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

Today, I offer Part 2 of my responses to the comments raised in the debate so far. I am still about 40 comments shy of the total. In general, I thank Scott, JKH, Ramanan, Sean and others who have provided excellent interventions into this debate based on their knowledge of how the monetary system actually works rather than a stylised representation of it which leaves out the government sector and is liberal with the accounting conventions applied to account for asset and liability flows and flow to stock relations. But there still appears to be major confusions which I will try to address here.

Today, we step down from the heights of the modern money-debt deflation debate and consider macroeconomic developments which demonstrate the deficit-debt hysteria is ramping up here. I may come back to the debate in later blogs but I think the issues have been well considered. While the debate has uncovered some useful issues that I often get asked about (particularly in relation to the accounting and definitional matters) it also demonstrated that very simple and unthreatening concepts get conflated into horror stories if we let the dominant neo-liberal ideology control the way we think and the language we use. Also, I know I promised a G-20-IMF blog and that will emerge but some things emerged today that need commentary.

As indicated yesterday, Steve Keen and I agreed to foster a debate about where modern monetary theory sits with his work on debt-deflation. So yesterday his blog carried the following post, which included a 1000-odd word precis written by me describing what I see as the essential characteristics of modern monetary theory. The discussion is on-going on that site and I invite you to follow it if you are interested. Rather than comment on all the comments over on Steve’s site, I decided to collate them here (in part) and help develop the understanding that way. That is what follows today.

Readers of my blog often ask me about how modern monetary theory sits with the views of the debt-deflationists (and specifically my academic colleague Steve Keen). Steve and I have collaborated in the last few days to foster some debate between us on a constructive level with the aim of demonstrating that the common enemy is mainstream macroeconomics and that progressive thinkers should target that school of thought rather than looking within.

Household saving ratios (saving as a percentage of disposable income) have risen significantly in most countries since the onset of the recession. In many countries this has come after a period of increasing indebtedness as national governments pursued budget surpluses. As a result, the macroeconomic concept of the paradox of thrift has been resurrected in the popular press as a discussion point. There are fears that the end of the “consumer boom” will lead to stagnancy. A recently published IMF paper addresses this point but just cannot let themselves address the elephant in the room. They present a new way version of deficit hysteria.

Today we go into the kitchen cupboard for a lesson in macroeconomics. That is according to the main economics writer of the Sydney Morning Herald, which is published in a city of over 4 million people. The reality is that while we are encouraged to get our heads into the cupboard, all we succeed in doing is further obscuring any understanding at all of how budgets work and the opportunities and capacities of a sovereign government operating within a fiat monetary system. We were really scraping the barrel today!

This week’s Economist Magazine (print edition) is running a story Making fiscal policy credible – Bind games, continues the mounting conservative push for governments to return fiscal conduct back to the days before the crisis. The conservatives (except the really loopy ones) are begrudgingly being forced to recognise that the fiscal stimulus packages have saved the World economy from a total disaster. But after taking a deep breath they get back on track with the “debt is bad” “surplus is good” mantra that got us into this mess in the first place.

Mostly, financial markets (the wealth shuffling casino) and the real economy (where people live and work) run as parallel universes. But occasionally as in the case of the GFC morphing into a full-blown real crisis with massive income and job losses the two merge. In many cases the merger is driven by a poor understanding of the way the fiat monetary system operates. As a consequence we get decisions taking by the gamblers (they prefer to be called speculators – it sounds better) based on faulty analysis of how the econmy works, pushing asset prices up (or down) which in turn affect the way governments are reacting to the “real crisis”. The surge in gold prices in the last few days might be an example of that.

On July 8, 2009 a world first occurred in Sweden when the Swedish Riksbank (its central bank) made announced that its deposit interest rate would be set at minus 0.25. While this has set the cat among the pidgeons around the financial markets, it is a classic example of “central banking gone crazy” or more politely “quantitative easing on steroids”. The only problem is that performance enhancing drugs seem to make athletes ride or run faster. This move will do very little to make the Swedish economy increase output or employ more people. For a background to my analysis on this event in central banking history you might like to read my blog – Quantitative Easing 101.

I saw the latest Government Finance Statistics released by the ABS today just after I read the Financial Times where there was an article by former Cambridge Professor of Modern History, Peter Clarke entitled This is no time to throw away the crutches. There was a symbiosis in time. Then I read all the geeing up that is going on about rising manufacturing output in China and Japan and the News Limited themes that we have to get interest rates up sooner rather than later or the inflation genie will escape and I remembered the real world.

I have been intrigued with Japan for many years. It probably started with the post-war hostility towards them by the soldiers who saw the worst of them. The Anzac tradition was very unkind to Japan and its modern generations. It always puzzled me how we could hate them so much yet rely on them for our Post-World War II boom. I also thought we owed them something for being part of the political axis that dropped the first and only nuclear weapon on defenceless citizens when the war was over anyway. Whatever, I have long studied the nation and its economy. So yesterday’s election outcome certainly exercises the mind. Will it be a paradigm shift or a frustrating period where an ostensibly social democratic government runs up against the neo-liberal machine? I put these thoughts together about while travelling to and from Sydney on the train today.

In today’s Australian newspaper ex Federal Treasury official Tony Makin writes that We keep repeating Keynes’s mistakes. Do we now? The story is a litany of half-truths and basic conceptual errors. He is now a professor of economics. Bad luck for his students. The article, one of a regular contribution he makes to the increasingly squawking right-wing News Limited daily, is a classic example of how to deceive the public with spurious economic reasoning – that the author knows most of the public will just accept without question.

In yesterday’s (August 23 2009) Financial Times, so-called financial markets expert Nouriel Roubini wrote that The risk of a double-dip recession is rising. The American academic was recently in Australia as a speaker at the Diggers & Dealers Forum which is an annual mining conference. The problem is that Roubini is an influential advisor to the US Government and so will have a hand in determining the direction of fiscal policy. He continually demonstrates, however, that he does not understand how the fiat monetary system operates and in that context becomes part of the problem.

Someone wrote to me today and said they had been reading Paul Krugman’s 1999 book Peddling Prosperity, where he presents the now-famous baby-sitting model. You can read a shortened version of the model HERE. The reader asked me whether the model had any relevance to modern monetary theory. The short answer: yes but not necessarily in the way Krugman thinks (he is still locked into gold standard thinking).

I am catching up on the mountains of things I have to read. It is a pointless task – the pile rises faster than my eyes can process it. But I try. There was an article in the June 25, 2009 edition of The Economist entitled A slow-burning fuse, which carried the by-line “Age is creeping up on the world, and any moment now it will begin to show. The consequences will be scary”. It definitely might be scary getting old but the discussion that needs to be had is nothing remotely like the discussion that dominates the current policy debate about the ageing society.

This blog is based on some research on Japan I have been doing as a precursor to a book contract I am working on which will be about developing a progressive macroeconomic narrative – a sort of cookbook for progressives to enable them to challenge the major myths that are perpetuated by neo-liberals. These myths lead to the imposition of voluntary constraints on the government capacity to achieve and sustain full employment. Some of the underlying dynamics of the system which expose these constraints for what they are – an ideological distaste for fiscal intervention – are still not well understood though. Here is some more on that theme.