\t\t\t\tYesterday, regular commentator JKH wrote a very long comment where he\/she challenged some of the statements and logic that modern monetary theorists including myself have been making. While I don’t want to elevate one comment to any special status – all comments are good and add to the debate in some way – this particular comment does make statements that many readers will find themselves asking. In that sense it is illustrative of more general principles, points etc and so today’s blog provides a detailed answer to JKH and tries to make it clear where the differences lie. Some of these differences are at the level of nuance but others are more fundamental.
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To also make it a little more interesting my mates Warren Mosler and Scott Fullwiler who were mentioned in the comment by JKH also decided to send me their version of a reply which I dutifully acknowledge throughout. To make it clear who is saying what, all comments other than my own are in blockquote format with the notation: JKH, Warren or Scott on the first line before the statement.<\/p>\n
Scott started his reply with a personal message to JKH:<\/p>\n
\nScott F: Dear JKH Thank you for the comments. You are certainly one of the more thoughtful commentators of all those who post to this and related blogs, and I appreciate the fact that you don’t just “buy” what we’re selling but rather subject it to very careful thought. Of course, as you probably expect, I think your entire critique either misinterprets or otherwise misunderstands the points we’ve made. So, respectfully, I have made the following rejoinders. That I and others took your comments seriously enough to respond at length hopefully shows that we have a good deal of respect your views and your analysis, continuing disagreement or points to be discussed further notwithstanding. Finally, I should note that overall I am in far more agreement with you than I am with neoclassicals … and even the points of continued disagreement are more easily discussed\/debated given that we have for the most part a common language and common understanding of accounting.\n<\/p><\/blockquote>\n
Okay, pleasantries over lets see where the discussion takes us.<\/p>\n
JKH started with the statement:<\/p>\n
\nJKH: My general impression however is that in making the case you and the others are combining the correct explanation of operational capability with a near-rejection of the real world importance of balance sheet “policy” restraints or constraints.\n<\/p><\/blockquote>\n
My view is that this is not what I do. I first consider that what is held out as a financial constraint is usually not that at all. Typically, in macroeconomic policy the constraints are political and voluntarily imposed. The sophists then dress these political constraints up as financial constraints using gold standard type macroeconomic models which appear throughout the literature to avoid addressing the real issue.<\/p>\n
My assessment is that if the general populace was better educated in these matters – that is, understood the actual operational capabilities of the national government it would be very difficult for the politicians to conflate their own ideological desires with the concept of a financial constraint. In that context, telling us that we had to have 5 or 8 per cent unemployment and rising underemployment because the government cannot afford to purchase all the labour and even if it did it would be inflationary, takes on a different slant.<\/p>\n
We would know that they could afford to fully employ the available workforce as long as their were sufficient real resources available to provide the extra food and other things the higher employment levels would invoke. This would then require a higher level of sophistication in the public debate. Are there the extra resources? How close to real capacity are we? That would then promote new research that focused on the nub of the problem rather than the array of dishonesty that parades as knowledge out there in the form of academic papers – which say the government has a financial constraint and will cause higher interest rates, higher taxes, higher inflation if it bucks against it.<\/p>\n
Businesses would also have to justify their opposition to true full employment in more sophisticated ways because we would all know that the usual reasons they give – again relating to government budget constraints – are all deeply flawed.<\/p>\n
I also would not use the term “balance sheet policy restraints” because that implies that there are financial matters that are at play. By your own admission there are not. I will deal with this in more detail later because I know you think there are “financial issues”.<\/p>\n
Warren said at this point that:<\/p>\n
\nWarren M: I for one criticize these policy constraints as counterproductive all the time. That’s hardly rejecting their importance- in fact, that’s pretty much the entire problem!\n<\/p><\/blockquote>\n
While Scott added (note Scott provided several points rather than a line by line commentary – so I am threading them in where I can and some of this comments apply to later points as well):<\/p>\n
\nScott F: We don’t reject “policy” restraints or constraints as you call them. The point is that the intellectual foundation of such restraints\/constraints is most often either a misunderstanding of the operations OR the restraints actually do exist but only under different monetary regimes. Get rid of those foundations, and we can then have an honest discussion about the interest burdens you mention. Further, and related, we have ALWAYS and REPEATEDLY acknowledged the inflationary potential of either debt service burdens or just overly large deficits in general. Our point is that THIS should be the issue to debate in regard to macro policy, NOT the stuff that comes from a flawed understanding of operations or the monetary system. Again, our point is that unless you get rid of the flawed intellectual foundations of current policy debates, you can’t have an appropriate discussion of policy or of the “practical constraints” that definitely do exist and which we acknowledge exist.\n<\/p><\/blockquote>\n
JKH then continued:<\/p>\n
\nJKH: E.g.: It’s quite clear the government has the operational capability to spend ’till the cows come home, creating broad money and bank reserves in the process. There is no operational limit. But there is a real policy concern in terms of practical balance sheet debt and the interest burdens associated with it. And in the real world, that translates to the notion of a policy limit. And a policy limit is a constraint of sorts. My general impression is that your associated school of thought tends to demote the importance of such practical constraints in order to emphasize the correct operational understanding.\n<\/p><\/blockquote>\n
Okay, so there are no financial constraints. We all agree on that. So it would be good jettison all the macroeconomic theory that construes the government budget constraint as an ex ante<\/em> financial constraint instead of seeing it as an ex post<\/em> accounting statement, with no operational relevance.<\/p>\n
Then we also agree that the public perception of rising public debt arising from the fact that we have been erroneoulsy conditioned (relentlessly) to equate the household budget with the sovereign government’s budget presents a problem to a government who wanted to increase spending. A political problem rather than an economic problem.<\/p>\n
I make that distinction because I do not accept the relevance of the Ricardian equivalence theorem. For non-economists – this piece of neo-liberal dogma says that the non-government sector (consumers explicitly) having internalised the government budget constraint will negate any government spending increase whether the government “finances” its spending via taxes or borrowing. So if the government spends and borrows, consumers will anticipate higher future taxes and spend less now offsetting the stimulus).’<\/p>\n
I also reject the Policy ineffectiveness proposition from Sargent and Wallace which says that because private agents have rational expectations (RATEX) and truly understand the exact nature of the economic model, the government is powerless to influence real output levels. Private agents will anticipate perfectly what is going on and adjust their behaviour to offset the public policy. I recall Arthur Okun once saying that if we all knew the exact structure of the economy then there would be no need for economists – we would all be forecasters with 100 per cent expectational accuracy! I have noted that none of the RATEX exponents ever turned in their highly paid cosy academic or other positions in response to Okun’s challenge.<\/p>\n
I think Modern Monetary Theory (MMT) shows that in a technical sense (after understanding how the operational matters work) that deficits will drive down interest rates unless there is some offsetting central bank action.<\/p>\n
The fact that the government voluntary decides to constrain itself by issuing debt $-for-$ into private markets using auction systems which allow the final bidder to determine the bond yield for that issue doesn’t alter that fact. The rising yields might reflect the perceptions of the markets that the deficits are too large – conditioned by the mainstream economics – just as they may reflect a desire to diversify investment portfolios towards higher risk positions. Whatever, the rising yields have nothing to do with the deficits in an intrinsic sense.<\/p>\n
That is the problem though. Our mis-education on these matters and the dominance of the mainstream profession in the public debate allows us all to be hoodwinked and see rising yields and rising deficits as in some way substantiating the loanable funds doctrine of classical thought. All the rest of the spurious conclusions follow from these voluntary (neo-liberal) structures that the government erects to obscure there real capacity to advance public purpose.<\/p>\n
So far from ignoring these voluntary contraints I am always writing about them – to emphasise the political nature of the decisions taken and the way the options are presented. But as an educator I think it is also important to provide as much detail as I can about the way the system actually should function from first-principles so that the public can make better conclusions about the way the political process deviates from the intrinsic.<\/p>\n
In that regard, I hope that as citizens become more and more informed they will actually engage in debate and ask questions of the politicians and commentators in general. The result might be that pressure is brought bear on these characters to really explain why they will not increase public employment, or why they are selling off excellent public enterprises at huge discounts only to see service delivery fall and private wealth more skewed than before. And the rest of it.<\/p>\n
Warren’s response:<\/p>\n
\nWarren M: Yes, and that’s exactly the problem. Policy makers who don’t understand the monetary system and therefore fail to recognize the policy options that are wide open operationally.<\/p>\n
And the policy limit is definitely a constraint of sorts.<\/p>\n
For me, those ‘practical constraints’ are public enemy #1.\n<\/p><\/blockquote>\n
JKH continued:<\/p>\n
\nJKH: The constraint shows up in this example in the following ways. First, the operational capability described requires the freedom for the government to run an unlimited overdraft at the central bank. Overdraft is equivalent to credit on demand. Both are equivalent to monetization on demand.\n<\/p><\/blockquote>\n
This is the way you are presenting it. The government is the central bank. The fact that we decide to split the treasury and the central bank up into two entities is misleading in terms of understanding the operational side of the government and non-government interaction. It has also been an ideological venture to claim that the central bank is independent and therefore somehow inflation-first monetary policy is above the political process. Which in my view means we degrade our democracies if the cabinet (whatever executive arrangement is in place) can avoid responsibility for stupid monetary policy by saying some non-elected officials have forced this on the economy.<\/p>\n
Monetisation is also a term that is ideologically loaded and not very helpful. It is in the ranks of “printing money” as ill-suited terms when describing how governments spend.<\/p>\n
Warren elaborated further on this:<\/p>\n
\nWarren M: Depends on your definition of ‘monetization.’ Years back it was a gold standard term.\n<\/p><\/blockquote>\n
JKH then says:<\/p>\n
\nJKH: So here’s the policy reality: When was the last time you saw such a government overdraft of any size on a central bank balance sheet?\n<\/p><\/blockquote>\n
What exactly is the point? In Australia, we have established processes where the Australian Office of Financial Management (a division of Treasury) manages all government debt issuance. By law it invokes an auction system to raise private funds exactly equal to the net government spending projection. In other words, imposing on the government a voluntary arrangement that eliminates the need for the central bank to purchase treasury bills prior to government spending. <\/p>\n
Before 1982, a tap system was used and the bond issue was regularly undersubscribed and the gap was filled by the central bank buying the bonds. The change to the auction system was designed to impose “fiscal discipline” on the elected government – totally voluntary and totally unnecessary.<\/p>\n
As Warren points out you will never see this in the US because “it’s prohibited”. A legal constraint not an economic one.<\/p>\n
JKH then says:<\/p>\n
\nJKH: I’m sure you can read my mind for the rest of the argument from there. Suffice to say, there are decisions to be made about converting that overdraft into debt issued by the government, etc. Those are policy decisions that act as constraints on the operational freedom that is the foundation of this line of thinking.\n<\/p><\/blockquote>\n
We all agree on that. As Warren says “The problem is allowing the Treasury to spend directly without first issuing treasury securities.” This can also be seen in the voluntary decision in Australia to move from a tap to auction system.<\/p>\n
Scott F elaborates further:<\/p>\n