{"id":43961,"date":"2019-12-24T11:35:46","date_gmt":"2019-12-24T01:35:46","guid":{"rendered":"https:\/\/billmitchell.org\/blog\/?p=43961"},"modified":"2019-12-24T11:35:46","modified_gmt":"2019-12-24T01:35:46","slug":"a-response-to-greg-mankiw-part-2","status":"publish","type":"post","link":"https:\/\/billmitchell.org\/blog\/?p=43961","title":{"rendered":"A response to Greg Mankiw – Part 2"},"content":{"rendered":"

\t\t\t\tIn – A response to Greg Mankiw – Part 1<\/a> (December 23, 2019) – I provided the E-mail correspondence that preceded the publication of – A Skeptic’s Guide to Modern Monetary Theory<\/a> (December 12, 2019) – by Greg Mankiw. In this blog post, I provide a response to the specific points made in that paper and conclude that if it aims to be a fair ‘guide’ to MMT (even from a critical perspective) then it fails badly. So let me explain why I hold that view. Today’s post is long and will take some reading. It could have been a lot longer. But I intend to take a break from writing the blog until next week (the Quiz will appear as usual though), so you have plenty of time to read this longer than usual post. Normally, I would have spread it out over 3 or 4 parts.
\n<\/p>\n

Referencing<\/h2>\n

I will dispense with this issue quickly.<\/p>\n

Some think that it is unfair to critique Modern Monetary Theory (MMT) by drawing on material in our textbook – Macroeconomics<\/a> – which was published by leading textbook publisher Macmillan in March 2019.<\/p>\n

That is the only reference Greg Mankiw draws upon and cites eight mainstream references as an alternative authority.<\/p>\n

I don’t take exception to that.<\/p>\n

First, our textbook purports to represent the body of work we have developed which is now referred to as MMT.<\/p>\n

Second, as an undergraduate textbook it clearly simplifies the exposition and does not include all the work that has been published in scholarly books and journal articles.<\/p>\n

So that should be understood.<\/p>\n

But as it stands, if the textbook exposition simplifies to the point of misleading or creating fictions then it deserves to be criticised.<\/p>\n

In my view, as one of the authors, the textbook faithfully conveys the principles of MMT as we know it.<\/p>\n

Academic disdain<\/h2>\n

You get a feel for how Groupthink operates in the opening paragraph of the ‘Guide’ when Greg Mankiw refers to “top universities” where “prominent scholars” spend their time debating “the fine points of macroeconomic theory” and his reference to “a small corner of academia”.<\/p>\n

There is implicit disdain being displayed here.<\/p>\n

It is true that MMT has risen to public attention in a unique way.<\/p>\n

First, we tried the usual academic route – writing papers, presenting at conferences and workshops etc. A lot of work was produced – many papers, books etc – and we were able to put down the major body of work in this manner.<\/p>\n

Second, we didn’t cut through until we embraced social media first through my blog and then other blogs and then other social media tools.<\/p>\n

This has allowed us to present quite complex economic ideas to a non-academic audience and given that audience a framework for understanding why their lives and their communities are being devastated by neoliberal policies that draw on the economics coming out of those “top universities”.<\/p>\n

People instinctively know something is wrong and the that the predictions from those “prominent scholars” have failed to realise.<\/p>\n

But they didn’t have a framework for assembling an understanding of those instinctive feelings.<\/p>\n

Now they have.<\/p>\n

Third, that grassroots development is now filtering upwards to the political space as Greg Mankiw notes.<\/p>\n

Fourth, new paradigms rarely emerge out of debates on the “fine points” of the dominant theory. The history of scientific development describes quite a different process.<\/p>\n

Groupthink, which is a group dynamic that resists change usually precludes radical developments arising from within the mainstream orthodoxy.<\/p>\n

For example, think about the development of – Adult Neurogenesis<\/a> – by – Joseph Altman<\/a> – in 1962, which is a typical case of how a mainstream paradigm resists change but is finally usurped by an empirically more robust and logically-consistent alternative paradigm.<\/p>\n

American biologist Joseph Altman was an outsider to the mainstream of his profession. He was a doctoral student in “a small laboratory … at the New York University Medical School”.<\/p>\n

He specialised in neurobiology and discovered adult neurogenesis in the early 1960s. He showed that adult brains could create new neurons but the idea was fiercely denied by contemporary thought at the time.<\/p>\n

Clinical practice was based on the dominant notion that there was no capacity for adult neurogenesis.<\/p>\n

Altman’s work was “largely ignored” by the mainstream profession.<\/p>\n

In his – Memoir: The Discovery of Adult Mammalian Neurogenesis<\/a> – published in 2011, five years before his death, Joseph Altman notes that:<\/p>\n

1. “I did have the proper academic credentials; I was known in the neuroscientific community; and most of the scientists who tried to stop my work were younger and many of them were less well established than I was.”<\/p>\n

2. After receiving initial publicity for his research, including articles in the media, “things started to change in the late 1960s, although it took me several more years to realize that something was amiss. The first wake-up call came when I was supposed to be granted tenure at MIT and my promotion was denied.”<\/p>\n

3. “there was a concerted attempt by some influential members of the neuroscientific community to marginalize us”.<\/p>\n

4. “While he refers to several of our papers on adult neurogenesis, he misquotes them” – he, being a leading academic in the field of development neurobiology.<\/p>\n

5. “Another introductory text on brain development (Lund 1978), makes no reference at all to adult neurogenesis and quotes none of our papers on that subject.”<\/p>\n

6. “This neglect of our work continued during the 1980s.”<\/p>\n

7. “Reference to our published evidence of postnatal neurogenesis was omitted not only by these widely circulated introductory textbooks (of course, I find textbooks that did refer to our work) but also in some more advanced publications.”<\/p>\n

8. “There was obviously a movement afoot to marginalize us.”<\/p>\n

9. “(a) by the early 1980s we were starting to have difficulties in getting our grant applications approved; (b) by the mid-1980s we lost all our grant support; and (c) by the early 1990s we had several of our submitted papers outright rejected.”<\/p>\n

10. “Students and postdoctoral fellows quickly learned while they listened to popular speakers making their rounds, and dominating endless symposia and conferences, as to who was “in” and who was “out”; whom to quote or not quote in your bibliography to make it more likely that it will be reviewed by a peer sympathetic to your approach or findings; and what line of research to pursue in light of what is favored or not favored by the granting agencies at any given time.”<\/p>\n

And on he went, describing in detail the way the mainstream suppressed his work.<\/p>\n

But meanwhile, the evidence base was building which supported the work of his laboratory and creating dissonance for the mainstream paradigm, just as is happening in economics.<\/p>\n

Joseph Altman writes:<\/p>\n

\nScientific theories-unlike political attitudes, religious faiths or aesthetic judgments- are not matters of personal or group preferences … Scientific theories must comply with the objective facts ascertained by empirical observations and research findings; they stand or fall as new data gathered confirm them or refute them … sooner or later the facts will prevail and no matter how powerful or prestigious the supporters of a refuted theory, the theory will eventually be abandoned.\n<\/p><\/blockquote>\n

And it wasn’t until the evidence was so strongly supporting the neurogenesis idea (Elizabeth Gould in 1999) that the proposition became fashionable. <\/p>\n

Neurogenesis is now one of the most significant areas in neuroscience. The clinical practice changed radically in the light of the paradigm shift.<\/p>\n

So people had had their lives blighted by the clinical practice they had received which reflected the failed views of the brain.<\/p>\n

You can see strong resonance with the communities and people who are having their lives and vitality taken from them by economic policies that are based on the mainstream myths, that people like Greg Mankiw propagate.<\/p>\n

Altman’s experience helps us understand how the mainstream economics profession sustains its position in the academy as its inability to explain anything important is increasingly exposed.<\/p>\n

First, academic disciplines (such as, neurobiologists, economists etc.) work within organised ‘paradigms’, which philosopher – Thomas Kuhn<\/a> – identified as “universally recognized scientific achievements that, for a time, provide model problems and solutions for a community of practitioners” in his 1966 book The Structure of Scientific Revolutions<\/a>.<\/p>\n

Typically, the body of knowledge that defines the paradigm are “recounted … by science textbooks, elementary and advanced” (Kuhn, 1996: 10).<\/p>\n

Kuhn challenged the notion that ‘scientific’ activity is a linear process, whereby scholars add new empirically supported facts to the knowledge base to replace previously accepted notions.<\/p>\n

Rather, Kuhn said that dominant viewpoints persist until they are confronted with insurmountable anomalies, whereupon a revolution (paradigm shift) occurs.<\/p>\n

The new paradigm exposes the old theories as inapplicable, introduces new concepts, asks new questions and provides students with a new way of thinking with a new language and explanatory metaphors.<\/p>\n

Once supplanted, the old theories are no longer considered valid knowledge. Kuhn also noted that there is a sort of mob rule among practitioners within a dominant paradigm and they vehemently hold onto their views even in the face of logical or empirical anomaly.<\/p>\n

Altman’s work represented the potential for a paradigm shift and was resisted by the mob until change became ineluctable.<\/p>\n

So paradigm change usually comes from an emerging body of work that comes out of a “small corner of academia”.<\/p>\n

Alleged opaqueness of MMT<\/h2>\n

I often read mainstream economists claim, just before they launch into a dismissal of MMT, that our work is hard to grasp or even find in any coherent form.<\/p>\n

It is usually because they have no interest in reading the body of work and often quote secondary sources (including prior flawed critiques) as their version of MMT.<\/p>\n

A classic recent case of this is the paper published by the BIS (October 13, 2019) – Exiting low inflation traps by “consensus”: nominal wages and price stability<\/a> – which attacks MMT as likely to cause hyperinflation, but, uses as its source Op Eds by Paul Krugman and Larry Summers.<\/p>\n

None of the MMT literature is cited (or read presumably).<\/p>\n

Arrant dishonesty from the central bank for the central banks.<\/p>\n

It doesn’t even comprehend that MMT is not a policy regime but a way of understanding the monetary system and the capacities of the currency-issuer within that system.<\/p>\n

Greg Mankiw plays the same card:<\/p>\n

\nAt the outset, I should admit that I found the task of figuring out MMT to be vexing. As I studied it, I was often puzzled about what precisely was being asserted. I hasten to add that the problems I had could have been of my own making. Perhaps after forty years in the profession, I am too steeped in mainstream macroeconomics to fully appreciate MMT. I raise this possibility because MMT proponents may say that I missed the nuances of their approach. But what follows is my honest reaction to MMT after a sincere effort to understand it.\n<\/p><\/blockquote>\n

Whether he has tried to understand our work in good faith is not something I can conclude on. His behaviour – sending an E-mail to discuss fine points then writing a paper without further correspondence or recognition of what went before – is not encouraging.<\/p>\n

But that is a small issue in the bigger picture.<\/p>\n

The other and more significant (telling) reason, mainstream economists find our “MMT to be vexing” is because they try to absorb some of the statements we make back into their own paradigmic structure, using their frames, language, concepts, causalities etc.<\/p>\n

Quite clearly when an emerging paradigm comes along with new conceptual structures, new framing, new language, one cannot simply stay ‘thinking within the box’ and hope to make any sense of what they are coming into contact with.<\/p>\n

Groupthink is a trap and a blinker.<\/p>\n

I think that is what is going on here.<\/p>\n

Turning to substance<\/h2>\n

Even the language, Greg Mankiw uses is loaded:<\/p>\n

\nMMT begins with the government budget constraint under a system of fiat money.\n<\/p><\/blockquote>\n

MMT doesn’t begin with a GBC – we reject the concept outright.<\/p>\n

Mainstream economics starts with the flawed analogy between the household and the sovereign government such that any excess in government spending over taxation receipts has to be ‘financed’ in two ways: (a) by borrowing from the public; and\/or (b) by ‘printing money’.<\/p>\n

Neither characterisation is remotely representative of what happens in the real world in terms of the operations that define transactions between the government and non-government sector.<\/p>\n

The foundation of many mainstream macroeconomic arguments is the fallacious analogy they draw between the budget of a household\/corporation and the government fiscal balance.<\/p>\n

The basic analogy is flawed at its most elemental level.<\/p>\n

In the real world (and in MMT), there is no parallel between the household (for example) whose spending is clearly revenue-constrained because it uses the currency in issue and the national government, which is the issuer of that same currency.<\/p>\n

The choice (and constraint) sets facing a household and a sovereign government are not alike in any financial way.<\/p>\n

Clearly, in real terms, both can only buy what is available for sale although the capacity of the government to make those purchases is financially unlimited. After that point, there is no similarity or analogy that can be exploited.<\/p>\n

The evolution in the 1960s of the literature on the so-called ‘government budget constraint’ (GBC), was part of a deliberate strategy to argue that the microeconomic constraints facing the individual applied to a national government as well.<\/p>\n

Accordingly, the literature claimed that just as the individual had to “finance” its spending and choose between competing spending opportunities, the same constraints applied to the national government.<\/p>\n

The logical development was then to examine the ways in which this ‘financing’ was done and the alleged consequences of each.<\/p>\n

The GBC says, in English, that a fiscal deficit equals Government spending + Government interest payments – Tax receipts and, must, in turn, be ‘financed’ (equal) by a change in outstanding bonds (issuing debt) and\/or a change in high powered money (‘printing money’).<\/p>\n

While the mainstream infer that this statement delivers causality from the financing side to the spending side (as if the currency-issuing government is like a household), in fact, it is merely an accounting statement that is of no particular importance in the MMT framework.<\/p>\n

In a stock-flow consistent macroeconomics, as an accounting statement the relationship must always hold. That is, it has to be true if all the transactions between the government and non-government sector have been correctly added and subtracted.<\/p>\n

So in terms of MMT, the previous equation is just an ex post<\/em> accounting identity that has to be true by definition and has no real economic importance.<\/p>\n

But for the mainstream economist like Greg Mankiw, the GBC represents an ex ante<\/em> (before the fact) financial constraint that the government is bound by.<\/p>\n

The difference between these two conceptions is very significant and the second (mainstream) interpretation cannot be correct if governments issue fiat currency (unless they place voluntary constraints on themselves to act as if it is).<\/p>\n

MMT exposes the voluntary nature of any such constraints and makes them a political issue rather than a binding law as is presented in the mainstream approach.<\/p>\n

Further, in mainstream economics, money creation is erroneously depicted as the government asking the central bank to buy treasury bonds, which the central bank, in return, then ‘prints’ money so that the government can facilitate its spending.<\/p>\n

Mainstream economists call this debt monetisation and you can find out why this is typically not, usually, a viable option for a central bank pursuing a positive policy rate target, by reading the blog posts in the Deficits 101 suite:<\/p>\n

1. Deficit spending 101 – Part 1<\/a> (February 21, 2009).<\/p>\n

2. Deficit spending 101 – Part 2<\/a> (February 23, 2009).<\/p>\n

3. Deficit spending 101 – Part 3<\/a> (March 2, 2009).<\/p>\n

The point is that fiscal deficits increase bank reserves and hence the pressure on the overnight interest rate will be downward, all else equal.<\/p>\n

The mainstream theory predicts the opposite, which was one of the ‘experiments’ I noted in my response to Greg Mankiw’s E-mail to us in October 2019 to differentiate the two approaches.<\/p>\n

The central bank has two options in this case:<\/p>\n

(a) conduct open market operations to drain the excess bank reserves and prevent competition in the Interbank market from driving them towards zero. So debt issuance is an interest-rate maintenance operation rather than a funding of government deficit spending operation.<\/p>\n

(b) pay a competitive rate on the excess reserves.<\/p>\n

If you think about it, there is no real operational difference between (a) and (b). The differences would be in which account the funds are located (government debt or reserves).<\/p>\n

Mainstream theory completely misses out on all that.<\/p>\n

Rather, it focuses on the ‘printing’ money aspect and claims that if governments increase the money growth rate (they erroneously call this “printing money”) the extra spending will cause accelerating inflation because there will be “too much money chasing too few goods”!<\/p>\n

As a consequence, the least worst option for a mainstream economist is for the government to ‘fund’ its deficit spending by issuing bonds to the non-government sector, as if this reduces the inflation risk of the deficits.<\/p>\n

Mainstream economists consider this to be the least worst option because in the GBC framework, the bond issuance pushes up interest rates (as the government is seen to be competing for a finite pool of savings) and ‘crowds out’ private investment expenditure.<\/p>\n

Neither mainstream proposition bears scrutiny – you can read these blog posts for more detail:<\/p>\n

1. Will we really pay higher taxes?<\/a> (April 7, 2009).<\/p>\n

2. Will we really pay higher interest rates?<\/a> (April 8, 2009).<\/p>\n

When I replied to Greg Mankiw’s E-mail (see A response to Greg Mankiw – Part 1<\/a> (December 23, 2019)) – I raised these essential facts about the real world.<\/p>\n

He clearly chose to ignore these points of departure.<\/p>\n

Further, the whole characterisation that governments only ‘print money’ if the central bank buys its debt is false.<\/p>\n

All government spending involves new ‘money’ (liquidity) being created by dint of the digital changes to the banking system that the government facilitates. Nothing is ‘printed’.<\/p>\n

The process is the same irrespective of whether tax revenue balances the spending, whether bond issues are made to match the spending, or whether the central bank just credited bank accounts on behalf of the treasury department.<\/p>\n

And:<\/p>\n

1. MMT predicts that there is no difference in the inflation risk of the deficit spending arising from these ‘funding’ choices – noting that MMT does not consider the government to be financially constrained anyway.<\/p>\n

2. Issuing debt does not reduce the inflation risk of the spending as the funds to purchase the debt were not being spent anyway.<\/p>\n

3. Banks are not reserve-constrained so there is no sense to say that when governments issue debt they are increasing competition in the finite saving pool and pushing up interest rates as a consequence. Bank loans create deposits and banks will make those loans to any credit-worthy borrower who seeks funding, meaning that the whole premise of crowding out (which is central in the mainstream GBC story) is false.<\/p>\n

I raised all those points in my response to Greg Mankiw.<\/p>\n

It is clear he ignored them, and, instead wrote, in relation to the MMT observation that a sovereign government is never intrinsically revenue constrained”:<\/p>\n

\nTo be sure, a currency-issuing government can always print more money when a bill comes due. That ability might seem to release the government from any financial constraints. Certainly, if an individual were granted access to the monetary printing press, his or her financial constraints would become much less binding. But I am reluctant to reach a similar conclusion for a national government, for three reasons.\n<\/p><\/blockquote>\n

He goes on to juxtapose different options which he thinks justifies his inability to accept the simple MMT proposition.<\/p>\n

First, Greg Mankiw writes:<\/p>\n

\n… in our current monetary system with interest paid on reserves, any money the government prints to pay a bill will likely end up in the banking system as reserves, and the government (via the Fed) will need to pay interest on those reserves. That is, when the government prints money to pay a bill, it is, in effect, borrowing. The money can stay as reserves forever, but interest accrues over time. An MMT proponent will point out that the interest can be paid by printing yet more money. But the ever-expanding monetary base will have further ramifications. Aggregate demand will increase due to a wealth effect, eventually spurring inflation.\n<\/p><\/blockquote>\n

He understands that an open market operation (sale of debt by the central bank) is equivalent to paying interest on excess reserves. So step 1 is okay.<\/p>\n

But, all government deficit spending ends up in the banking system as reserves. There is no “likely will end up” about it.<\/p>\n

Government spending creates net financial assets (and reserves) in the currency of issue, taxation destroys those net financial assets (and reserves).<\/p>\n

Clearly government spending adds to aggregate demand, which carries an inflation risk – that is core MMT.<\/p>\n

But an “ever-expanding monetary base” does not increase that inflation risk. The banks can make loans whenever they like if there are credit-worthy customers coming in search of credit.<\/p>\n

If the subsquent deposits (that are created by the loans) are then spent, then there is an inflation risk there.<\/p>\n

All spending – whether government or non-government carries an inflation risk. That is core MMT.<\/p>\n

Further, while rising stocks of financial wealth may lead to non-government sector entities feeling wealthier and thus increasing their expenditure, this is hardly a problem that will evade policy attenuation.<\/p>\n

We just revert back to saying all expenditure whether derived from private income growth, wealth effects or sentiment changes in general carry an inflation risk.<\/p>\n

If that risk manifests then policy changes are required.<\/p>\n

And, if the goal of the fiscal deficit is to maintain full employment to fill the spending gap left by the non-government saving choices, then if the non-government sector chooses to spend more, then the government has a choice – either reduce its own net spending and\/or reduce the non-government’s spending – a choice that will depend on political considerations such as the desired size of government relative to the economy, etc.<\/p>\n

Second, Greg Mankiw writes:<\/p>\n

\n… if sufficient interest is not paid on reserves, the expansion in the monetary base will increase bank lending and the money supply. Interest rates must then fall to induce people to hold the expanded money supply, again putting upward pressure on aggregate demand and inflation.\n<\/p><\/blockquote>\n

So we have a Japan-type situation.<\/p>\n

The central bank leaves excess reserves in the system and allows the monetary base to expand.<\/p>\n

In the mainstream framework, the money multiplier is a central mainstream proposition but is absent in MMT – in fact, we consider the causality runs in the reverse direction – broad to base.<\/p>\n

In mainstream courses, students get taught that the central bank determines the supply of loans in the economy by controlling the quantity of base money (reserves).<\/p>\n

They then learn that there is a (constant) ratio of broad money (money supply) to base money, and when the central bank adds reserves, they are multiplied up to create a greater change in bank loans and deposits.<\/p>\n

The theory has two elements:<\/p>\n

1. Reserves constrain lending – a supply-determined approach.<\/p>\n

2. Central banks control reserves.<\/p>\n

Again this was a point of departure by MMT from the mainstream that I noted for Greg Mankiw in my E-mail response to him. He clearly chose to ignore it. Whether he understood the distinction I do not know.<\/p>\n

Please read these blog posts (among others) for further discussion:<\/p>\n

1. Money multiplier and other myths<\/a> (April 21, 2009).<\/p>\n

2. Money multiplier – missing feared dead<\/a> (July 16, 2010).<\/p>\n

The important point to understand is that banks do not loan out reserves. A build-up of bank reserves doesn’t increase their capacity to make loans nor does it guarantee that there will be more loan activity.<\/p>\n

The latter depends on the number of credit-worthy customers who seek credit.<\/p>\n

The central bank will always ensure there are sufficient reserves in the system to maintain integrity of the payments system (cheque clearing etc).<\/p>\n

It is an absolute error to think that leaving excess reserves in the system increases the inflation risk of government deficits.<\/p>\n

And consider this graph (among others) which shows the M1 money multiplier for the US (calculated by the Federal Reserve Bank of St Louis).<\/p>\n

Try justifying a theory that requires this aggregate (ratio) to be pretty much constant. There are many ways to compute the conceptual money multiplier that students find in their textbooks that link the money base to the broad money supply – but all deliver a similar story of variability.<\/p>\n

\"\"<\/a><\/p>\n

<\/div>\n

Third, Greg Mankiw writes:<\/p>\n

\n… the increase in inflation reduces the real quantity of money demanded. This fall in real money balances, in turn, reduces the real resources that the government can claim via money creation … Faced with these circumstances, a government may decide that defaulting on its debts is the best option, despite its ability to create more money. That is, government default may occur not because it is inevitable but because it is preferable to hyperinflation.\n<\/p><\/blockquote>\n

Note we are still operating within the GBC framework. He has not been able to free himself from that flow of reasoning.<\/p>\n

A rising inflation rate does not alter the ability of a currency-issuing government to purchase real goods and services through government spending.<\/p>\n

That ability is only constrained by what is available for sale in the currency the government issues.<\/p>\n

Clearly, if the nation runs out of available real resources or if the government tries to aggressively seek to use a greater share of the existing productive resources by competing with the existing users through market bids, then an inflationary spiral will result.<\/p>\n

That is the inflation constraint.<\/p>\n

Whether there are excess reserves or not has no particular bearing on that real resource constraint.<\/p>\n

Failing to differentiate the two concepts of contraints – GBC (financial), MMT (real) – and conflating the two as if they are intrinsically linked shows that Greg Mankiw cannot escape the straitjacket that he operates within.<\/p>\n

That is a common problem for people trying to learn something new. They keep trying to absorb the new into the old and in many cases that is impossible.<\/p>\n

So they conclude that trying to learn the new is a vexing task and blame the new for being opaque (as above).<\/p>\n

I am currently learning Japanese. If I tried to understand the language in terms of English constructs I would not make much progress. The challenge is to avoid thinking like that. So I have to just flow with the new framework and it is then much easier to make progress.<\/p>\n

Greg Mankiw continues:<\/p>\n

\nThis discussion brings us to the theory of inflation. I have been adopting the mainstream view, explained most simply by the quantity theory of money, that a high rate of money creation is inflationary. Proponents of MMT question that conclusion. They assert that “no simple proportionate relationship exists between rises in the money supply and rises in the general price level.”\n<\/p><\/blockquote>\n

Apparently, we overstate “the case against the mainstream view” because “the correlation between inflation and money growth is 0.79” for the US since 1870.<\/p>\n

We can argue correlation coefficients until the cows come home.<\/p>\n

They are lower, say for Japan.<\/p>\n

But they remain statements of ‘correlation’ whereas the quantity theory of money is a view of causation. Elementary statistics classes are taught not to conflate the two – correlates with causes.<\/p>\n

Further, MMT is about fiat currency monetary systems. In the US, that system really only began in 1971 after President Nixon suspended the convertibility under the Bretton Woods system.<\/p>\n

Greg Mankiw also basically tells us that at any rate “mainstream macroeconomists also go beyond the most simplistic quantity theoretic reasoning.”<\/p>\n

To the extent, apparently, that “central banks target interest rates in the short run and inflation in the longer run and that monetary aggregates play a small role”.<\/p>\n

Which leaves me to wonder, exactly what is the inflation theory that Greg Mankiw is invoking when he simplistically says that expanding bank reserves will ultimately cause inflation.<\/p>\n

All his prior reasoning suggests a pretty basic quantity theory approach.<\/p>\n

The point is that if his critique of MMT was reasonable and carried empirical weight, then we should have seen:<\/p>\n

(a) Accelerating inflation in Japan long ago given the scale of expansion of the Bank of Japan’s balance sheet, the extent of its ownership of outstanding Japanese government bonds, and the size of their continuous fiscal deficits.<\/p>\n

(b) The ECB should have easily satisfied its price stability target of 2 per cent instead of running huge bond-buying programs and failing every year to go close the generating the inflation levels it desires.<\/p>\n

(c) The US should have experienced accelerating inflation post Lehman’s given the US Federal Reserve’s bond-buying program.<\/p>\n

As I outlined when I responded to his initial E-mail entreaty:<\/p>\n

1. At the empirical level, mainstream macroeconomics struggles to explain why the broad monetary aggregates have not grown commensurately (as if multiplied) with the dramatic expansion of the asset side of central bank balance sheets.<\/p>\n

2. Mainstream theory predicted inflationary consequences arising from Quantitative Easing (QE) because they considered the increase in base money would feed in, via the money multiplier, to broad money, which, via the Quantity Theory, would drive up prices as bank lending accelerated.<\/p>\n

MMT predicted that bank lending would not accelerate as a result of QE because the sluggish lending was not due to a deficiency of reserves (banks do not loan out reserves) but, rather, a shortfall of creditworthy borrowers due to the uncertain conditions following the GFC.<\/p>\n

There is no doubt which predictions were accurate.<\/p>\n

Greg Mankiw then moves on to refine the discussion concerning inflation theory and it is hard to understand what point he is actually making in relation to being a ‘guide’ to MMT.<\/p>\n

First, inflation arises from multiple causes emanating from the supply-side and the demand-side. As he notes, MMT fully explains the various ways in which a continuous price rise can occur.<\/p>\n

A core idea in MMT is that, as Greg Mankiw quotes from our textbook: “all spending (private or public) is inflationary if it drives nominal aggregate demand above the real capacity of the economy to absorb it.” <\/p>\n

From day one, we have emphasised this is how a demand-side inflation can occur.<\/p>\n

But it is hard to see where Greg Mankiw gets the justification to make his next assertion that:<\/p>\n

\nThe advocates of MMT, however, make this possibility seem more hypothetical than real.\n<\/p><\/blockquote>\n

There is no diffidence in our statement that he had previously quoted.<\/p>\n

If government spending drives nominal aggregate spending growth to fast relative to supply capacity then it is highly likely there will be inflationary pressures.<\/p>\n

The basic accounting is obvious and fully explained in the textbook. GDP is equal to the value of final goods and services produced in a year. Value is computed as Price times Quantity.<\/p>\n

At the aggregate level, if the economy is operating at full capacity so Quantity is unable to rise, then more spending will increase GDP but via the prices rises (to ration the excess demand).<\/p>\n

Firms are typically quantity-adjusters below full employment (so absorb extra spending by increasing production and sales) and price-adjusters once full capacity is reached. Bottlenecks may appear in sectoral markets before other markets reach full capacity. It is not an exact science when the supply-side capacity is exhausted.<\/p>\n

That is core MMT and we inherit that sort of reasoning from the Keynesian literature.<\/p>\n

At this stage, his motivation appears to be to say that there is nothing new in MMT that cannot be explained by the New Keynesian literature, and he harks back to the 1970s and 1980s developments in disequilibrium theory and efficiency wages, which was all the rage in the 1980s.<\/p>\n

So the reader is forced to wade through some ageing neoclassical literature where markets do not clear because firms are assumed to have market power and this causes unemployment which can be attenuated with government deficits.<\/p>\n

This really just restates the argument that sticky wages and prices will generate unemployment in the short-run until market forces eventually cause prices to adjust towards their neoclassical optimum.<\/p>\n

So if we construct this ‘neoclassical world’ where the market tendencies are in accord with competitive, profit maximisation and marginal productivity theory (real wages equal marginal products and prices equal marginal costs) then if we put rigidities into the price clearing process, we would get below full employment equilibria occurring.<\/p>\n

Apparently, “(i)n that sense, MMT is akin to new Keynesian analysis”.<\/p>\n

I asked myself, what “sense” exactly are we talking about?<\/p>\n

That economies are rarely at full employment? Is this because the real wage outcome is excessive so labour demand is insufficient to fully employment people and the unemployment creates unsold goods in the product market?<\/p>\n

This whole debate has been done to death many times (Marx, Keynes, and on into the 1970s and 1980) and the reasonable position to conclude is that cutting real wages will not reduce unemployment..<\/p>\n

The mainstream claim that Mankiw supports is that if real wages were reduced, firms would offer more work, and unemployed workers will spend more – thus eliminating the dual excess supplies – labour and products.<\/p>\n

But what the New Keynesian literature that Greg Mankiw suports never really came to terms with was the difference between nominal demands (desired) and effective demands for goods and services. The latter are backed by cash whereas the former reflect latent desires, which may be unlimited.<\/p>\n

We discuss this important point at length in the textbook. There are pages devoted to the rejection of marginal productivity theory and the idea that ‘factors of production’ are rewarded according to their contribution to production.<\/p>\n

It really takes us back to the debate in the C19th between Marx, Ricardo and Say. Marx clearly won that debate but it wasn’t until Keynes published the General Theory in 1936 that the western economists took heed and understood that mass unemployment cannot be explained by sticky prices.<\/p>\n

In TSV (Vol II, Ch XVII, para 712) Marx anticipated the modern distinction between nominal and effective demand which lies in the understanding of the real contribution of Keynes.<\/p>\n

Marx noted that in denying the possibility of a general glut, Ricardo appeals to unlimited needs of consumers for commodities and any particular saturation would be quickly overcome by increased demands for other commodities.<\/p>\n

Marx (TSV, Vol II, Ch XVII, para 712) rhetorically asked for an explanation of the connection between ‘over-production’ and ‘absolute needs’ and quoted Ricardo’s denial of the “possibility of a general glut in the market”:<\/p>\n

\nToo much of a particular commodity may he produced, of which there may he such a glut in the market, as not to repay the capital expended on it; but this cannot be the case with respect to all commodities; the demand for corn is limited by the mouths which are to eat it, for shoes and coats by the persons who are to wear them; but though a community, or a part of a community, may have as much corn, and as many hats and shoes, as it is able or may wish to consume, the same cannot be said of every commodity produced by nature or by art. Some would consume more wine, if they had the ability to procure it. Others having enough of wine, would wish to increase the quantity or improve the quality of their furniture. Others might wish to ornament their grounds, or to enlarge their houses. The wish to do all or some of these is implanted in every man’s breast; nothing is required but the means, and nothing can afford the means, but an increase of production …\n<\/p><\/blockquote>\n

Marx retorted:<\/p>\n

\nCould there be a more childish argument? It runs like this: more of a particular commodity may be produced than can be consumed of it; but this cannot apply to all commodities at the same time. Because the needs, which the commodities satisfy, have no limits and all these needs are not satisfied at the same time. On the contrary. The fulfilment of one need makes another, so to speak, latent. Thus nothing is required, but the means to satisfy these wants, and these means can only be provided through an increase in production. Hence no general overproduction is possible.<\/p>\n

What is the purpose of all this? In periods of over-production, a large part of the nation (especially the working class) is less well provided than ever with corn, shoes etc., not to speak of wine and furniture. If over-production could only occur when all the members of a nation had satisfied even their most urgent needs, there could never, in the history of bourgeois society up to now, have been a state of general over-production or even of partial over-production. When, for instance, the market is glutted by shoes or calicoes or wines or colonial products, does this perhaps mean that four-sixths of the nation have more than satisfied their needs in shoes, calicoes etc.? What after all has over-production to do with absolute needs? It is only concerned with demand that is backed by ability to pay. It is not a question of absolute over-production-over-production as such in relation to the absolute need or the desire to possess commodities. In this sense there is neither partial nor general over-production; and the one is not opposed to the other.\n<\/p><\/blockquote>\n

Note the reference to the capitalist market being “only concerned with demand that is backed by ability to pay. It is not a question of absolute over-production – over-production as such in relation to the absolute need or the desire to possess commodities.”<\/p>\n

This wisdom lies at the heart of the modern problem of high unemployment and stagnant growth. Keynes didn’t offer much more than you can find in this work by Marx.<\/p>\n

The New Keynesians have nothing in common with this view.<\/p>\n

The textbook also rejects the New Keynesian demand for labour concept. In Chapters 13 and 14, we present the alternative approach that bears no relationship to the New Keynesian approach.<\/p>\n

There is no way MMT can be subsumed back into New Keynesian thinking as a special case, in the same way that Keynes’ General Theory was absorbed back into the ‘Neoclassical synthesis’ and lost the most important insights.<\/p>\n

Firms create employment in response to demand for their products. They might be confronted by millions of desperately hungry workers who want to work but they still won’t put them on because there is insufficient effective demand to justify expanding production.<\/p>\n

A latent or notional demand for a crust of bread is not a demand backed by cash!<\/p>\n

Mainstream economists have never really understood that. Marx knew it. Keynes and Kalecki knew it. Clower and Leijonhufvud elaborated on it again in the 1960s but the conservative, free market types couldn’t see past Say’s Law!<\/p>\n

At any rate, Greg Mankiw’s divergence into the core neoclassical literature only serves to highlight how different the mainstream approach is to the way MMT constructs the issue of inflation and unemployment.<\/p>\n

Conclusion<\/h2>\n

Greg Mankiw’s track record is not a shining light of predictive accuracy.<\/p>\n

In 2010, he wrote a paper based on a Presidential Address to the Eastern Economics Association – Spreading the Wealth Around: Reflections Inspired by Joe the Plumber<\/a>.<\/p>\n

The substance of his argument is interesting in itself but not germane to the topic here.<\/p>\n

In the introduction, though, he wrote about the motivation for considering tax rises (in 2010) in the US:<\/p>\n

\nAnother, perhaps more important, reason is that the US federal government is running a large budget deficit and faces an ominous fiscal gap looming on the horizon. As the baby boom generation retires and starts claiming Social Security and Medicare, government spending will slowly and steadily continue to rise as a share of the economy. It is possible that Congress will suddenly read Milton Friedman’s book Capitalism and Freedom<\/em>, become committed classical liberals (in the 19th century use the term), and decide to scale back the size and scope of government. But, more likely, Congress will find past entitlement promises hard to break, and so it will have little choice but to raise taxes to levels unprecedented in US history\n<\/p><\/blockquote>\n

An MMT economist would never make such statements.<\/p>\n

And Greg Mankiw still hasn’t worked out why!<\/p>\n

That is enough for today!<\/p>\n

(c) Copyright 2019 William Mitchell. All Rights Reserved.\t\t<\/p>\n","protected":false},"excerpt":{"rendered":"

In – A response to Greg Mankiw – Part 1 (December 23, 2019) – I provided the E-mail correspondence that preceded the publication of – A Skeptic’s Guide to Modern Monetary Theory (December 12, 2019) – by Greg Mankiw. In this blog post, I provide a response to the specific points made in that paper…<\/p>\n","protected":false},"author":1,"featured_media":0,"comment_status":"open","ping_status":"closed","sticky":false,"template":"","format":"standard","meta":{"_jetpack_memberships_contains_paid_content":false,"footnotes":""},"categories":[14,38],"tags":[],"class_list":["post-43961","post","type-post","status-publish","format-standard","hentry","category-debriefing-101","category-mmt-textbook","entry","no-media"],"jetpack_featured_media_url":"","jetpack_sharing_enabled":true,"_links":{"self":[{"href":"https:\/\/billmitchell.org\/blog\/index.php?rest_route=\/wp\/v2\/posts\/43961","targetHints":{"allow":["GET"]}}],"collection":[{"href":"https:\/\/billmitchell.org\/blog\/index.php?rest_route=\/wp\/v2\/posts"}],"about":[{"href":"https:\/\/billmitchell.org\/blog\/index.php?rest_route=\/wp\/v2\/types\/post"}],"author":[{"embeddable":true,"href":"https:\/\/billmitchell.org\/blog\/index.php?rest_route=\/wp\/v2\/users\/1"}],"replies":[{"embeddable":true,"href":"https:\/\/billmitchell.org\/blog\/index.php?rest_route=%2Fwp%2Fv2%2Fcomments&post=43961"}],"version-history":[{"count":0,"href":"https:\/\/billmitchell.org\/blog\/index.php?rest_route=\/wp\/v2\/posts\/43961\/revisions"}],"wp:attachment":[{"href":"https:\/\/billmitchell.org\/blog\/index.php?rest_route=%2Fwp%2Fv2%2Fmedia&parent=43961"}],"wp:term":[{"taxonomy":"category","embeddable":true,"href":"https:\/\/billmitchell.org\/blog\/index.php?rest_route=%2Fwp%2Fv2%2Fcategories&post=43961"},{"taxonomy":"post_tag","embeddable":true,"href":"https:\/\/billmitchell.org\/blog\/index.php?rest_route=%2Fwp%2Fv2%2Ftags&post=43961"}],"curies":[{"name":"wp","href":"https:\/\/api.w.org\/{rel}","templated":true}]}}