not be viable for a whole lot longer”. One senior US central banker claimed that the way to resolve the sluggish growth was to increase interest rates to ensure people would save. Funny, the same person also wants fiscal policy to contract. Another fiscal contraction expansion zealot. Pity it only kills growth. Another commentator – chose, lazily – to be the mouthpiece for the conservative lobby and wrote a book review that focused on the scary and exploding public debt levels. Apparently, this public debt tells us that the US is living beyond its means. Well, when I look at the data I see around 16 per cent of available labour idle in the US and capacity utilisation rates that are still very low. That tells me that there is a lot of “means” available to be called into production to generate incomes and prosperity. A national government doesn’t really have any “means”. It needs to spend to get hold off the means (production resources). Given the idle labour and low capacity utilisation rates the government in the US is clearly not spending enough. The US is currently living well below its means. But the US government can always buy any “means” that are available for sale in US dollars and if there is insufficient demand for these resources emanating from the non-government sector then the US government can bring those idle “means” into productive use any time it chooses.

Let Peter Costello work his magic at IMF – mounted a case for our former Treasurer (one of the worst this country has ever had) should get the baton and head to Washington. The problem is that Costello left a destructive mess in his wake and is a budget surplus obsessive. What the IMF needs is a budget deficit-biased head.

More rate rises on the way: economists – where various “leading” bank economists were interviewed about the release of the minutes from the last month’s Monetary Policy Meeting of the Reserve Bank Board and the pending release of today’s wage cost data from the Australian Bureau of Statistics. I heard that we are facing rising wage pressures which would force the RBA to hike interest rates soon and that increased fiscal rectitude was required to ease inflationary pressures. I checked the station to make sure I wasn’t receiving some short-wave radio station from an unknown planet somewhere. As it turned out I disagreed with everything my bank colleagues said which is no surprise. But I decided then to call today’s blog – “They will print low” – which was part a reflection of the opaque jargon these bank economists use to convince themselves that they have something important to say and partly my forecast for today’s wage data.

Der Spiegel carried the story (May 6, 2011) – Greece Considers Exit from Euro Zone. I thought that if the story was true then Greek leadership must finally be coming to their senses. The reality is that the EMU bosses have once again stalled the judgement day and provided some soft relief for an economy that continues to deteriorate. Everyone knows what the problem is – the EMU doesn’t work and without a federal fiscal redistribution mechanism it will never be able to deliver prosperity. Every time an asymmetric demand shock hits the Eurozone, the weaker nations will fail. Trying to impose fiscal rules and austerity onto the EMU monetary system just makes matters worse. Greece should definitely leave the Eurozone. Life will be difficult then but the adjustment mechanisms that would then be available to the government (floating exchange rate and currency monopoly) are more people-friendly (capable of increasing jobs and income) than the way they are currently pursuing the problem (internal devaluation and demand contraction). Europe continues to demonstrate it has no answers worth considering.