Hard Keynesianism in the European Union

by Henry on April 26, 2011

John Quiggin and I have a piece on the eurozone mess in the new issue of Foreign Affairs. The piece is subscriber-only, but we’re allowed to post it (in Web format) for six months or so on a personal or institutional website. Accordingly, the piece can be found below the fold. The piece was finished some weeks ago, but I think it holds up quite well.

Four things worth noting. First – I suspect we would put our argument that the politics are more important than the economics even more strongly in the light of current events. It looks as though demonstrations against the austerity agenda are beginning to take on a European dimension. In addition, a dimension of the politics that we did not discuss – the rise of nationalist resentments in countries that are on the giving rather than receiving end of loans-linked-to-brutalism – has come more obviously to the fore with the success of the True Finns in the recent election.

Second – Paul de Grauwe has a new paper which points to a complementary mechanism through which monetary union plausibly damages political legitimacy at the national level (although his discussion is largely framed in terms of the economics).

Once in a bad equilibrium, members of monetary union find it very difficult to use automatic budget stabilizers: A recession leads to higher government budget deficits; this in turn leads to distrust of markets in the capacity of governments to service their future debt, triggering a liquidity and solvency crisis; the latter then forces them to institute austerity programs in the midst of a recession.

Third: the Daniel Davies qualification. We refer to BIS data on bank holdings in the article – but as we specifically note (and as dsquared has pointed out in comments here and elsewhere), this data is biased by tax avoidance wheezes and similar. It is plausible to infer that e.g. German banks have some considerable exposure to PIIGS from the way that they are behaving, and the numbers are the best that there is, but they should be treated with caution.

Finally – the piece is written in the rhetorical style of US policy articles. This differs from that of blogposts and academic articles, in that it encourages emphatic claims rather than cautions and caveats, and self-assurance rather than social-scientific humility. Please read accordingly.

How to Save the Euro—and the EU
Reading Keynes in Brussels

By Henry Farrell and John Quiggin
May/June 2011

The European Union is in danger of compounding its ongoing economic crisis with a political crisis of its own making. Over the last year, crises of confidence have hit the 17 EU members that in the years since 1998 have given up their own currencies to adopt the euro. For the first decade of this century, markets behaved as though the debt of peripheral EU countries, such as Greece and Ireland, was as safe as that of core EU countries, such as Germany. But when bond investors realized that Greece had been cooking its books and that Ireland’s fiscal posture was unsustainable, they ran for the door. The EU has stopped the contagion from spreading—for now—by creating the European Financial Stability Facility, which can issue bonds and raise money to help eurozone states. Together with the International Monetary Fund, the European Financial Stability Facility has already lent Greece and Ireland enough money to cover their short-term needs.

But such bailouts are only stop-gap measures. Portugal and Spain, and to a lesser extent Belgium and Italy, remain vulnerable to pressure from bondholders. Portugal is likely to receive 50-100 billion euros over the next few months. But should Spain also need a bailout—which could cost as much as 600 billion euros—the 750 billion euro European Financial Stability Facility would soon be exhausted. In that event, the main euro creditors, primarily British, French, and German banks, might have to accept so-called haircuts, substantial cuts in the principals of their loans. (The banks’ tax-avoidance strategies might inflate this total, but the Bank for International Settlements has estimated that the exposure of British, French, and German banks to the group of vulnerable debtor states referred to as the PIGS —Portugal, Ireland, Greece, and Spain—amounted to more than $1 trillion in mid-2010.) Encouraged by Germany, some of the states in difficulty have sought to placate bond markets by making ruthless cuts in government spending. But as many economists have pointed out, these measures are hindering growth without satisfying bondholders that their money is safe; bondholders worry that these measures are not politically sustainable. In fact, they are likely to undermine Europe’s political union.

Nevertheless, Germany has been pressing European countries to institutionalize more stringent cuts in spending. In February, it, along with France, proposed that members of the eurozone introduce “debt brakes,” inflexible limits on deficit spending. Germany had already incorporated such a cap into its own constitution, one that severely restricts any government deficit spending, including the kind that might benefit the country’s long-term growth. In early March, the other 16 eurozone states agreed to introduce such debt brakes or some equivalent into their domestic laws and to make them as durable and binding as possible, for example, by incorporating them into their national constitutions.

But institutionalizing austerity will badly damage European economies in the short term—and the long-term consequences will be even worse. European politicians worry about the economic consequences if their attempts at fiscal stabilization fail. They should be far more worried about the political consequences. Even if these strict spending limits do calm bond markets somehow, they will destroy what little is left of the EU’s political legitimacy.
The eurozone states should be required to put surpluses aside during good years for the purpose of stimulating demand during bad ones.

BAD AS GOLD

The EU is now drifting toward a thinly disguised version of the gold standard, which wreaked economic havoc in the 1920s and led to a toxic political fallout. Under that system, European states had fixed exchange rates. During economic crises, they refused to increase government spending because of a failure to either understand or care that monetary disturbances and shocks to demand could lead to joblessness. The result was generalized misery. Governments responded to economic crises by allowing unemployment to go up and cutting back wages, leaving workers to bear the pain of adjustment. As Golden Fetters, Barry Eichengreen’s classic history of the period, shows, the gold standard began to collapse when workers in Europe gained the power to vote out of office the parties that supported austerity.

The measures that the eurozone states have recently decided to adopt will be even harsher, if they make the mistake of following Germany’s example. Germany’s debt brake, which at first Berlin implicitly proposed as a model for other European countries, turns austerity into a constitutional obligation. In theory, it provides some flexibility during hard economic times, but in practice it makes deficit spending as difficult as possible: only the vote of a supermajority of German legislators can relax it. And it rules out debt-financed investment, such as in infrastructure, even though that can spur long-term growth.

As they begin to adopt Germany’s model, or something along those lines, the other eurozone states will find it nearly impossible to use fiscal stimulus in times of crisis. And with monetary policy already in the hands of the dogmatically anti-inflationary European Central Bank, their only means of adjusting to crises will be to stand by as wages fall and unemployment soars. Ireland—with its collapsed tax revenues, massive cuts in government spending, shrinking wages, and skyrocketing unemployment—is the unhappy exemplar of rigid austerity measures in the new Europe.

This approach cannot be sustained for long. The EU has never had much popular legitimacy: many voters have gone along with it so far only out of the belief that their politicians knew best. Today, they are more suspicious. And if they come to think that further European integration is causing more economic hardship, their suspicion could harden into bitterness and perhaps even xenophobia. Ireland’s new finance minister, Michael Noonan, has told voters that the EU is a game rigged in Germany’s favor; editorials in major Irish newspapers warn of Germany’s return to racist imperialism. As economic shocks hit other EU countries, politicians in those states will also look for someone to blame.

If the EU is to survive, it will have to craft a solution to the eurozone crisis that is politically as well as economically sustainable. It will need to create long-term institutions that both minimize the risk of future economic crises and refrain from adopting politically unsustainable forms of austerity when crises do hit. They must offer the EU countries that are the worst hit a viable path to economic stability while reassuring Germany, the state currently driving economic debates within the union, that it will not be asked to bail out weaker states indefinitely.

The short-term solution is clear—even if the European Central Bank, which is still fighting the war against the inflation of the 1980s and 1990s, refuses to recognize it. The solution is a one-off combination of market purchases of bonds and other financial assets, temporarily higher inflation, and fiscal support with the issuance of a common European bond. Quantitative easing and higher inflation would help ease the pain of adjustment, and a European bond would allow the weaker eurozone states to raise money on international markets. All of this would shore up the euro long enough to allow for further-reaching reforms down the road. The major euro bondholders would have to bear some of the costs—as they should, since they lent excessively during the first years of this century—through either explicit haircuts (in effect a discount of their bonds’ value) or inflation. Germany might not enjoy experiencing temporarily higher inflation, but if this were a one-time cost, it could probably live with the results—as long as it was also reassured that the long-term gain would be stability in the eurozone.

IN THE BEST OF TIMES, FOR THE WORST OF TIMES

Instituting effective long-term reforms will be a harder sell. Germany adopted its own large-scale fiscal stimulus in 2009, but it returned to its traditional anti-Keynesian stance as soon as the danger of total systemic collapse had passed. Yet Keynesianism, at least properly understood, is the only way forward.

Contrary to the beliefs of nearly all anti-Keynesians—and, regrettably, some Keynesians, too—Keynesianism demands more, not less, fiscal rectitude in normal times than does the orthodox theory of balanced budgets that underpins the EU. John Maynard Keynes argued that surpluses should be accumulated during good years so that they could be spent to stimulate demand during bad ones. This lesson was well understood during the golden age of Keynesian social democracy, after World War II, when, aided by moderate inflation, the governments of the countries in the Organization for Economic Cooperation and Development greatly reduced their ratios of public debt to GDP. This approach should not be confused with the opportunistic support for large budget deficits evident, for example, among advocates of supply-side economics. If anything, “hard” Keynesianism suggests that the problem with the macroeconomic rules governing the euro is not that they are too tough and too detailed but that they are not tough or detailed enough. States in the eurozone should not be allowed to run moderate budget deficits in boom years, the Keynesian argument goes; instead, they should be compelled to run budget surpluses. The surpluses could then be saved in rainy-day funds or used to pay down government debt or, if the country had reached a satisfactory debt-to-GDP ratio, spent as a fiscal stimulus in the event of a crisis. Unlike the kind of budget management advocated by the German government, this approach does not seek to eliminate or minimize governments’ leeway to conduct fiscal policy. It gives governments up-front the means to manage demand whenever they might need to.

Resorting to hard Keynesianism to deal with the euro crisis would require making far-reaching changes to the rules and practices of the EU’s economic and monetary union. It would mean both toughening the requirements of the Stability and Growth Pact, which governs the euro, and strengthening the enforcement of these rules. As they stand, the Stability and Growth Pact’s bylaws require the eurozone states to maintain budget deficits under three percent of GDP and debt-to-GDP ratios under 60 percent. The system does not provide enough flexibility during downturns: even German politicians ignored these requirements a few years ago, when Germany was suffering from a recession—much as they prefer not to remember this today.

To be more effective, the system needs to be stricter. The Stability and Growth Pact should be strengthened so that it requires countries to put aside surpluses during auspicious years. Since governments are persistently tempted to squander surpluses, a new supervisory institution should be introduced at the EU level. It should be granted access to detailed budget-planning and other economic information from the eurozone states and should be empowered to sanction misbehaving states. Such a reform could be integrated into other proposals under consideration today, such as the “European semester system,” which would give the European Council the responsibility to assess member states’ budgetary policies. A new European college of budgetary supervisors, with one supervisor from each member state, could assess the budget-planning processes of the member states and provide short-term flexibility in times of real crisis. Its staff would come from the ministries of finance of the eurozone states. When states faced hard economic times, the college could decide, with a simple majority, to relax fiscal strictures on a six-month basis.

The Stability and Growth Pact, a semi-formal protocol of dubious legal standing, should also be properly incorporated into the EU’s basic treaties. That would allow the European Court of Justice to adjudicate disputes between EU bodies and member states and help with the pact’s enforcement. These arrangements would prevent national governments from unjustified deficit spending while giving them flexibility in times of real need.

Such an active use of fiscal policy requires the coordination of fiscal and monetary policies. This, in turn, means that the European Central Bank can no longer be totally independent, as it has been since the implementation of the euro. As it stands, the European Central Bank is possessive about its powers. For example, it has resisted oversight by the European Parliament even though it has begun to take on an increasingly important political role through its support for the European banking system. It has assiduously avoided mingling monetary policy and fiscal policy, focusing instead on targeting inflation. But it nonetheless failed to prevent asset price booms, and these could only have been prevented with much more direct institutional control over unsound financial innovations. As the interaction between governments and central banks is unavoidable and the role of the European Central Bank is increasingly political, it would be better to properly define the relations of authority among these bodies. The European Central Bank must be more willing to adjust its policies so that they do not undercut those of elected national governments. Even if this were not necessary economically, it would be necessary politically. Handing the power to destroy national economies to unelected technocrats is simply not politically sustainable.

Creating an active fiscal policy regime of this kind would reduce the volatility of interest rates, the result of an excessive reliance on monetary policy. Manipulating interest rates helped stabilize inflation during “the great moderation,” the era of relative economic calm between the late 1980s and the late years of the first decade of this century. But in the long term, it contributed to the growth of the asset price bubbles that almost destroyed the entire system in the global financial crisis. To be most effective, these reforms would have to go together with the creation of a limited fiscal union that would balance out the asymmetric effects of economic shocks by allowing limited fiscal transfers between member states. Managing surpluses as hard Keynesianism recommends would go some way toward providing the eurozone states with an important buffer against crises. But in hard times, imperfect monetary unions, such as the eurozone, require temporary transfers to the countries most hurt from the countries that are less affected. This is not to argue that the EU should become a “transfer union,” with the extensive fiscal transfers of a full-fledged federal system, as the German government fears. But the eurozone should allow for more short-term fiscal transfers to deal with asymmetric shocks. A common bond mechanism, for example, would help states in difficulty raise money on international markets or allow resources that are, say, earmarked for agriculture to be redirected to an emergency fund.

ROOM WITH A VIEW

Hard Keynesianism would not solve all of the EU’s economic and political problems. But it would steer the union away from the disaster toward which it is now sleepwalking. A new set of rules based on this approach could form the basis of a solution that is politically viable for both Germany and its European partners most suffering from the crisis. With only limited fiscal transfers allowed, Germany could be further assured that it would not have to continually bail out its profligate partners. Such an approach would maximize the fiscal room that states in distress need in order to deal with economic shocks while ensuring the eurozone’s long-term fiscal sustainability. In the short term, hard Keynesianism, like enforced austerity, would impose real adjustment costs on the eurozone’s weaker economies; there is no cost-free path to fiscal balance. But if the costs were shared with bondholders and were alleviated by a one-off loosening of monetary policy, they could be politically acceptable.

By concentrating on its economic problems but ignoring their political consequences, the EU is setting itself up for failure. The case for austerity does not make sense. And if the EU fails to deal with the political fallout of its own institutional weaknesses, it is going to collapse. No political body can force voters to repeatedly shoulder the costs of adjustment on their own and expect to remain legitimate. During the gold standard, nation-states tried this and failed—and they had considerably more authority than the EU has today. Hard Keynesianism offers a means to combine fiscal discipline with flexibility in order to cushion the political costs of adjustment in times of economic stress. EU leaders must institute it in a hurry.

{ 190 comments }

1

William Timberman 04.26.11 at 2:14 pm

I’m very glad to see this, as it confirms some of my own conclusions, which are admittedly those of an observer rather than a participant, but honestly come by nevertheless. What worries me is the ease with which our current best and brightest have descended into apparent folly, which even the most astute observers, with actual experience in policy matters, can’t seem to bring themselves to admit — not at least, without leaving themselves open to the charge of being Unserious.

If the Germans persist too long in their current pursuit of virtue, they may find that the only alternative left to them will be to re-arm. And honestly, folks, wasn’t once or twice enough, even for them? (Disclaimer: this is definitely an Unserious observation, but it may serve to illustrate how worrisome many of us on this side of the Atlantic find the current policy split in the EU.)

2

dsquared 04.26.11 at 2:31 pm

A few comments.

1. All of the sting in “PIGS” is in Spain, and Spain has much, much better debt/GDP position than the rest. Furthermore, looking at the bond yields, I don’t think the contention “these measures are hindering growth without satisfying bondholders that their money is safe; bondholders worry that these measures are not politically sustainable” is true of Spain either. This matters because if it’s a PIG problem with no S, then it’s much smaller and much less likely to blow out the funding arrangements.

2. Playing devil’s advocate for a minute, let’s look at this from the point of view of Germany, shall we? Ireland, Greece, etc are complaining that they might have to go through a lost decade of growth and suffer elevated unemployment for years, and that they don’t appreciate being given sanctimonious and self-serving lectures on economic management by people who are to a significant degree responsible for their problems. Can you see how this might be seen in Paris and Berlin as perhaps just a little bit ironic? France and Germany had something close to a lost decade themselves, at least partly as a result of joining EMU at an unfavourable cyclical position.

3. Given that, a longer period of lower inflation could do the job of a shorter period of high inflation. In other words, this is a can which can be kicked down the road a lot longer than people seem to think. As long as Spain stays up.

3

Tim Worstall 04.26.11 at 3:16 pm

“In fact, they are likely to undermine Europe’s political union.”

And the problem with this is?

“States in the eurozone should not be allowed to run moderate budget deficits in boom years, the Keynesian argument goes; instead, they should be compelled to run budget surpluses.”

Yes, but. I’m entirely unconvinced that that is politically possible. I base this on events over the last decades in the UK. The boom started in what, 1992? 3? By 97 budget surpluses were in sight (or were they actually being run?) and certainly the turn of the millennium saw some surpluses. But at that point the cries, screams even, that all of this money piling up should be spent were deafening.

The deficits that were being run, 10, 11, 12 years into the boom were not large. 3%, 4%, of GDP perhaps. But I see no way at all, given the calls for more “investment” in this, that or the other, that the necessary surpluses (of what, 5% of GDP? More?) could possibly have been run in that political environment.

An abiding memory is of the tone of Polly Toynbee columns at that time. That for only a little more, we could abolish child poverty, or set up Sure Start centres for all, or cut inequality or get the NHS up to something like European levels of spending…..sure, we don’t have to run the country the way Polly wants it to be run but that was the sort of political pressure that was out there.

I’m simply unconvinced that, even assuming that hard Keynesianism is “correct”, that it’s politically possible.

4

Sev 04.26.11 at 3:49 pm

#1 But aren’t there reasons to think Spanish banks are a lot shakier than their PR would have us believe (real estate loans, in particular)?

5

chris 04.26.11 at 3:55 pm

But at that point the cries, screams even, that all of this money piling up should be spent were deafening.

TW seems to see this through a partisan lens, but in the US much the same thing happened… except instead of *spending* the surplus, the US government massively cut taxes to create a deficit during a boom, instead. Again, over the heads of Keynesians who claimed that the money should be saved for a rainy day. The pressure to slip the leash of hard Keynesianism during good times can come from anywhere on the political spectrum; only the precise means of eating the seed corn vary. (I assume, for the sake of argument, that if the programs TW refers to were worth doing at all, they were worth raising taxes to do, and therefore doing them without raising the tax money to pay for them would have been irresponsible.)

Ultimately, I think, in a democracy, if the people don’t want to enforce fiscal discipline in booms, no other institution is going to find itself able to do so. And if there is no fiscal discipline in booms, nations will find themselves in dire straits in recessions and possibly forced to pursue contractionary austerity. This is obviously a terrible outcome, but if the electorate has no foresight, how can anyone else in the political system have it without being turfed out for trying to take away the punchbowl?

6

dsquared 04.26.11 at 4:07 pm

#4 – there are problems, but I really don’t recognise the EUR600bn figure for their size. What’s the source for that one, John or Henry?

7

Martin Bento 04.26.11 at 4:10 pm

ISTM, at this point, that the intellectual challenge to Hard Keynesianism posed by MMT should at least be addressed. Responses like that of DD in a previous thread – it is tedious theory (economics will never suffer from a shortage of tedium) , it takes too much time, and it is unpromising for my career – seem to me a cop-out. If MMT is correct, the whole “must run surpluses in good times” part of your argument does not hold. Given the failure of the orthodoxy, dismissing MMT because simply because it is heterodox would seem a non-starter. Perhaps there has been a definitive refutation of MMT from an orthodox Keynesian perspective. If so, I would like to be clued in. It looks more like MMT is simply being ignored for partly moralistic reasons – people have an instinctual belief in “fiscal rectitude”, however defined, because creating money from nothing seems like getting something for free, which suggeststo some people’s intuition, there is theft going on somewhere. This isn’t rational: every efficiency discovered produces “something for nothing” relative to what was previously possible, and the natural environment provides a great deal “for nothing”. “You can’t get something for nothing” reflects Calvinist morality, not the nature of the world. Yglesias recently suggested that, even if MMT is right, it may be necessary for people to disbelieve it for Straussian reasons. Whenever you use “Straussian” in a favorable sense, you should probably rethink your argument. If our financial system requires people to believe untruths, there is probably a better one possible that does not require this. Partly, this is about the element of faith that is involved in treating money as having value, and the fact that, since people have differing amounts of money, the faith of all individuals is not equal in effect (hence the outsize impact of the “confidence” of financial markets).

I realize all this is beyond the scope of the paper, but it does seem to me it should be part of the broader discussion.

8

Kevin Donoghue 04.26.11 at 4:15 pm

“Handing the power to destroy national economies to unelected technocrats is simply not politically sustainable.”

The history of the IMF suggests that it’s sustainable as long as the nations in question are small. dsquared is right I’m afraid: as long as Spain holds up there’s no great pressure on Germany to change. And even if things get a lot worse, Europe isn’t really ready for Keynes. Something else will be tried. But Keynes was right, so HF and JQ deserve credit for boring the hard boards.

9

Tim Worstall 04.26.11 at 4:16 pm

@5 Well, yes, I am partisan. And also English, so my examples are likely to be from there. But yes, you’ve given exactly the same argument from the other side of the “fiscal responsibility” fence, tax cuts instead of spending rises.

“This is obviously a terrible outcome, but if the electorate has no foresight, how can anyone else in the political system have it without being turfed out for trying to take away the punchbowl?”

Same general conclusion in the end though. Which leads to, if the electorate won’t put up with hard Keynesianism, what use is it as an operating theory for a democracy?

10

dsquared 04.26.11 at 4:21 pm

I still need to feed my family, so am not getting into the MMT time-sink, but surely if the government deficit (surplus) is equal to the private sector surplus (deficit), then the government needs to run an anticyclical fiscal policy under MMT too? Any recognisably Keynesian policy would have recognised Ireland in the 00s as a state in which aggregate demand was well beyond the productive capacity of the economy and recommended “hard-Keynesian” surpluses (given that the Central Bank of Ireland cannot, as we are aware, control the supply of euros in Ireland).

11

bert 04.26.11 at 4:53 pm

Unsurprising that British commenters are sounding sceptical. Gordon Brown’s golden rule was an attempt to apply this sort of framework. In the event, the requirement for balance “over the course of the cycle” and the exception made for investment borrowing introduced two big fudging opportunities. Influenced by immediate political pressures, fudge was the result.

You also mention the stability pact – another cautionary tale about the difficulties of institutionalising fiscal rules.

I’m intrigued by this:

A common bond mechanism, for example, would help states in difficulty raise money on international markets or allow resources that are, say, earmarked for agriculture to be redirected to an emergency fund.

This is two separate things, surely. The second part — funding fiscal transfers by reallocating existing spending at the expense of well-entrenched and actively-defended client groups — is an enormous chunk to chew off. Presumably you’ve more to say on the subject, and if I’ve missed something of yours I should have seen, my apologies. But it needs more than half a sentence, mysteriously tacked on to a statement about eurobonds.

12

Kevin Donoghue 04.26.11 at 5:04 pm

“… if the electorate won’t put up with hard Keynesianism, what use is it as an operating theory for a democracy?”

All sorts of things have been unpopular with electorates: civil rights, contraception, free trade agreements etc. It’s amazing what people will learn in the hard school of experience. The thing to understand is that Keynes was right. Once you get that, it’s just a matter of convincing enough people.

13

Tim Worstall 04.26.11 at 5:10 pm

“Once you get that, it’s just a matter of convincing enough people.”

Unfortunately, it appears from the article that John and Henry are advocating something different, the imposition of what the electorate won’t put up with through that, umm, how to put this delicately, less than perfectly democratic institution, the EU.

14

Martin Bento 04.26.11 at 5:18 pm

DD, sure, but anti-cyclical need not mean running surpluses in good times sufficient to finance the deficits in bad times. Running smaller deficits in good times is also a (more modest) anti-cyclical policy. Under MMT, as I understand it, and I could be wrong, since monetary expansion is always necessary in a growing economy, especially one that desires modest inflation, and since expansion from the banking sector results in expansion of private sector debt (not, in itself, desirable, and often dangerous at high levels), the only constraint on monetized government deficits is inflation. The government should run surpluses as needed to tame inflation. But we have seen that we can have booms without excessive – for commonly-accepted values of “excessive” – inflation. So booms do not necessarily imply a need for surpluses, nor constrain what can be spent during downturns provided that inflation is not an immediate problem.

This is relevant here because, as Tim and Chris have pointed out, maintaining the surpluses is the hard, possibly impossible, part of this proposal to pull off politically. Things look a lot different if it is not necessary. Besides which, surpluses aren’t the only way government can tame inflation.

Like I say, I’m just looking into MMT, but would like an idea of the state of the discussion, if there is a discussion, rather than some people putting forth theories and others ignoring them. After all, Minsky seems to have gained a lot of credibility lately. Galbraith seems respected, at least on the left (and no one on the left seems respected on the right), so there are people regarded as serious who believe this stuff.

15

mpowell 04.26.11 at 5:49 pm


DD, sure, but anti-cyclical need not mean running surpluses in good times sufficient to finance the deficits in bad times. Running smaller deficits in good times is also a (more modest) anti-cyclical policy.

This. I can understand if someone doesn’t want to get into this full bore debate, though. But the most significant consequence of MMT, as far as I can tell, is that inflation becomes nearly the only thing you need to worry about. But can you even apply MMT to the Eurozone? I think you need your political units lined up with your monetary ones. Or maybe just a central bank that is willing to extend credit to political units with an eye towards balancing employment and inflation?

16

Davis X. Machina 04.26.11 at 6:04 pm

I’m simply unconvinced that, even assuming that hard Keynesianism is “correct”, that it’s politically possible.

If it’s correct, it’s almost certainly politically impossible…and if it’s politically impossible, it’s almost certainly incorrect.

Politics after all isn’t the art of the possible, so much as the art of the entirely-plausible-if-you-stand-right-here, lean-over-and-squint-just so.

17

Kevin Donoghue 04.26.11 at 6:15 pm

Tim W: … John and Henry are advocating … the imposition of what the electorate won’t put up with through … the EU.

Well the existing arrangements were put in place by the EU without much concern for what electorates wanted. But those arrangements are now discredited so you have a point. For the Farrell-Quiggin plan to have a future it would need to be sold to Germans, in particular, who are likely to take some persuading. Personally I think a more realistic way to get to a place where Keynes would want to be is to break up the Eurozone, leaving full participation to those countries which can stand a one-size-fits-Germany monetary policy.

18

Alex 04.26.11 at 6:17 pm

The argument about nobody being willing to accept running a fiscal surplus in the boom is very easy to turn around, though. Why should I accept your Tough Seriousness’s stringency in the boom in exchange for promises of stimulus in the bust? Where are the guarantees? How do I know you won’t give it all to the bankers, pay yourself a giant tax cut, or just sit there congratulating yourself on Sound Finance and the Virtues of Saving while I’m in my cardboard box?

Of course the constraint isn’t actually that strict – there’s going to be some on-going requirement for public investment, and there’s at least a little force in the point that pension funds don’t work very well when the supply of long government bonds is constrained. Non-growing public debt as a share of GDP is a significantly less demanding target, as is something like Gordon’s good old golden rule. Labour in 1997-2001 was after all an example of the public enthusiastically voting for fiscal consolidation during a boom.

19

Henry 04.26.11 at 7:00 pm

The economics I will mostly leave to John (who is presumably asleep now given time differences). But some brief responses to the other stuff.

(1) dsquared – yes – the German and French side of the story is not entirely wrong. I disagree with those who see the Germans as pantomime villains. But the regulatory debate in Europe seems to be driven pretty well entirely by the German/French/ECB view-set (which has some significant internal divergences, but not on the major topics of the piece). Hence, we are trying to tell the other side of the story. The political message we’re trying to get across is that you can have enforced austerity, or you can have some prospect of a politically successful European Union. You can’t have both. And that’s something that doesn’t seem to me to be particularly well appreciated or understood in Paris and Berlin at the moment. The history of the last year has been of a succession of kludges which are set to have politically damaging consequences, and of a German push for a non-kludge which would likely be much, much worse. All of this also speaks to Tim in a sense – the intended audience for this piece is not UK euroskeptics, but people who think that the EU (if it were to work properly) is worth saving and indeed extending further.

On

bq. In other words, this is a can which can be kicked down the road a lot longer than people seem to think.

This is a plausible analysis of what markets are prepared to bear. But that at most is an ancillary part of our argument. The interesting question for me at least is – if this is so, what are the political consequences of a continued fudge with enforced austerity for the peripherals going to be? My very strong expectation is that they are not going to be great for European Union politics. To put it another way – if (as you’ve argued – rightly as far as I can tell) – this all reduces down to a distributional battle over whether bondholders or citizens are going to take the brunt of it – then the continued forbearance of bondholders doesn’t necessarily tell us much about what citizens are going to put up with. If the Eichengreen version of history is right, they are likely to start getting quite pissy indeed.

On the broader question of ‘whether it is just or right to have countries salt away a fair chunk of their surpluses in good years’ – this is the part that I thought about the most after realizing that binding constraints really are required for Keynesianism to work. I am, for the most part, against technocracy and for direct democratic control. But thinking about it, this does seem to me to be a good candidate for a kind of self-binding policy that democrats could embrace – it really is in nobody’s interests to have all the money spent during the good times, so that there is nothing left to cushion the downturns. Nor do I see this as likely to be politically problematic to nearly the same extent as e.g. having an independent ECB effectively making fundamental political decisions while maintaining an ostensibly technocratic role.

And I do think that binding institutions are sometimes possible on the national level (see e.g. Norway until the recent past) and perhaps better possible on the international level. Indeed, I don’t think that the risk of fundamental eurozone collapse is nearly as high as many economists think it is – I would guess that we will see a move towards much stronger eurozone rules that will avert the immediate economic problems, after a couple more series of lurches, agreements-in-principle that don’t mean very much etc. . What I see as the more subtle but important danger is the risk that these rules will succeed in the short run, but turn out to be too inflexible, and make it nearly impossible for eurozone members to respond to asymmetric shocks through targeted policy measures, given the already existing impossibility of in-Europe devaluation and the inflation-targeting role fixation of the ECB. Eventually the rules will get righted – but only after they have done crippling damage to EU legitimacy. So what the article is really calling for is for strong rules – but rules with some specific leeway to deal with asymmetric crises through fiscal policy at the national level. It is also trying to tell Germans that ‘Keynesianism’ and ‘fiscal profligacy’ are not two terms on either side of an identity – but convincing them of this is at best an uphill battle.

20

Henri Vieuxtemps 04.26.11 at 7:25 pm

Wouldn’t it be funny if, for any given unemployment/inflation target, Keynesian and MMT monetary policies would both amount to exactly the same thing, with only difference being the terminology.

21

Kevin Donoghue 04.26.11 at 8:02 pm

Martin Bento: “Galbraith seems respected, at least on the left (and no one on the left seems respected on the right), so there are people regarded as serious who believe this stuff.”

Is there any important difference between Galbraith’s brand of Keynesianism and Krugman’s? The had an argument about deficit limits last July. My impression is that they were in agreement, although Krugman couldn’t quite admit it. He wrote:

Someday the private sector will see enough opportunities to want to invest its savings in plant and equipment, not leave them sitting idle, and the economy will return to more or less full employment without needing deficit spending to keep it there. At that point, money that the government prints won’t just sit there, it will feed inflation, and the government will indeed need to persuade the private sector to make resources available for government use.

But AFAICT Galbraith doesn’t dispute that at all.

22

Tim Worstall 04.26.11 at 8:21 pm

“Personally I think a more realistic way to get to a place where Keynes would want to be is to break up the Eurozone, leaving full participation to those countries which can stand a one-size-fits-Germany monetary policy.”

Agreed….which just brings us back to the original argument about the euro, which is it an optimal currency area or not? If peeps aren’t willing to deal with the strictures necessary for it to be an oca, then it isn’t and the original experiment was a dud.

Henry:

“And I do think that binding institutions are sometimes possible on the national level (see e.g. Norway until the recent past) “

I assume you’re talking about the oil fund. The entire point of which is to make sure that the oil money *is not* invested in the Norwegian economy for fear of Dutch Disease. And yet as you say, even there, the domestic pressure is to do so, in the one economic action that would condemn the Norwegian economy to Dutch Disease.

23

Chris E 04.26.11 at 9:33 pm

“The argument about nobody being willing to accept running a fiscal surplus in the boom is very easy to turn around, though. Why should I accept your Tough Seriousness’s stringency in the boom in exchange for promises of stimulus in the bust? Where are the guarantees? How do I know you won’t give it all to the bankers, pay yourself a giant tax cut, or just sit there congratulating yourself on Sound Finance and the Virtues of Saving while I’m in my cardboard box?”

This argument has a very powerful observation in it’s favour – namely that the idea that banks might have to take a haircut has to be couched in so many comfortable words.

24

James Wimberley 04.26.11 at 9:35 pm

dsquared in 4: I second the call for the authors to source their €600 bn number for a Spanish bailout. Possibly from some worst-case scenario that the Spanish government is in a Greek/Irish position where it cannot borrow anything. But this would have to be a market panic disconnected from Spain’s intact ability to service its debts by taxing eg. me.
Moody’s produced an alarmist report on Spanish banks saying the cajas needed $40-50bn more public money to recapitalise. The Bank of Spain thinks the current €15bn recapitalization should do it, and I suspect it know more about Spanish mortgage law then Moody’s. Is the doom theory that Moody’s is right, the Spanish government tries and fails to borrow the money, then panic?

25

Kindred Winecoff 04.26.11 at 9:42 pm

Henry, which BIS data were you using (i.e. which table)? And could someone quickly fill me in on what D^2’s argument is regarding why the stats aren’t trustworthy? I briefly looked for his previous comments but didn’t see them. Most BIS data is stocks, not flows, so laundering through tax havens isn’t such a major concern.

More generally, we know that there is a lot of debt (not just public debt) from the PIGS floating around out there, and we know that a good bit of it is owned by banks in the EU core (and the US, to a lesser extent). We know that many of those banks are still quite weak, so a major default/writedown right now would be potentially devastating. That’s why 2013 is so important: by then, the hope is that the banks will be sufficiently recapitalized to be able to absorb some haircuts. At that point, Germany is unexposed from the periphery, and can stop paying.

That’s why this crisis has as much in common with the 1980s LA debt crisis as the 1930s.

26

dsquared 04.26.11 at 10:50 pm

Kindred – the stocks data is also distorted in the case of Ireland because there are so many banks headquartered there which aren’t Irish, aren’t guaranteed by the Irish state, aren’t funded in Ireland etc etc, and their assets get recorded as part of the Irish banking system. There’s a good box on the subject in the present Quarterly Review which doesn’t mention Ireland by name, but it’s about Ireland.

27

ovaut 04.26.11 at 11:11 pm

‘even’ before ‘xenophobia’ makes you sound a bit naive

28

John Quiggin 04.26.11 at 11:28 pm

As regards MMT, my reading is that Wray says there is no need for surpluses during booms because booms don’t exist, except as rare exceptions

The state can take advantage of its role in the monetary system to mobilize resources in the public interest, without worrying about “availability of finance.” It still has to worry about real resources: are they underutilized? If not, increased government use means that other activities will have to be curtailed — a tradeoff that should be considered. But in the normal situation in which many resources are underutilized, the government can use the monetary system to put them to work, simply through its spending financed by crediting bank accounts. If that results in a budget deficit, there is no cause for alarm. Lerner called this the “functional finance approach”: the government’s spending and taxing policies should be formulated to achieve public objectives, rather than to “balance the budget.”

(emphasis added)
This doesn’t convince me, but I’d like to read some more, with some actual numbers and empirical evidence. Unfortunately, most of what I’ve seen of MMT is word games about the nature of money, not a topic that interests me much. Can anyone point me in the right direction?

29

Kindred Winecoff 04.26.11 at 11:55 pm

DD -

I assume you’re referring to the box on p. 19 explaining why the BIS data isn’t comparable to the CEBS data? I went back and checked it, along with the box above it on p. 17. The box on p. 19 refers only to exposure to public debt, so foreign firms located in Ireland don’t qualify. But I get your broader point about the data on p. 17.

I think I just read sloppily. I thought John and Henry were referring to exposure to public debt, not total exposure. They don’t actually say that, but the lead-up sort of suggests it. Obv that doesn’t make sense either, since $1tn in public debt is far too much.

Of course, many of the foreign banks in Ireland will have ties to the local banks or other parts of the economy, so you can’t discount all of that. Moreover, the CEBS test says that the 65% of the EU banking sector included in their adverse scenario would face ~ $825bn in losses (at today’s exchange rate). Extrapolate that out to the other 35%, and $1tn seems like a reasonable upper bound. Or, if Ireland’s true number is roughly proportional to Greece and Portugal’s — smaller economy, but bigger local financial sector — you’re still talking ~ $500bn exposure in Greece and Ireland alone, ~ $90bn of which is public debt, and that’s plenty to shake up a still-shaky EU banking sector that has to meet new Basel requirements in a few years.

30

Tom T. 04.27.11 at 1:36 am

I can’t get past the assertion that blogposts encourage cautions and caveats rather than emphatic claims.

31

Martin Bento 04.27.11 at 3:19 am

Kevin, to me what you quoted does not imply the “hard” Keynesianism that is being argued here. It doesn’t necessarily mean the budget has to be balanced over the business cycle. It does suggest that balancing the budget is desirable in a boom, but that doesn’t imply compensating fully for previous or subsequent deficits. Clinton didn’t; his surpluses were quite modest compared to the deficits before and after..And the question raised by the Wray quote John cited – whether the economy normally has full deployment of resources or significantly less – seems applicable to the question of whether the situation Krugman envisions is likely to actually arise much.

And I don’t think Galbraith and Krugman actually do agree here, save on the immediate course of action in this particular situation. I think Galbraith really is saying that deficits are good, save in rare situations. Here he is from an interview with Ezra Klein::

“Since the 1790s, how often has the federal government not run a deficit? Six short periods, all leading to recession. Why? Because the government needs to run a deficit, it’s the only way to inject financial resources into the economy. If you’re not running a deficit, it’s draining the pockets of the private sector. “

It looks to me like recent history, too, supports Galbraith against Krugman. Krugman speaks of a return to a normalcy where full employment can be maintained without deficits, and where deficits will therefore be inflationary. Other than a few years under Clinton, the US has been running deficits, high deficits, for three decades. “Full” employment as contemporary economists define it was approximated for a portion of that time. There have been real problems in this period, but inflation was not one of them. Nonetheless, Christina Romer was warning just a few years ago about the dire consequences surely coming from relentless deficits. You know, three decades seems a pretty long time in a modern economy. If you’ve been starring your whole adult life in a Beckettian tragifarce called Waiting For Inflation, before you pass the role on to your grandkids, you might consider the hypothesis that Inflation ain’t gonna show up. More likely, though, there will eventually be some inflation from some cause and the grey-bearded remote descendents of the twenty-first century’s economists shall hold their trembling palms to the sun in praise that the ancient prophecies have been fulfilled.

To be sure, there is more to it. I think it makes a big difference to what degree the deficits are monetized. Krugman seemed to be implying this when he said that, under full inflation, it was running the printing presses that would be inflationary. But he also said that he was talking about a state where full employment could be maintained without deficits and the only recent candidate for such a period is 96-99. However, the starting point for a discussion of the last 30 years has to be that high deficits with low inflation were the norm, and 96-99 an outlier to be accounted for, not the baseline for generalizations. The Clinton boom, I suspect, had a lot to do with foreign capital freed by free trade agreements and fleeing developing-nation instability finding its way into the US and other advanced economies, including the funding of governments. If so, even that solution is not generalizable, as globally, there is no net capital transfer.

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John Quiggin 04.27.11 at 3:38 am

Martin, I think there’s a confusion here between
(1) The proposition that on an economically correct interpretation of “budget balance over the cycle”, standard measures of the budget balance will show a small deficit on average. This is true, and complicates the story, but doesn’t affect the validity of a Keynesian prescription of deficits in slumps, surpluses in booms.

(2) The proposition, advanced in different ways by supply-siders and MMTers that (the right kind of) deficits will pay for themselves, and therefore we need not be concerned about budget balance. I don’t buy this, and I don’t find an appeal to (most of) the last three decades in the US very encouraging. The 1980s and early 90s were spent getting over the inflation of the 60s and 70s, and Clinton was an exception so the argument boils down to an endorsement (or not) of the Bush tax cuts and Greenspan’s monetary policy.

33

Martin Bento 04.27.11 at 6:29 am

John,

1)The 80’s and early 90’s had much higher deficits than the 60s and 70s. If deficits were the inflation culprit, and the 80s and early 90s the cure, how can this be?
2)What effects of inflation are still being felt 15 years later? Inflation is a dynamic, no? The price is higher today than yesterday. What kind of memory do prices have that still haunts after a decade?
3)I have never heard supply-siders say deficits pay for themselves. They say tax cuts pay for themselves, but I’ve never heard one suggest that spending increases do. By some measures, the position you’re attributing may be more consistent than their actual position, but it is still their actual position by which they should be evaluated.
4)Greenspan’s monetary policy, like Volcker’s, was never to monetize unless it was sanitized. That’s quite distinct from MMT’s liberal attitude towards monetization, and much closer to the monetization hostility of more orthodox Keynesians. including Krugman. Deficits, of course, are a fiscal matter, and Greenspan’s position was to welcome them from Republicans and threaten to tank the economy rather than allow them from Democrats. That is not a policy; that is a politics.

34

dsquared 04.27.11 at 7:06 am

Of course, many of the foreign banks in Ireland will have ties to the local banks or other parts of the economy, so you can’t discount all of that.

Many of them don’t, though – viz Depfa Bank plc, which is simply a German public finance bank headquartered in Dublin for tax reasons, and which is close to EUR100bn on its own.

you’re still talking ~ $500bn exposure in Greece and Ireland alone, ~ $90bn of which is public debt, and that’s plenty to shake up a still-shaky EU banking sector that has to meet new Basel requirements in a few years.

Actually it isn’t. The preprovision profit of the EU banking sector is a bit more than $350bn a year.

35

Alex 04.27.11 at 8:34 am

There is every reason for UK eurosceptics to care. Namely, our biggest trading partner pulling a Hoover is not going to do us any good however eurosceptic we are. Especially as the political party they all vote for (UKIP, feh – hands up if you’re in the five people who really, really do vote for them) has committed us to a strategy of export-led growth. The sterling/euro (before than, sterling/dmark) rate and the level of aggregate demand in the eurozone are absolutely critical to the West Midlands-centred, engineering-heavy export economy.

36

hopkin 04.27.11 at 9:31 am

I can’t help thinking that, good though the QF article is, we’re all missing something here. The reason for the size of the budget imbalances has an awful lot to do with the size of trade imbalances within the Eurozone. Even the most herculean efforts of fiscal responsibility and foresightedness wouldn’t have saved Ireland or Spain from the boom/bust journey they’ve experienced, which is the main reason for their fiscal problems. Germany had a lousy fiscal position for years, but this was offset by private austerity. In Spain it was the other way around. How big a fiscal surplus would Spain have had to run to offset its housing boom? Is there any democratic country that has ever pulled this off?

37

Ltw 04.27.11 at 10:27 am

If the EU is to survive

The euro and the ECB is not the EU. The main debate here surely should not be how European governments address their fiscal problems or how to sell fiscal transfers politically to their electorates, but whether the euro should exist at all? It doesn’t have to mean the end of the EU. If the policies of the ECB are exacerbating the issue, perhaps the answer is to end the experiment?

38

John Quiggin 04.27.11 at 10:29 am

Martin: To focus on the central point, I imputed to both supplysiders and MMT the view that “(the right kind of) deficits will pay for themselves, and therefore we need not be concerned about budget balance”. I thought it obvious that the parenthetical remark included, for supply-siders, the qualification that the deficit had to arise from tax cuts, but thanks for spelling it out.

As you further note, most of the Bush deficits weren’t monetised but were financed by debt. (Presumably you don’t claim, on the basis of recent experience, that governments can issue as much debt as they like.) But that makes the experience of the 2000s much less relevant to the proposition that deficits financed by money creation aren’t inflationary (note that Keynesians like Krugman take this view in the exceptional context of a liquidity trap – the distinguishing feature of MMT seems to be the claim that this is true in general)..

39

Hoover 04.27.11 at 10:39 am

Did Keynes say countries should build up a surplus for the downturn?

Elsewhere, he said that countries persistently in credit with his hypothetical union should be obliged to devalue their currency.

I see a conflict.

40

John Quiggin 04.27.11 at 11:30 am

@Hoover: I think he said “revalue (upwards)” not devalue, and I don’t see any conflict – maybe you can spell this out

41

Metatone 04.27.11 at 5:27 pm

FWIW, I think some level of hard Keynsianism is probably a good idea, although I think that MMT reminds us that the level of surplus/deficit may not be symmetrical, AND we need to remember that booms are not a product of interest rates so much as a product of loose margin requirements – and in open zones, that money can travel, it’s beyond purely national regulation.

Anyway, surely the key point is that if there’s going to be a single currency and no great level of fiscal transfer within the Eurozone then a Eurozone Clearing Union is critically needed.

This complicates matters because it goes against the “exporter good, importer bad” frame that the Germans and others want to put around the core/periphery problem in the Eurozone.

42

selise 04.27.11 at 6:23 pm

John Quiggin – I recommend another article by L. Randall Wray: “Teaching the Fallacy of Composition: The Federal Budget Deficit.”

We hear politicians and the media arguing that the current federal budget deficit is unsustainable. I have heard numerous politicians refer to their own household situation: if my household continually spent more than its income year after year, it would go bankrupt. Hence, the federal government is on a path to insolvency, and by implication, the budget deficit is bankrupting the nation.

That is another type of fallacy of composition. It ignores the impact that the budget deficit has on other sectors of the economy. Let me go through this in some detail, as it is more complicated than the other examples.

We can divide the economy into 3 sectors. Let’s keep this as simple as possible: there is a private sector that includes both households and firms. There is a government sector that includes both the federal government as well as all levels of state and local governments. And there is a foreign sector that includes imports and exports; (in the simplest model, we can summarize that as net exports—the difference between imports and exports—although to be entirely accurate, we use the current account balance as the measure of the impact of the foreign sector on the balance of income and spending).

At the aggregate level, the dollar spending of all three sectors combined must equal the income received by the three sectors combined. Aggregate spending equals aggregate income. But there is no reason why any one sector must spend an amount exactly equal to its income. One sector can run a surplus (spend less than its income) so long as another runs a deficit (spends more than its income).

Historically the US private sector spends less than its income—that is it runs a surplus. Another way of saying that is that the private sector saves. In the past, on average the private sector spent about 97 cents for every dollar of income.

Historically, the US on average ran a balanced current account—our imports were just about equal to our exports. (As discussed below, that has changed in recent years, so that today the US runs a huge current account deficit.)

Now, if the foreign sector is balanced and the private sector runs a surplus, this means by identity that the government sector runs a deficit. And, in fact, historically the government sector taken as a whole averaged a deficit: it spent about $1.03 for every dollar of national income.

Note that that budget deficit exactly offsets the private sector’s surplus—which was about 3 cents of every dollar of income. In fact, if we have a balanced foreign sector, there is no way for the private sector as a whole to save unless the government runs a deficit. Without a government deficit, there would be no private saving. Sure, one individual can spend less than her income, but another would have to spend more than his income.

While it is commonly believed that continual budget deficits will bankrupt the nation, in reality, those budget deficits are the only way that our private sector can save and accumulate net financial wealth.

Notes:
1. In the EMU, nations are to the euro as states in the USA are to the dollar — currency users.
2. I have used this extended quote (with permission of the author) recently in a post on the topic which includes a handy figure of the sectoral balances from Scott Fullwiler.

43

selise 04.27.11 at 7:07 pm

Kevin Donoghue – I agree with Martin Bento, I don’t think Galbraith and Krugman agree on the issue of USA fed govt budget deficits. They’ve additional public discussions since July. Here are some posts from Mike Norman Economics that give links to Galbraith’s and others response to a blog post by Krugman on deficits and MMT:

Jamie Galbraith smacks down Paul Krugman
Responses to Paul Krugman
Summing Up Krugman and MMT

In addition, my impression is that Galbraith’s and Krugman’s economic differences run deeper than USA fed govt budget deficits. Galbraith described some of these in his article, “Who Are These Economists, Anyway?

And if all the above is not enough, Tom Hickey has recently compiled a list MMT Links. I especially recommend Warren Mosler’s short book, “Seven Deadly Frauds of Economic Policy,” for a excellent and fun intro to MMT.

44

wh10 04.27.11 at 7:08 pm

@ John Quiggen 38

“As you further note, most of the Bush deficits weren’t monetised but were financed by debt. (Presumably you don’t claim, on the basis of recent experience, that governments can issue as much debt as they like.) But that makes the experience of the 2000s much less relevant to the proposition that deficits financed by money creation aren’t inflationary (note that Keynesians like Krugman take this view in the exceptional context of a liquidity trap – the distinguishing feature of MMT seems to be the claim that this is true in general)..”

MMT says deficits are inflationary only when spending exceeds full employment. It’s quite logical. Only when maximum economic capacity is reached should additional money create inflation (more money chasing after the same amount of goods). However, prior to full output, deficits (in the form of spending or tax cuts- that’s more of a political choice) should further stimulate aggregate demand to bring the economy to full employment without inflation.

As far as deficits being financed by debt vs monetized, all deficits by law are required to be financed by debt. The treasury cannot deficit spend without issuing debt $-for-$ with the deficit, but MMT argues this is an unnecessary, arcane law held over from the gold standard. Today, as a monopoly supplier of the currency in a floating exchange rate regime, the government operationally does not need to borrow to spend- all money comes from the US govt. The point of bond sales in the US modern day economy is to stabilize the federal funds rate. With deficit spending comes excess reserves, which must be drained with the sale of bonds so that the FFR doesn’t drop to zero. Bond sales are purely an interest rate maintenance tool- not funding.

If you’re interested in reading more about MMT, I refer you to http://pragcap.com/resources/understanding-modern-monetary-system . That is the most comprehensive yet succinct summary of MMT that I have seen, and it lists a bunch of great resources at the bottom if you want to look more deeply into the MMT literature. Warren Mosler, one of the core founders of MMT as we know it, has an excellent website and great essential readings here : http://moslereconomics.com/mandatory-readings/ ; his paper “Soft Currency Economics” sort of started the whole thing – http://moslereconomics.com/mandatory-readings/soft-currency-economics/; if you want the lay-person’s version, he wrote a book called “The 7 deadly, innocent frauds of economic policy,” a really easy, quick read, though I find it a bit too simplistic (and almost disingenuous in this regard) for those who are educated in economics. L. Randall Wray, Bill Mitchell, and Scott Fullwiler are some of the foremost academic experts on MMT and have published significantly on this topic; some of their work/websites and more are listed here: http://mikenormaneconomics.blogspot.com/2011/04/mmt-links.html .

If you really want to dig into the literature full-on, Scott Fullwiler wrote this near 50 page behemoth http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1722986 , but I would start with the links I gave above.

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wh10 04.27.11 at 7:14 pm

I’d also like to reiterate that much of MMT is purely descriptive of actual monetary operations. It’s not theory. Only in the policy prescriptions of MMTers is there theory.

Additionally, MMT tries to make clear that it describes a monetary system in which the govt is the monopoly supplier of currency in a floating exchange rate regime- ie the govt has full monetary sovereignty. This was not the case for the US prior to 1971 before Nixon took us completely off the gold standard, and it is not the case for countries in the eurozone (since they function more like US states, which are not monetarily sovereign). This is a very important distinction one must keep in mind when learning MMT. It means you can’t extrapolate MMT to any country or any time period, and it also provides the basis for refuting the common hyperinflation examples people attempt to use when trying to dismantle MMT (e.g., Greece, Weimar, Zimbabwe, etc.).

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wh10 04.27.11 at 7:20 pm

@ John Quiggen 28

Here is Scott Fullwiler’s paper “Macroeconomic Stabilization Through an Employer of Last Resort ,” which quantitatively models out the idea that you highlighted in Wray’s quote:

http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1722991

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wh10 04.27.11 at 7:52 pm

To follow on Selise and the MMT/Krugman debate, I think this was the best recap and explanation. Authored by Scott Fullwiler, MMT academic.

http://www.nakedcapitalism.com/2011/03/scott-fulwiler-paul-krugman%E2%80%94the-conscience-of-a-neo-liberal.html

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John Quiggin 04.27.11 at 8:14 pm

“MMT says deficits are inflationary only when spending exceeds full employment. “

Well, that’s pretty much the orthodox Keynesian view too, and seems exactly consistent with what’s being advocated in the article.

49

John Quiggin 04.27.11 at 8:29 pm

As I said first up, the problem seems to be that according to MMT, the economy is almost never at or above full employment, which (as Martin Bento spells out) should imply that we will never see inflation. As Martin says, based on the last thirty years, that claim looks pretty good. Older readers may have a slightly different view of things.

In that context, I found the Fulwiler paper pretty disappointing. The data period goes back to 1952, but the results reported are all for the “Great Moderation” period post-85, which isn’t very interesting. What do MMT theorists say about stagflation?

On the other link, I couldn’t follow the Fulwiler response to Krugman at all – Krugman seemed to me pretty convincing, and Fulwiler just waffled, in both US and Australian senses of the word.

50

chris 04.27.11 at 8:33 pm

MMT says deficits are inflationary only when spending exceeds full employment. It’s quite logical. Only when maximum economic capacity is reached should additional money create inflation (more money chasing after the same amount of goods). However, prior to full output, deficits (in the form of spending or tax cuts- that’s more of a political choice) should further stimulate aggregate demand to bring the economy to full employment without inflation.

AFAICT, this is indistinguishable from the Keynesian view of the same situation, which suggests that Henri @20 is correct, and the two theories are isomorphic up to a change in terminology.

But maybe there are differences that are going over my head.

51

Detroit Dan 04.27.11 at 8:53 pm

Chris @50–

There are clear theoretical differences and clearly different policy implications between Keynesians and functional finance (aka MMT) advocates. At least this true with regard to the prominent Keynesians like Krugman who fret about the bond vigilantes. For example, Krugman argued in 2003 that we need “phased elimination of all the Bush tax cuts, plus some additional taxes”, because “you might get in a situation where the interest rates the government has to pay to roll over its debt become so high that you get an accelerating problem, which is what happened in Argentina.” He may have changed his position on these points, but not that I know of and, if so, only on the basis of his thoughts that we are in a liquidity trap.

I don’t think any MMTer would agree with Krugman on the points above. I, for example, am certainly in favor of higher taxes on the wealthy, but do not think that higher taxes on the middle class are a good idea at the present time. And Krugman’s suggestion that we need to lower fiscal deficits as an antidote to current account deficits will only work by plunging the U.S. economy into recession or depression. The comparison of the U.S. to Argentina is misplaced since Argentina had pegged its currency to the U.S. dollar, which violates one of the basic assumptions as to when MMT applies.

On the other hand, there are obviously many points of agreement between liberal MMT economists (although not all MMT economists are liberal) and Keynesians such as Krugman…

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studentee 04.27.11 at 8:53 pm

“What do MMT theorists say about stagflation?” cost-push, not demand-pull.

i’d also like to point out that many mmt’ers believe that bond issuing is unnecessary. if they’re correct, and issuing bonds at the federal level is irrelevant for both the raising of revenues (clearly) and for demand-management (probably), then the whole apparatus is an unnecessary welfare package for banks and the holders of tsy’s. this should upset progressives

53

wh10 04.27.11 at 8:54 pm

Dr. Quiggen, fair enough and there is not much more I can personally add, especially regarding the ELR simulation. I am hoping some of the MMT heavyweights, such as Scott, will join into the discussion and address your concerns.

I think to appreciate Fullwiler’s response, one needs to already see where MMT is coming from and also has to understand that Krugman wasn’t really critiquing MMT since he was basing his argument on assumptions that MMT does not make (i.e. it was a straw man argument); in other words, Krugman and MMT are mostly talking past each other. However, Scott argues that Krugman, in the midst of his straw man argument, reveals a fundamental misunderstanding of monetary operations. *This* is where some differences between the Keynesian view and MMT may lie (again because MMT is mostly about operations).

54

Tom Hickey 04.27.11 at 8:57 pm

MMT is built on 1) a general description of monetary/fiscal operations under the current monetary system, and specific description wrt various countries, including the EMU as a special case, 2) a description of the relationship of the government fiscal authority, government monetary authority, private financial sector and real economy, 3) the sectoral balance approach articulated in stock-flow consistent macro models as developed by Wynne Godley, 4) the use of Abba Lerner’s functional finance as a fiscal policy instrument in favor of monetary policy that focuses on interest rates and monetary aggregates, and 5) a Minskyian approach to inherent financial instability.

According to MMT, the government fiscal balance, the domestic private balance, and the external balance all sum to zero. Taxes, saving, and net imports all constitute demand leakage. The role of the budget is therefore to adjust the government fiscal balance to the nongovernment balance in order to maintain full employment along with price stability. The government fiscal balance is a policy outcome rather than a policy determinant. A government should be aiming at optimal economic performance as measured by full employment and price stability rather than the absolute size or sign of its fiscal balance as a criterion.

The EMU is a special case because, having foregone monetary sovereignty, the EMU nations are similar to US states; they are currency users rather than currency issuers. Problems rise since there is only a central monetary authority (ECB) and no central fiscal authority. In addition, the EZ is not an optimal currency area because the asymmetries. Therefore, it is difficult to come up with an MMT-based fiscal solution such as would apply in the case of monetary sovereigns like the US, UK, Canada, Australia, and Japan.

Here is Warren Mosler’s proposal, using the ECB.

55

Detroit Dan 04.27.11 at 9:01 pm

John Quiggin @49 –

What do you think of the concept of functional finance, i.e. that the objectives of macroeconomic policy should be full employment and stable prices? This is in contrast to the conventional view that lower government deficits are desirable in and of themselves. Functional finance advocates (also referred to as advocates of modern monetary theory (MMT)) would acknowledge that absolutely full employment with zero inflation may not be attainable. Nevertheless, these are the targets and fiscal policy is the more effective way of meeting these targets. MMT/functional finance is not a utopian theory that will solve all problems, but is more realistic than a theory which advocates balanced fiscal budgets, which are rare indeed and for good reason…

56

studentee 04.27.11 at 9:03 pm

to jump off wh10 (sort of): i’m not sure how intrinsic this is to mmt per se (i think it’s something that’s been realized by post-keynesians and horizontalists in general), but they were the first to show me, at least, that the monetary multiplier is bogus. i was taught the money multiplier, just two years ago, in undergraduate macro! stock-flow consistent approaches like mmt reveal said bogus-ness. the money supply determines the monetary base, not the other way around. mmt’ers argued that qe2 would be a non-event and that any changes would not be fundamental but simply speculation and irrational exuberance. they were correct

57

John Quiggin 04.27.11 at 9:06 pm

If MMT has a cost-push theory of inflation, I’m not really interested. I was a believer the first time around with cost-push theory, back in the early 70s, and was eventually pushed to the conclusion that it didn’t work. I think there are problems with “Phillips curve + expectations”, but cost-push is not the answer.

Even more, I don’t think talk about the true nature of money is of any use (except as a warning of crankiness ahead), and there seems to be an awful lot of that in the MMT literature.

58

studentee 04.27.11 at 9:09 pm

“If MMT has a cost-push theory of inflation, I’m not really interested.”

they have both

59

Detroit Dan 04.27.11 at 9:21 pm

John Quiggin @57 –

It’s not clear to me what you are objecting to in MMT. Somebody mentioned cost-push inflations, but that’s certainly not a central concept in MMT, and it’s anyway unclear exactly what you are objecting to about that concept. Also, regarding the true nature of money, apparently you’ve been irritated by some previous experience, but the rest of us here have no idea what you are referring to…

60

studentee 04.27.11 at 9:26 pm

“…but the rest of us here have no idea what you are referring to…”

austrians? mmt’ers describe the history of money to show that it wasn’t something that was wrenched from the private sector or goldbugs or something. it’s almost always been a creature of the state

keynes on abba lerner (sort of a godfather to mmt):

“[Lerner’s] argument is impeccable, but heaven help anyone who tries (to) put it across to the plain man at this stage of the evolution of our ideas.”

61

Detroit Dan 04.27.11 at 9:33 pm

Keynes to Lerner

“My dear Lerner,

Your book arrived in London whilst I was away at Bretton Woods. But now again I am on the sea for yet another visit to the U.S.A., and the sea voyage has given me an opportunity to read it.

It is a grand book worthy of one’s hopes of you. A most powerful piece of well organized analysis with high aesthetic qualities, though written more perhaps than you see yourself for the cognoscenti in the temple and not for those at the gate. Anyhow I prefer it for intellectual enjoyment to any recent attempts in this vein.

In the second of the two books which you have placed within one cover, I have marked with particular satisfaction and profit three pairs of chapters—chap 20 and 21, chap 24 and 25, and chap 28 and 29. Here is the kernel of yourself. It is very original and grand stuff. I shall have to try when I get back to hold a seminar for the heads of the Treasury on Functional Finance. It will be very hard going—I think I shall ask them to let me hold a seminar of their sons instead, agreeing beforehand that, if I can convince the boys, they will take it from me that it is so!

62

Detroit Dan 04.27.11 at 9:33 pm

so much for block quotes…

63

chris 04.27.11 at 9:35 pm

There are clear theoretical differences and clearly different policy implications between Keynesians and functional finance (aka MMT) advocates. At least this true with regard to the prominent Keynesians like Krugman who fret about the bond vigilantes.

I find it interesting, and slightly mindboggling, that there is a point of view from which Krugman can be described as “fretting” about the bond vigilantes. Apparently because he concedes that they might theoretically exist somewhere, before going on to say, repeatedly, with charts, that they aren’t here now and there is no prospect of their being here in the foreseeable future.

I don’t think any MMTer would agree with Krugman on the points above. I, for example, am certainly in favor of higher taxes on the wealthy, but do not think that higher taxes on the middle class are a good idea at the present time.

But neither does Krugman — at the present time. You’ve quoted him from 2003. A lot has happened since 2003!

He may have changed his position on these points

Well, yeah. Anybody who hasn’t changed their policy advice for the U.S. at any point between 2003 and now is somewhat suspect on that basis alone, aren’t they? A doctor who prescribes the same medicine for all patients is no doctor, but a snake oil salesman.

But he does still support getting rid of the Bush tax cuts — eventually. He thinks (insofar as I can presume to represent his positions based on reading him now and then) that we won’t be in a liquidity trap forever and when we are (a) out of a liquidity trap and (b) at or near full employment (and obviously those conditions are not independent), *then* it will be necessary for the government to raise more revenue because continuing to run a large fiscal deficit will have unfavorable effects.

On the other hand, I think he does still think that if we *had* gotten rid of most of the Bush tax cuts sometime between 2003 and when the crisis hit, we would be better off now — partly because we would have less debt load, and partly because the tax increase would have reduced the size of the bubble. Do MMT-ers disagree, and if so, why?

64

Hoover 04.27.11 at 9:45 pm

@John Quiggin: You could well be right.

There’s a record of his explanation of the ICU in the Lords, but the Hansard site isn’t currently responding.

On the other hand Felix Salmon summarises the penalise-both-surpluses-and-deficits as “any country racking up a large trade deficit […] would be charged interest on its account. It would also be obliged to reduce the value of its currency and to prevent the export of capital. But – and this was the key to his system – he insisted that the nations with a trade surplus would be subject to similar pressures. Any country with a bancor credit balance that was more than half the size of its overdraft facility would be charged interest, at a rate of 10%.”

http://seekingalpha.com/article/231671-tim-geithner-s-poor-imitation-of-john-maynard-keynes

65

Kevin Donoghue 04.27.11 at 9:46 pm

Unlike dsquared, who has a family to feed, I could devote a few months to MMT if I were so inclined. But before I do, I’d like the proponents of this theory to assure me that there is something – other than new jargon — in MMT which will come as news to somebody who has read Keynes’s General Theory, most of Joan Robinson’s macroeconomic essays, Galbraith the Elder’s Money: Whence it Came, Where in Went and Minsky’s J. M. Keynes. Presumably there is something to justify the ‘Modern’ in MMT, but what I’ve seen so far is just a re-hash of Post-Keynesian and Old Keynesian doctrines. What am I missing?

Of course I don’t mean to say that if MMT is old it must be crap; quite the contrary. The aforementioned writings stand up pretty well and the oldest of them stands up best of all.

66

Detroit Dan 04.27.11 at 9:50 pm

@Chris–

Thanks for the response. Most, if not all, MMTers do not believe in bond vigilantes for countries which control their own currency and allow its value to float and do not borrow in foreign currencies. This is a big difference from what Krugman believes, as he made clear again recently.

Sorry for quoting such an old Krugman post, but I don’t think he’s ever come clean on the mistakes in made back then with regard to the bond vigilantes.

I have to run now so I won’t be able to address your other points now. Maybe some others can jump in and filling the gaping void my absence will leave (c;

67

Kindred Winecoff 04.27.11 at 10:02 pm

DD -

Surely the Big Four have counterparties, yes? I agree that an Irish writedown/devalue won’t be nearly as bad as Lehman/AIG, but it would hurt.

350bn PPOP isn’t a lot when your exposure to just two countries is 500bn-1,000bn and you’re trying to raise hundreds of billions in new private capital to meet Basel III.

68

john c. halasz 04.27.11 at 10:19 pm

Quiggin @57:

As to the 1970’s stagflation and the wage-price spiral, here’s Abba Lerner’s proposed solution:

http://community.middlebury.edu/~colander/books/map.html

69

wh10 04.27.11 at 10:25 pm

@ chris / 63

“On the other hand, I think he does still think that if we had gotten rid of most of the Bush tax cuts sometime between 2003 and when the crisis hit, we would be better off now—partly because we would have less debt load, and partly because the tax increase would have reduced the size of the bubble. Do MMT-ers disagree, and if so, why?”

Mind you, I am not an expert on MMT, and I hope I do not misrepresent their position, but I think MMT would disagree. From a sectoral balances perspective (this is not MMT specific), smaller government deficits means less private sector income/savings. When the private sector cannot save as much, they are forced to take on debt to sustain their spending preferences. So, smaller deficits would have likely exacerbated the “debt bubble” if anything. Also, and perhaps more relevant and importantly, you have to distinguish debt in the form of treasuries from the debt that was relevant to the financial crisis. I am not sure how private sector holdings of treasury bonds contributed to the securitization fiasco. So, without invoking MMT, I’m not sure I understand your argument.

70

John Quiggin 04.27.11 at 10:30 pm

@Hoover: If you read carefully, you’ll see the implication is exactly what I said. Deficit countries and surplus countries would both be pushed to adjust, and it’s obvious that just as deficit countries are supposed to depreciate, surplus countries are supposed to appreciate. It’s the second part of the idea – that surplus countries should also face penalties – that’s novel in Keynes.

And this approach to external balance exactly fits the Keynesian approach to internal balance – deficits in slumps, surpluses in booms.

71

John Quiggin 04.27.11 at 10:36 pm

@jch Lerner’s model was, I think, a revamp of the tax-based inflation plans put forward by cost-push theorists in the 1970s. Some policies along those lines were tried, either in isolation or in combination with wage-price controls. They didn’t get anywhere, although (unlike wage-price controls) the attempt wasn’t sustained enough to draw a definitive conclusion of failure. Still, I don’t see any reason to believe that the cost-push account of inflation is valid.

72

wh10 04.27.11 at 10:39 pm

@ Kevin 65

You can judge for yourself in a very short amount of time. I recommend reading through this article, and you will either by tittilated or not http://pragcap.com/resources/understanding-modern-monetary-system .

73

Tom Hickey 04.27.11 at 10:56 pm

See your fellow Australian Bill Mitchell (University of Newcastle)

MMT and inflation – part 1 [demand side origin]
http://bilbo.economicoutlook.net/blog/?p=10554

MMT and inflation – part 2 [supply side origin]
http://bilbo.economicoutlook.net/blog/?p=13035

74

John Quiggin 04.27.11 at 11:17 pm

I’m having a hard time seeing the link between the Job Guarantee (versions of which both Bill and I were pushing in the early 1990s*) and MMT, or indeed monetary theory in general. Certainly, at that time, I can’t remember Bill saying anything about monetary theory.

It seems to me far more satisfactory to address these things in real terms and with a focus on fiscal policy and labor markets.

* And the Job Guarantee itself was only a rebadging (unfortunately, not a politically successful one) of the commitment to full employment which was the central element of mainstream Keynesianism after WWII. You don’t need a new monetary theory for this, and I don’t think it helps

75

Tom Hickey 04.27.11 at 11:47 pm

MMT is not a new monetary theory. One of the developers of MMT said that Modern Monetary Theory is a debt-based theory of money, and debt-based money is at least 4000 years old. MMT’s theory of money is Neo-Chartalism, extending the insights of previous Chartalists. Others take “modern” to mean post-gold standard, when the international monetary system shifted from a convertible fixed rate regime to a nonconvertible floating rate one.

As I said in #54 above, MMT describes the current monetary system and from this description proposes a fiscal policy approach using sectoral balances and functional finance in favor of a monetary policy approach using interest rate management. The issue is recognizing the potential of the present monetary regime, which is not operationally constrained (although there may be political restraints imposed in various countries), in order to address demand leakage to saving desire and net imports fiscally. The only constraints on the present system are inflation, exchange rate, and the availability of real resources. For example, the MMT position is that a monetarily sovereign government can always afford to purchase idle resources, like workers without job offers, since it is the currency issuer.

Bill has written extensively on replacing rule-based monetary policy (NAIRU) with fiscal policy that adjusts the government fiscal position with changes in demand leakage due to private saving desire and net imports. The Job Guarantee serves as a price anchor as well as an employment buffer to replace the current unemployment buffer.

76

P O'Neill 04.28.11 at 1:19 am

Celtic Tiger Ireland looked hard Keynesian, at least at the time. Whatever test it will be said to have failed now is an ex post one, adjusted for the fact that the fiscal criteria failed to see the problem the 1st time around.

77

studentee 04.28.11 at 1:19 am

re: bond vigilantes, mmt, and krugman

i would say that krugman thinks that bond vigilantes (vis-a-vis the us) are invisible, and mmt’ers think they are impossible

78

studentee 04.28.11 at 1:25 am

“On the other hand, I think he does still think that if we had gotten rid of most of the Bush tax cuts sometime between 2003 and when the crisis hit, we would be better off now—partly because we would have less debt load, and partly because the tax increase would have reduced the size of the bubble. Do MMT-ers disagree, and if so, why?”

functional finance is agnostic about the size of the federal debt load (besides some wanting to get rid of the whole shebang). the goal is full employment and price stability. the size of the debt load should be irrelevant. i support increasing taxes on the superrich, but not out of a desire to reduce the deficit, debt, etc. probably what would have happened if you increased taxes when the economy isn’t at full employment is an increase in unemployment. thus higher welfare payments, and more debt?

why would letting the bush tax cuts expire have prevented the housing bubble? a tax on land might have worked

79

studentee 04.28.11 at 1:33 am

another point of departure is that krugman, etc. believe that the clinton surpluses were a good thing; mmt’ers in general don’t

80

Detroit Dan 04.28.11 at 1:50 am

Celtic Tiger Ireland looked hard Keynesian, at least at the time.[P O’Neill, #76]

Well, there’s another difference between conventional Keynesians and MMTers. MMTers would say that since Ireland does not control its own currency, MMT doesn’t apply…

81

John Quiggin 04.28.11 at 1:54 am

@PO’Neill I’m not an expert on the Irish economy, but this report indicates that the budget was almost exactly balanced before the crisis

http://www.finfacts.com/irelandbusinessnews/publish/article_1011535.shtml

That’s not consistent with the story of gross fiscal irresponsibility being told by the austerity fans, but it’s also not consistent with hard Keynesianism.

82

Henry 04.28.11 at 2:11 am

bq. Celtic Tiger Ireland looked hard Keynesian, at least at the time.

Charlie McCreevey would beg to differ ;)

83

john c. halasz 04.28.11 at 2:20 am

John Quiggin @71:

I’m not really sure what your objection to the wage/price spiral account of 1970’s stagflation is, as it was fairly standard at the time. (Of course, an economy is a complicated tangle of interlocking feed-back loops, so the distinction between cost-push supply side and demand-pull demand side explanations isn’t “causally” clear-cut to me, as effects from the one side will feed over to the other side, which, n turn, will feedback to the first side, etc.) Pardon my somewhat U.S.-centric account, (since that’s where I have some idea of the actual data-drip), but I’d thought that the generally accepted account was rising inflation from the Vietnam War, due to a politically motivated refusal to tax for it, met up with a supply-side shock of rising commodity prices, (especially oil), which itself was partly the effect of Nixon’s scuttling of Bretton Woods and thus devaluing the U.S.$, (since commodities were priced in $), which then was amplified through a wage-price spiral, when a still organized and militant labor force with rising expectations from the post-war years and COLAs in their contracts squeezed profits and confronted declining investment and productivity-rates. At any rate, it’s not clear to me why rising employment, wages and wage-shares as the economy approaches genuine full employment should be regarded as a supply-side cost/push rather than a demand-side demand/pull “problem”.

At any rate, back to Lerner. A Pigou inflation tax was associated with Weitraub back then. (Wage/price controls were obviously not going to work efficiently or at all and just amounted to a dimly remembered reflex of the WW2 hyper-employment economy. The other policy mooted was a negotiated national incomes policy, which had some chance of working in small homogeneous nations with the required institutional coordination.) But Lerner’s preference for a mark-up cap-and-trade system for wage-price spirals under full employment was that it would directly internalize the coordination problems within the relative price adjustments between sectors and firms in the production system, directing the mark-ups to the bottle-necks or choke-points where they were most genuinely needed. And I think he meant it as a more general solution to an immediately pressing problem, which he’d long been thinking about.

Getting back to MMT, I think a step back from it to the Godley inter-sectoral balances approach to national income accounting identities is more relevant here. That directly applies to the Euro-zone crisis in a way that MMT does not. And it makes clear that the problem doesn’t arise simply from public deficits/debt, but from the total deficits/debts situation. (Of course, if the PIIGS each had their own sovereign currencies, the ability to devalue would not just present a “solution” to the problem, but would have prevented the problem of CA deficits blowing out to such unmanageable proportions in the first place).

But it’s not clear to me that the likes of, e.g., Krugman even understand the Godley approach. At any rate, critics of deficit spending, from the standpoint of the orthodoxy of an inter-temporal public budget constraint, need to explain in some sort of model just why, as the economy approaches genuine full employment, large public deficits would persist, rather than the Debt/GDP ratio actually start to decline, and why the inflation threat couldn’t be dealt with simply by raising taxes to drain excess monetary demand. No doubt, it would have to involve factors like large rent-seeking interests riddling the production economy, (such as the U.S. health care system), persistent under-taxation, and persistent CA deficits. But then why blame such problems on public deficits as a cause rather than effect, and why not address such problems directly with targeted solutions? But then again, it’s not clear to me that the “crowding out” of private investment criticism of public deficits should be accorded so much weight so reflexively, when some forms of public spending on public goods, such as infrastructure, R&D, and even targeted industrial policy, amount to investment spending and “crowds in” “private” investment. That’s just begging the question.

On the other hand, what bothers me about MMT isn’t their position of public debt/deficits, but rather their rather cavalier attitude toward trade/CA deficits and their easy assurance of the efficacy of FX adjustments in a floating rate regime. That seems to me to ignore, via macro-economic abstraction, issues of the structure of production, and of the industrial hollowing out, analogous to the “Dutch disease”, that can occur, whereas, whatever one’s theory of FX adjustments, (covered interest rate parity/PPP, etc.), they seem to have little empirical predictive force, since short-run financial flows tend to recurrently swamp alleged long-run equilibrium. And ignoring the arbitrage activities of MNCs and Wall St. in international trade and finance flows strikes me as ignoring much of the actual “picture”.

Then again, given my priors and prejudices, that genuine full employment doesn’t occur, as a fact or as a policy aim, is hardly surprising, and not the invention of MMT. The interests of the capitalist class, given their druthers, are clearly opposed to such a prospect, since not only would it decrease labor “discipline” and the political power of the capitalist class, but rising wage rates/shares would not just squeeze profits, relatively, if not absolutely, but would tend to diminish the “value” of capital, in that productivity innovation would be the only response, which would accelerate the depreciation of extant capital stocks. That an elaborate techno-structure of economic theory would be erected to rationalize this capitalist class interest, in the name of fighting inflation or optimizing production or what not, is hardly, “epistemologically” speaking, surprising.

84

Detroit Dan 04.28.11 at 2:20 am

I’m having a hard time seeing the link between the Job Guarantee (versions of which both Bill and I were pushing in the early 1990s*) and MMT, or indeed monetary theory in general. [John Quiggin #74]

Obviously, you have a long record of macro economic thought with which many of us are not familiar. So it would be interesting to have this discussion in more depth to find out more specifically why you think that monetary theory (or monetary system description) is irrelevant to today’s macro issues.

And the Job Guarantee itself was only a rebadging (unfortunately, not a politically successful one) of the commitment to full employment which was the central element of mainstream Keynesianism after WWII. You don’t need a new monetary theory for this, and I don’t think it helps. [John Quiggin #74]

Colander addresses this here.

The generation before me—the sons whom Keynes spoke of—knew it was grand
stuff, but their sons—my generation and their grandsons—began to lose the vision… Functional finance was seen as having an expansionary and inflationary
policy bias. As modern Keynesians gave up their belief that they could specify the
desired inflation and unemployment rates independently of the actual functioning of the
economy, they simultaneously abandoned the functional finance policy prescriptions. As
a result, in the 1990s, the rules of functional finance are little discussed… Actually the giving up of the rules of functional finance by policy makers occurs
much more in words than in deeds. Despite what central bankers may say their policy is,
and despite the rhetoric of policy oriented macro economists, the actual policy reaction to
recessions is now quite different than it was in pre-Keynesian times. When presenting
fiscal policy to voters, governments talk about balanced budgets; but the benefits of
government deficits in a recession are recognized… The demise of functional finance on the theoretical
front is closely tied to major developments in theoretical macro—the rise to
power of neoKeynesianism, the micro-foundations revolution, the New Classical
revolution and the New Keynesian flash in the journals… Why were the neoKeynesians willing to agree to such a synthesis that
theoretically precluded Keynesian economics? As I argued in The Coming of
Keynesianism to America their primary interest was policy; theory for them was
something that led to a model with acceptable policy conclusions. The fact that one could
develop a model requiring the policy they wanted within a fixed-wage Walrasian
structure, led them to accept a synthesis based on that structure in order to avoid
unending, and quite irrelevant, arguments with Classicals over logical debating points
with little relevance on the checkerboard of real life…
Like many compromises based on short-run policy concerns, the neoKeynesian
compromise had within it the seeds of destruction of neoKeynesian economics. The
destruction of neoKeynesianism began with the work in microfoundations that led to the
rise of Phelps’s and Friedman’s concept of the natural rate of unemployment… The long run domain
was given to the Classicals, since wages and prices were assumed flexible in the long run
and the neoKeynesians had already agreed that with flexible wages and prices the
economy would gravitate to its long run equilibrium. For policy-oriented Keynesian
macro economists, these new terms of synthesis were still acceptable, since there was
still a short run role for their primary policy concern: stabilization policy. Functional
finance was still possible, as long as it was kept to a stabilization role around a
predetermined natural rate. However the stage was also set for the next theoretical
development in macro that was to undermine neoKeynesian analysis and place it in the
dustbin of history… The next step in the burial of Keynesian economics was the rational expectations
revolution… This assumption put neoKeynesians on the floor because it undermined the basis
of the compromise they had had with Classical economists. It essentially tied together the
long run and the short run and made it so that anything that could happen in the long run
would be anticipated in the short run and, therefore, short run policy could not be
effective unless based upon real cost differentials.

One reason why MMT matters is that it ties the short run and long run into a coherent description of how the economy works. What do you think?

85

P O'Neill 04.28.11 at 2:58 am

One problem with fitting Ireland into the story is that they were putting away money during the boom — the National Pension Reserve Fund, which was supposed to be walled off for pension obligations post 2025. 1 percent of GNP a year regardless of the rest of the budget. They did in fact build up a nice balance in the fund … which is now gone in the recapitalization (=black hole) of the banks. I think this illustrates a general point about the moral hazard that a pot of money creates during good times, as other commenters above have stressed.

But one very good warning indicator for Ireland is election year spending splurges. JQ’s link above is for 2007, and the man at the European Commission desk in 2002 says they should have reacted more to a blatant electioneering binge of that year.

86

Detroit Dan 04.28.11 at 3:10 am

john c. halasz –

I agree with you 100%, including your criticism of MMT with regard to the hollowing out of U.S. industrial capacity as a result of the chronic trade deficit. However, this (the cavalier attitude toward trade/CA deficits) is not an integral part of MMT and is rather a stance that has been taken by Bill Mitchell in describing an ideal MMT-based U.S. government…

87

John Quiggin 04.28.11 at 3:10 am

At any rate, critics of deficit spending, from the standpoint of the orthodoxy of an inter-temporal public budget constraint, need to explain in some sort of model just why, as the economy approaches genuine full employment, large public deficits would persist, rather than the Debt/GDP ratio actually start to decline, and why the inflation threat couldn’t be dealt with simply by raising taxes to drain excess monetary demand.

This is the standard hard Keynesian position: run deficits during recessions, and restore the debt/GDP balance [this is the correct notion of balanced budget over the cycle] by raising taxes/revoking tax cuts (and withdrawing special fiscal stimulus) during booms.

And your account of the inflationary upsurge, which is broadly the consensus view, correctly implies that the role of cost-push factors like commodity prices and COLA clauses was just to amplify the inflationary spiral generated initially on the demand side.

88

Detroit Dan 04.28.11 at 3:26 am

John Quiggin–

As regards MMT… I’d like to read some more, with some actual numbers and empirical evidence.

The best evidence in favor of MMT seems to be the Japanese economy, with the U.S. economy in recent years also quite supportive. Conventional wisdom would point to high interest rates in both Japan and the U.S., due to repeated quantitative easing and large fiscal budget deficits.

The current problems in Ireland and other Euro countries were also predicted by MMT, and thus provide supportive empirical evidence.

If you’re looking for empirical support for an employer of last resort program, I agree that little is available, although we do have considerable evidence from the U.S. in the depression and during WWII that massive government employment programs can provide a real boost to the economy. China today also seems to fit this model…

89

Senexx 04.28.11 at 3:44 am

@Kevin @65

I can’t say there is something new in MMT other than new jargon since the new jargon is more understandable to the layman like myself than the old jargon.

Ultimately it is a post-Keynesian school of thought, so in that sense, it is not new either.

However, as stated by others it is based on today’s modern monetary operational realities, the way it really works, not the way many theorists think it worth. It is largely based on fiat currency issuing nations and sectoral balances, also described earlier.

I don’t believe there is any economic school of thought that disagrees with the accounting identity C + S + T = GDP = C + I + G + (X – M) which becomes:

(I – S) + (G – T) + (X – M) = 0

After that its just a matter of envisioning a fiat currency being introduced to a sovereign non-monetary economy (that is the State issues the money) complete with the automatic stabilisers that we’re all familiar with.

And from there, at least from my perspective, the rest is largely common sense.

90

Detroit Dan 04.28.11 at 3:45 am

John @87,

It sounds like you’re trying to equate MMT with the “hard Keynesian” position. But, it’s definitely not the conventional wisdom, and not the liberal position advocated by Krugman who worries about the fiscal deficit and the bond vigilantes. Agreed? If so, you seem to agree that MMT is correct and that it does represent an important distinction from the conventional liberal wisdom…

91

Charles St. Pierre 04.28.11 at 4:05 am

It all comes down to the issue of international debt, thus trade imbalances.

It’s the producer-consumer problem. The producer produces, the consumer buys, the producer ends up with all the money. The system crashes. The addition of consumer debt merely delays and amplifies the final crash. Indeed, one of the fundamental problems of any economy is keeping money in the hands of its consumers.

Here, the problem is how to get the money back into the hands of the PIIGS consumers.

But this cannot be done, as long as Germany insists on being ‘paid back.’ And in fact, as long as Germany insists on running a surplus, Germany cannot ever be paid back. It will always be owed, and always be owed more. Only if the Germans run a deficit wrt the PIIGS, that is, if trade between Germany and the PIIGS balances over time, can the PIIGS earn the euros to pay back their debt. Doing this by austerity is definitely the hard, hard, way, since the only way in can happen is if domestic consumption by the PIIGS consumers goes so low that they begin exporting. This will not help the Germans, because the PIIGS are the market for German surplus production. Better to capitalize the PIIGS so they become industrial powerhouses, and that the Germans party harder.

Failing this, the only solution is, one way or another, forgiving the debt. Inflation, default, restructuring, showering euros on the PIIGS cities, choose your poison. Then the Germans can go back to working hard and producing a surplus, and the PIIGS can go back to consuming that surplus, providing the market that keeps the German industrial machine humming.

92

john c. halasz 04.28.11 at 4:40 am

John Quiggin @87:

“This is the standard hard Keynesian position: run deficits during recessions, and restore the debt/GDP balance [this is the correct notion of balanced budget over the cycle] by raising taxes/revoking tax cuts (and withdrawing special fiscal stimulus) during booms.”

No, it’s not quite the same. In the first place, the long-run cycle is not known ex ante, so what would constitute a long-run cyclical budget balance is speculative and “prudential”. In the second place, what matters is the debt/GDP ratio, not the budget balance, and that’s a dynamic “fact”. The argument against the inter-temporal budget constraint is that, given the “right” policy mix, (which is, of course, debatable, and where I would depart from the cure-all MMT proposal), the budget deficit “problem” basically takes care of itself, and besides which it is the overall debt/deficit situation and not just the public one that matters. What needs to be avoided is not long-run public deficit spending, but the long-run debt/GDP ratio, both public and private out-running the long-run actual/potential growth of the economy. (And there somewhat higher inflation is scarcely ruinously public enemy number one). And so the advocates of “hard Keynesianism” need to explain just how such run away deficit/debt levels would occur,- and the modeling and policy assumptions they are making. (Of course, there’s Greece, but whatever else might be said about it’s political economy, that’s precisely not an example of a sovereign currency). What is being argued to the contrary, under the rough rubric of “functional finance”, is that fiscal policy is actually far more effective to the task of demand management with full employment than “New Keynesian” quasi-monetarist policies.

As an aside, “Keynesian” is nowadays taken to mean policies of AD management, through manipulation of budgets and interest rates. But Keynes was a much more supple economic thinker than one-size-fits-all policy prescriptions. And I think it’s Keynes the theorist of international trade and FX adjustment who’s most relevant nowadays. (Though there is little hope for a rectification of the current trade/FX regime, given the coordination problems and competing interests involved).

93

John Quiggin 04.28.11 at 7:11 am

@jch It’s true that the long-run balance is not known ex ante, which only strengthens the case for surpluses during booms.

Also, as you can see from the original post, we agree that stability of the debt/GDP ratio is what matters – budget balance over the cycle is a shorthand for this, useful in some contexts, misleading in others.

The sticking point for me is the suggestion* that, in normal circumstances, governments can finance a significant part of their expenditure through their control of the monetary system, without resort to either taxation or debt. Unsurprisingly, given its appeal, this proposition has been tested many times, invariably failing. There is a small potential benefit from seignorage, but it’s only around 1 per cent of national income, so can be disregarded for most purposes.

* It’s hard to find this spelt out as baldly as I’ve put it, so I won’t claim that this is what MMT advocates believe. But without something like this, MMT just looks like soft Keynesianism(more inclined to support deficits, less to diagnose a boom that justifies a surplus relative to hard Keynesianism ) .

94

Martin Bento 04.28.11 at 7:25 am

John, first of all, supply-side economics does not claim that we do not need to be concerned about budget balance, as you state. It claims very loudly that deficits matter enormously. That’s what Reagan said running on a balanced budget platform in 1980, and it is the whole justification for Paul Ryan’s budget today. It is true that a Republican politician, Cheney I think, apologizing for Bush’s deficits said “Reagan proved deficits don’t matter”, but that was one-off cynical spin, not their general claim. What supply-siders claim is that tax cuts are so stimulative they increase revenue, reducing the deficit. Since this is false, supply-siders in fact end up increasing the deficits, as Reagan did and as Paul Ryan does once all the SS hocus pocus is stripped away. Indeed, in specifically targeting the structural deficit, Ryan is aligning himself precisely with the hard Keynesians, who also oppose structural deficits and applaud only countercyclical ones.

Secondly, you first claimed that “the argument boils down to an endorsement (or not) of the Bush tax cuts and Greenspan’s monetary policy.”, implying that the MMTers support it and you hard Keynesians do not, and then said “the experience of the 2000s [is] much less relevant to the proposition that deficits financed by money creation aren’t inflationary”. You can’t have it both ways. If the experience of the last decade is not relevant to the debate, the debate does not come down to the policies of the last decade.

Also note that Krugman’s argument that deficits are inflationary at (common) full employment cannot be limited to monetized deficits if it is to support hard Keynesianism. If financed deficits are not inflationary, surpluses must be deflationary, and presumably you don’t want deflation or imagine you can long sustain your boom in its presence. So hard Keynesians must believe that even financed deficits are inflationary at full employment.

As for the last 30 years, you don’t seem to have gotten what I was citing that experience to show. Hard Keynesians picture times of full employment where they can run surpluses to fund the deficits that will be necessary in other times. Note that these must be times of full employment achieved without deficits, as one cannot run a surplus and a deficit at the same time. I don’t think MMTers are claiming that full employment as such is rare; they are claiming it is rare and unsustainable in the absence of government deficits – that the specific form of full employment the hard Keynesians need for the project you propose, full employment with a balanced budget or better, is rare. Here is an empirical question: is full employment in the absence of deficits, HK full employment if you will, common or rare? What we find in the last 30 years is that an absence of deficits is itself rare, so wherever full employment was achieved, it was achieved with deficits save for a few years at the end of Clinton’s reign. Now you suggest I am too young to remember the 70s. OK, let’s push back clock another 30 years, to 1950, and see what we see:

A sea of red ink punctuated by 3 small islands of surplus: 58,59, and 69. For more than half this period, no high inflation. Then come the 13 years or so of inflation. A number of questions arise:

1) How can one base the general case (deficits causing inflation, assuming, as you do, frequent full employment) on the 13 years and ignore the other 47?
2) If the inflation was caused by deficits at HK full employment, how come the inflationary period contains neither the highest deficits nor the fullest employment of the 60-year period – far from it on both counts?
3) If HK full employment is common throughout the 60 years, and deficits as a point of fact are common, why is high inflation not common, but in fact constrained to one period less than a quarter of the total in duration?

95

Martin Bento 04.28.11 at 8:13 am

wh10 wrote:

“As far as deficits being financed by debt vs monetized, all deficits by law are required to be financed by debt.”

This is technically correct, but misleading. The Treasury must issue the bonds, but the Fed can print money to buy them, effectively monetizing the debt. In fact, the Fed does this routinely, but “sanitizes” or “sterilizes” the monetization by selling the bonds on the market later. AFAIK, though, sanitization is a matter of Fed policy, not law, and the recent interventions have seen much more delay before sanitization than in previous years. Also, the Fed usually does have significant T-bills on its balance sheet.

96

vimothy 04.28.11 at 11:38 am

“In fact, if we have a balanced foreign sector, there is no way for the private sector as a whole to save unless the government runs a deficit.”

^This is the most egregious MMT fallacy, IMO.

97

vimothy 04.28.11 at 11:49 am

“It’s not theory.”

^Wait–it could be this, akshully.

98

wh10 04.28.11 at 12:16 pm

Vimothy at 96, explain please? I’m pretty sure sectoral balances is widely excepted in any economic school of thought. If all 3 sectors must balance to zero, and the government sector is running a surplus, the foreign sector is balanced, then the private must be running a deficit.

Martin at 95, my understanding is that all of this is simply interest rate maintenance, it has nothing to do with “funding” government spending.

99

wh10 04.28.11 at 12:19 pm

Martin, here is where MMT takes issue with use of the term “monetize” and so forth. MMT would claim it is misleading.

http://pragcap.com/pomo-flip-matter

100

P O'Neill 04.28.11 at 12:28 pm

This thread is headed to the identity versus theory dead-end.

101

bert 04.28.11 at 2:51 pm

Hey, fanboys. I liked MMT’s early records, but they lost me when they went for that bigger stadium sound.

One further thought about the repurposed agriculture funds (comment #11). You’re addressing one problem — Germanic allergy to a transfer union — by actively steering away from the bigger problem of imbalances inside the eurozone.

Not to say that you haven’t written a thoughtprovoking piece. This is a nit; forgive me for picking it.

102

wh10 04.28.11 at 3:01 pm

I truly am on the constant outlook for arguments which “disprove” MMT. The thing is, all I ever run across are straw-man arguments, dismissals based upon gut reaction, or inane comments such as “Hey, fanboys. I liked MMT’s early records, but they lost me when they went for that bigger stadium sound.” No one ever takes it head-on.

103

bert 04.28.11 at 3:08 pm

Not dismissing MMT.
Addressing the original post.
Don’t fret.

104

Detroit Dan 04.28.11 at 3:10 pm

The sticking point for me is the suggestion* that, in normal circumstances, governments can finance a significant part of their expenditure through their control of the monetary system, without resort to either taxation or debt. Unsurprisingly, given its appeal, this proposition has been tested many times, invariably failing. There is a small potential benefit from seignorage, but it’s only around 1 per cent of national income, so can be disregarded for most purposes. [John Quiggin, #93]

That helps! I’d be interested in seeing how you come up with the 1%. I’m thinking more like 100% — we do use fiat currency after all. When the silver backing was eliminated from the U.S. dollar we went all in.

Admittedly, most (if not all) governments issue bonds these days to match deficits, so I get your point. Where is the empirical evidence that the bonds can be done away with? MMTers will point to the extensive QE in Japan, the US, and the UK to demonstrate that bonds are not necessary. But perhaps these monetization exercises have so far amounted to only as much as 1% of national income? And what are some examples of failure beyond that level?

Anyway, Martin Bento made an excellent case that the empirical evidence supports MMT where it counts — in terms of fiscal deficits and inflation. I think MMT is also correct with regard to the necessity of bond ‘financing’, but I don’t think we even need to address that to see that “hard Keynesianism” (i.e. view that we should normally have a balanced fiscal budget) is wrong…

105

Sebastian 04.28.11 at 3:57 pm

“I don’t think MMTers are claiming that full employment as such is rare; they are claiming it is rare and unsustainable in the absence of government deficits – that the specific form of full employment the hard Keynesians need for the project you propose, full employment with a balanced budget or better, is rare. Here is an empirical question: is full employment in the absence of deficits, HK full employment if you will, common or rare? What we find in the last 30 years is that an absence of deficits is itself rare, so wherever full employment was achieved, it was achieved with deficits save for a few years at the end of Clinton’s reign.”

Isn’t this a major caveat though? The few years at the end of Clinton’s presidency are the major recent example of full employment in the US, right? If the major example is achieved without deficits, that sounds like a problem for the way you are describing MMT.

106

Detroit Dan 04.28.11 at 4:13 pm

The causality goes both ways. The booming economy in the late 90s led to low deficits and, eventually, fiscal surpluses. The Clinton surpluses led to private sector debt problems and a slowing economy.

So I wouldn’t say this is a major caveat. Just the exception that proves the rule (or something like that — I couldn’t resist this superficially clever phrase)….

107

Martin Bento 04.28.11 at 5:04 pm

wh10, yes, this is usually done for interest rate maintenance, though the recent QE was expressly for monetary stimulus. What you said, though, is that US deficits legally could not be monetized, and that is false. They routinely are on a short-term basis. They recently have been for economic effect. Saying we’re going to monetize government debt to provide monetary stimulus and we’re going to monetize government debt so they government can spend money without pulling it back out in the form of taxes, are two different ways of saying pretty much the same thing. And interest rate maintenance itself is largely for the purpose of directing the growth of the money supply. I gather MMT may dispute this is fully effective, but that is the claimed purpose. The choice the Fed usually makes is to let the banks expand the money supply through multiplier effects, controlling this process through interest rates and reserve requirements (chiefly), rather than expanding it through sustained monetization. But that is a choice, not a matter of law.

108

Detroit Dan 04.28.11 at 5:11 pm

Martin– You’re familiar with the MMT belief that the money supply is endogenous? I think that’s pretty much indisputable, although certainly the Fed can influence the money supply in a number of ways (regulation perhaps being more important than interest rates)…

109

vimothy 04.28.11 at 5:24 pm

wh10, In terms of MMT’s favourite identity, (S – I) = (G – T), ignoring the foreign sector. Say that the budget is balanced so that G – T = 0. This implies that S = I. Ta-da. The private sector can save even if the budget is balanced.

Say that G is less than T. This implies that I is greater than S. The private sector can still save in this case, but some investment will be funded by govt saving.

110

studentee 04.28.11 at 5:35 pm

vimothy:

“Say that the budget is balanced so that G – T = 0. This implies that S = I. Ta-da. The private sector can save even if the budget is balanced.”

sure, absolutely. this is where minksy enters the equation. at a balanced budget, the private domestic sector can furnish its own savings, and things could work! but they don’t, because private financial markets are unstable

“The private sector can still save in this case, but some investment will be funded by govt saving.”

the private sector cannot net save

111

Martin Bento 04.28.11 at 5:42 pm

Sebastian, if you can make a case for a general correlation between low deficits and high employment, that example would loom large, but it is hard to make that case. Prior to the last ten years, Reagan was the deficit king by a mile, but employment increased considerably under Reagan, though not to Clintonian levels. The (sometimes) high unemployment of the 70’s was associated with deficits that were quite modest by subsequent standards.

112

Martin Bento 04.28.11 at 6:46 pm

John, one more thing.You wrote:”Keynesians like Krugman take this view [that debt can be safely monetized – M] in the exceptional context of a liquidity trap” If that is the case, why do you need to run surpluses during good times? Monetized debt need not be repaid, nor financed in advanced. Perhaps you’re thinking of running deficits during slumps even if they do not reach the point of being liquidity traps?

113

Sebastian 04.28.11 at 6:50 pm

“Sebastian, if you can make a case for a general correlation between low deficits and high employment, that example would loom large, but it is hard to make that case.”

Well there are the Clinton years. Which may or may not prove anything ultimately (as always with economics there can be hundreds of other factors at work), but insofar as they apply to MMT, it seems to be a strong counter example from the way MMT says that things work.

So far as I can tell for MMT important factors, the timeline in the late Bush I early Clinton years went raise taxes (Late Bush I early Clinton), reduce deficit (Clinton and *restrained* spending because of divided Congress) THEN employment increased to previously unheard of levels (mid to late Clinton). From my understanding of MMT, and how it has been described here, not only should that deficit reduction have been unnecessary, it should have created more unemployment, not less. Furthermore, the relative lack of growth under the Congress/Clinton standoff toward the middle should have caused unemployment, not led to some of the lowest unemployment in the history of the modern US economy.

Now again, I’m not actively asserting that the low deficits/active surplus CAUSED low unemployment. I’m saying that so far as I can tell, under MMT they should have caused higher unemployment, and therefore represents a challenge to the theory.

And this is of course the problem with most economic theories, they are difficult to disprove or prove because you can always come up with caveats. But the Clinton years look like a major challenge to MMT, and should definitely not be waved off with statements like “What we find in the last 30 years is that an absence of deficits is itself rare, so wherever full employment was achieved, it was achieved with deficits save for a few years at the end of Clinton’s reign.” As phrased, it sounds like there are lots of cases of full employment, with Clinton’s presidency being one of the few under low deficit/surplus facts.

But couldn’t the sentence be even more accurately phrased “What we find in the last 30 years is that deficits were incredibly common, while full employment was very rare.”? But this is not what MMT seems to predict!

Do you have lots of full employment cases in mind such that the Clinton presidency can fairly be relegated to footnote?

114

Sebastian 04.28.11 at 6:51 pm

Hmmmm, I should probably have said restrained growth of government spending under the divided government of most of the Clinton years. I don’t believe that changes any of the MMT important arguments, but I should be clear.

115

wh10 04.28.11 at 7:05 pm

Sebastian I think it is a fair point. Like you said though you have to take into account a lot of variables.

A lot of MMTers try to link today’s problems with the Clinton Surpluses of the late 90s, but I don’t buy that.

116

studentee 04.28.11 at 7:38 pm

“I’m saying that so far as I can tell, under MMT they should have caused higher unemployment, and therefore represents a challenge to the theory.”

not really. the deficit often shrinks itself when the economy is doing well, and mmt’ers don’t think that government deficits are what *create* full employment; the federal gov’t has no monopoly on the creation of jobs, or savings, etc. the private sector can do it on its own, it’s just difficult for the private sector to maintain because of financial instability, animal spirits, etc. unlike wh10, i do believe they make a good case that the surpluses weren’t a good thing, and that the domestic private sector went increasingly in debt to maintain its standard of living and full employment in the face of shrinking federal deficits

mmt theorists would agree that during a boom and in the face of inflationary pressures the gov’t should shrink the size of the deficit (or at least allow the deficit to shrink). it’s just that the idea that balanced budgets or surpluses should be run towards the tail end of booms that is questionable

anyway, the argument behind functional finance stands: why do we care so much about the size of the deficit, or debt, in and of themselves?

117

john c. halasz 04.28.11 at 7:49 pm

Sebastian @113:

Umm…you do know, of course, that the capital account is the obverse of the current account. The Clinton boom was due to the tech bubble, as the current account deficit blew out when foreign capital, “savings”, rushed in to join the party, even as domestic household savings declined, “the wealth effect”, sparking an accompanying consumption boom that raised the employment level. And the rising tax revenues which closed the budget deficit, rather marginally, were largely a one-off windfall, and not something due to policy planning, (though Clinton was the sort of politician who would claim credit for the weather on a sunny day).

So it is rather much the case of an exception that proves the rule, as the CA account was largely providing the “savings”, that allowed for a modest gov. surplus, (as has been the case ever since). And it was a bubble, which, I’m fairly sure you’d agree, is not optimal economic policy, since it not only mis-allocates investment capital in proportion to its scale, but disrupts the continuity of investment in technical innovation, (such that the U.S. was #1 in internet technology in the 1990’s, whereas nowadays the title belongs to the likes of S. Korea and Finland, after the post-bubble investment drought that was eventually filled by the housing bubble!) The rule remains that gov. fiscal surpluses will be offset elsewhere in the inter-sectoral balances and that balanced budgets are not somehow the key to optimal economic performance.

118

John Quiggin 04.28.11 at 8:17 pm

Martin @112 I think most Keynesians would agree with the proposition that in the special case of a liquidity trap, there is no need to finance new public expenditure with debt, or to sterilize the addition to the money base when the economy recovers. In these circumstances, an increase in inflation is desirable. So, if the MMT claim is confined to the case of liquidity traps, MMT is, as I said, just Keynesianism.

If the claim is more general, then we can look to the experience of governments that have, in the absence of a liquidity trap, attempted to rely on seignorage to finance their operations (usually because of an inability to collect tax revenue). The evidence on this is clear – attempting to do this for more than a couple of years leads to inflation, which wipes out much of the revenue benefit. Persisting beyond this point leads rapidly to hyperinflation, typically within five years, and to the collapse of the currency, commonly replaced by external hard currency, as recently in Zimbabwe.

So, one way of putting one of the propositions that’s being discussed here is: a government that issues its own money, can issue as much as it chooses, but, if it issues too much (where too much = enough to finance a substantial deficit), it won’t be issuing its own money for long.

What this means is that deficits must be (and are) financed mainly by debt, and here there is an obvious constraint, namely that the debt/GDP ratio cannot rise indefinitely. That brings us back to the point of the original post. If you want large deficits in recessions, you need to run surpluses (in the sense of a fiscal policy that reduces the debt/GDP ratio) at other times.

119

Sebastian 04.28.11 at 8:18 pm

I’m perfectly willing to allow for the idea that much of Clinton’s GDP success was illusory or bubbly, but MMT (and lots of other theories) suggest that the super low level of unemployment success is still something very important.

What do you think of the summary, “What we find in the last 30 years is that deficits were incredibly common, while full employment was very rare.”?

Maybe it is too broad to be useful, but it seems to be a problem for MMT. It doesn’t seem that studentee’s response to the effect that the government doesn’t have a monopoly on job creation answers the MMT problem. It doesn’t have a monopoly, but deficits are supposed to help almost any time there isn’t full employment, which as we have discussed is almost all of the time.

120

john c. halasz 04.28.11 at 10:05 pm

This, lifted from a comment at another econ blog, might prove helpful here:

Also from Mathew Forstater’s “LERNER, Abba Ptachya (1903-1982)” http://www.cfeps.org/pubs/wp/wp52.htm

Quote:

Decisions concerning taxation are to be made only with regard to the economic effects in terms of the promotion of full employment, price stability, or other economic goals, and not ever because ‘the government needs to make money payments’ (Lerner, 1943, p. 354). Likewise, ‘the government should borrow only if… the effects’ of borrowing are desired, for example ‘if otherwise the rate of interest would be too low’ (Lerner, 1943, p. 355).

These points of view were repeated and elaborated by Lerner in his 1951 book, The Economics of Employment:

[T]axes should never be imposed for the sake of the tax revenues. It is true that taxation makes money available to the government, but this is not an effect of any importance because money can be made available to the government so much more easily by having some created by the Treasury. (1951, p. 131, original emphasis).

Likewise, ‘borrowing’ is also not a funding operation for Lerner.

What are the purposes of taxation and borrowing, if not to fund government spending? The purpose of taxation for Lerner is its ‘effect on the public of influencing their economic behavior’ (Lerner, 1951, p. 131, original emphasis) including, as we will see below, creating a demand for government fiat currency. Like taxation, borrowing is not a funding operation; rather, it is a means of managing reserves and controlling the overnight interest rate when the government runs a budget deficit:

[T]he spending of money…out of deficits keeps on increasing the stock of money [and bank reserves] and this keeps on pushing down the rate of interest. Somehow the government must prevent the rate of interest from being pushed down by the additions to the stock of money coming from its own expenditures…. There is an obvious way of doing this. The government can borrow back the money it is spending (Lerner, 1951, p. 10-11, original emphases).

Two extraordinary results follow from Lerner’s analysis here. First, the implication is that ‘borrowing’ logically follows, rather than precedes, government spending. In fact, this analysis questions the accuracy and relevance of the term ‘borrowing’ itself for discussing government bond sales. Second, note that the budget deficit is causing interest rates to fall, the exact opposite from what traditional theory has long predicted (i.e., ‘deficits cause high interest rates’).

The role of taxation and borrowing, reserve management and interest rate maintenance will become clearer upon examination of two, less well-known, Lerner contributions, ‘Money as a Creature of the State’ (1947) and his Encyclopaedia Britannica entry on ‘Money’ (1946), which place him squarely in the Keynes-Knapp Chartalist school, and which is key to fully understanding the possibility and effectiveness of Functional Finance. The ability of the government to conduct fiscal and monetary policy according to the principles of Functional Finance is made possible by the fact that, as the title of Lerner’s paper states, ‘money [i]s a creature of the state’:

The government — which is what the state means in practice — by virtue of its power to create or destroy money by fiat and its power to take money away from people by taxation, is in a position to keep the rate of spending of the economy at the level required to fill its two great responsibilities, the prevention of depression, and the maintenance of the value of money. (Lerner, 1947, p. 314)

In adopting this view Lerner followed Keynes ….

End Quote

121

Walt 04.28.11 at 10:11 pm

I’ve been reading some MMT, and I’m having trouble getting from what I’ve read to the policy positions I’ve seen here. As far as I can tell, MMT doesn’t argue that governments can fund themselves by seignorage alone. Rather, the argument is that with a fiat currency the fundamental operations are fiscal, rather than monetary. So a government can finance itself by printing money and spending it, and mop up any inflation by raising taxes. The ability to tax in your own currency is what underwrites the value of the fiat currency. Taxation is essential to the process. The policy argument about debt is that the amount of debt is not an important policy variable — governments should aim for full employment and low inflation, and they are not constrained from meeting these objectives by the level of debt.

122

Sebastian 04.29.11 at 12:16 am

“[T]axes should never be imposed for the sake of the tax revenues. It is true that taxation makes money available to the government, but this is not an effect of any importance because money can be made available to the government so much more easily by having some created by the Treasury.”

It is this kind of talk that seems to betray a loss of touch with what money is. Money is a marker used as a medium to exchange for scarce goods or services. Noting that money can be “created by the Treasury” without being very careful about the fact that the ultimate goal is to get goods and services seems to be a fallacy that MMT proponents fall in to often. The ability to print money (or nowadays to add zeros to bank accounts) doesn’t magically vanish supply and demand problems.

MMT advocates seem to be impressed by the idea that governments can’t really default on debt issued in their own currency. Even ignoring real world counterexamples, the insight isn’t as exciting when you realize that runaway deficit spending can still wreck your economy even without the technicalities of ‘default’. So wrecking the economy isn’t always ‘default’. So what?

123

wh10 04.29.11 at 12:28 am

Sebastian, you’re basing your comments on practically zero knowledge of the actual MMT literature. MMT acknowledges everything you’ve mentioned. We’ve provided severally links in this thread if you’re interest in actually learning about it, rather than speculating.

124

Detroit Dan 04.29.11 at 1:38 am

I agree, wh10. Sebastian and John don’t seem to be comprehending the fundamental points of MMT.

John makes a point that the evidence is clear (#118), but the only example provided is Zimbabwe, which suffered a major decrease in productive capacity, as did the Weimar Republic. These have been extensively discussed elsewhere. Please provide a relevant example and maybe we can make some progress!

125

wh10 04.29.11 at 1:48 am

Also those examples violate a central tenet of MMT- you can’t apply MMT to monetary regimes which are not fully sovereign! Here’s Bill Mitchell on Zimbabwe http://bilbo.economicoutlook.net/blog/?p=3773 . Cullen Roche also addresses this issue http://pragcap.com/hyperinflation-its-more-than-just-a-monetary-phenomenon

126

Detroit Dan 04.29.11 at 1:52 am

And countries that have “an inability to collect tax revenue” (see #118) are going to fail in either type of system being discussed here (MMT or hard Keynesian).

My feeling is that the balance of trade will prove to be more important than the fiscal balance in assessing the fundamental causes of countries that have suffered soaring inflation. Hard Keynesian policies don’t address trade issues, whereas MMT leaves room for government investment to strengthen the real economy, by putting people to work and addressing real needs, rather than assuming that the market will take care of these matters.

Anyway, I look forward to some real life case examples for discussion…

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Detroit Dan 04.29.11 at 2:03 am

What do you think of the summary, “What we find in the last 30 years is that deficits were incredibly common, while full employment was very rare.”? [Sebastian, #119]

This is a fair statement for the U.S., I think. And I would guess that it applies more generally– i.e. fiscal deficits are more common than balanced budgets and economies are rarely at full employment. But we’re getting into Utopian territory here. As I said previously, I don’t expect MMT to solve all problems and to miraculously bring full employment with perfect price stability. The question is, would more or less fiscal deficits have made the employment and inflation situations better or worse?

Martin compared time frames with greater and lesser deficits and looked at the corresponding inflation and unemployment figures. Sebastian looked at the reality of deficits and less than full employment and made a judgment based upon comparison to an absolute ideal of full employment…

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Detroit Dan 04.29.11 at 2:06 am

Money is a marker used as a medium to exchange for scarce goods or services. Noting that money can be “created by the Treasury” without being very careful about the fact that the ultimate goal is to get goods and services seems to be a fallacy that MMT proponents fall in to often. The ability to print money (or nowadays to add zeros to bank accounts) doesn’t magically vanish supply and demand problems…
MMT advocates seem to be impressed by the idea that governments can’t really default on debt issued in their own currency. Even ignoring real world counterexamples, the insight isn’t as exciting when you realize that runaway deficit spending can still wreck your economy even without the technicalities of ‘default’. So wrecking the economy isn’t always ‘default’. So what? [Sebastian #122]

As noted by wh10, the text above is a series of straw men…

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Detroit Dan 04.29.11 at 2:23 am

Here’s a good paper related to this topic — Demand Constraints and Big Government.

This should not be interpreted as endorsement of Keynesian “pump-priming” to “fine-tune” the economy. Indeed, Hansen had previously demonstrated that pump priming would fail (Vatter and Walker 1997). If government increases its spending and employment in recession, raising aggregate demand and thus, economic activity, only to withdraw the stimulus when expansion gets underway, it will simply take away the jobs that had been created, restoring a situation of excess capacity.

This echoes Colander’s paper, quoted above, in that it argues that markets do not automatically tend to equilibrium at full employment.

By the way, as an MMT advocate, I find the whole concept of a liquidity trap ludicrous. Along with seignorage, this is one of the terms that should be consigned to the dustbin of economic history…

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Sebastian 04.29.11 at 2:57 am

“Sebastian, you’re basing your comments on practically zero knowledge of the actual MMT literature. MMT acknowledges everything you’ve mentioned. We’ve provided severally links in this thread if you’re interest in actually learning about it, rather than speculating.”

No, I read about a year’s worth of posts on the BillyBlog about six months ago, I’m not coming at it from nowhere.

“The question is, would more or less fiscal deficits have made the employment and inflation situations better or worse? “

Yes that is indeed the question, and the case for “more deficits over the long run in the US” is pretty darn hard to make, and I haven’t seen the MMT advocates make a very good case for it. So make it if you think it is a good one. Argue that say 1980-1990 the US would have been better off with larger deficits. Argue that 1990-2000 was ruined because of the lower deficits. Argue that 2000-2010 would have been better with larger deficits. Those are very counter-intuitive arguments, and MMT advocates only seem willing to make them theoretically, not actually say “Reagan deficits should have been bigger, Clinton shouldn’t have tried for surpluses, Bush II should have had more deficits.”

Are you willing to make those statements? Are you willing to defend them? I’m not trying to strawman, they seem to me very strongly implied by MMT.

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Sebastian 04.29.11 at 3:03 am

“This is a fair statement for the U.S., I think. And I would guess that it applies more generally—i.e. fiscal deficits are more common than balanced budgets and economies are rarely at full employment. But we’re getting into Utopian territory here. As I said previously, I don’t expect MMT to solve all problems and to miraculously bring full employment with perfect price stability.”

But this is actually a pretty serious problem with MMT because it implies that absent full employment (which is to say almost all the time) governments should be running fairly hefty deficits until they get to full employment. And that is one of those things that if you happen to be wrong about deficits and full employment (one of the very central questions) you’ve just completely screwed over the economy over a theory. Which admittedly wouldn’t be the first time that has happened, but it doesn’t mean we should encourage it.

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wh10 04.29.11 at 3:57 am

Well if for whatever reason there were drastic inflation, I think policy makers would be smart and pull back. That said, to challenge MMT with the data we have, I think you need to find a period in U.S. history where deficit spending was actually leading to accelerating demand-pull inflation.

For me personally. I find MMT to be most helpful in today’s environment, where there is no threat of inflation but huge threat of prolonged recession/depression, yet people are rushing into austerity because they think bankruptcy/hyperinflation is on the horizon. MMT provides a clear framework for understanding the issues at hand.

With regards to full employment, I think the Employer of Last Resort idea is essential to actually achieving this in MMTs mind- but this has never been implemented, thus you don’t see actual full employment.

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Scott Fullwiler 04.29.11 at 3:59 am

Sebastian,

This is rather simple, and is all over the MMT blogs and literature:

1. There is NO suggestion in MMT that the govt should run deficits all the time. The point is to adjust AD to get to full employment, not to run deficits regardless of the macroeconomic context. That’s so basic it’s ridiculous that it even needs to be defended or repeated.

2. We argue that, ON AVERAGE (i.e., NOT NECESSARILY EVERY YEAR), the domestic private sector (households mostly, if you look at the data) will desire to net save. Absent a trade surplus, by accounting identity, the only way for this to happen (for the domestic sector as a whole) is for a govt deficit.

3. If the current account is positive, it is by accounting identity possible for the govt sector to run a surplus while the domestic private sector still net saves. Again, there is no requirement in MMT that the govt run deficits all the time.

4. Instances in which the non-govt pvt sector does not net save–net dis-saves–such as 1998-2008, are rare and often associated with increases in Minskyan fragility. You may have noticed that there are probably a few hundred MMT publications regarding Minsky, particularly given that Randy Wray was a student of Minsky’s. Anyway, the point here is that in these cases, the problem is primarily the fragility, though the govt can go into surplus as a result of the increased desired dissaving of the pvt sector–as an effect. In these cases, MMT would argue that it is the fragility that should be remedied FIRST (i.e., the stock market bubble, the housing bubble, etc.); MMT would not argue for a deficit in the face of full employment, however created except within the context of an increase in the pvt sector’s desire to net save.

So, the example of the “Clinton Surpluses” is a straw man here. The surpluses were largely the result of rising AD due to a stock market bubble that also reduced unemployment rates substantially. The stock market bubble enabled a desire by the non-govt sector to net dis-save in a manner unlike anything that had happened since WWII (and repeated again in the 2000s). While you obviously have seen MMT’ers argue that these surpluses were bad, it should be understood that this is being said in the context of the stock market bubble and the net dis-saving that caused the surpluses.

The MMT argument here is for an entirely different fiscal/monetary/regulatory regime (again, recall the Minskyan influence) in which the pvt sector net saves, likely via govt deficits. This means that MMT’ers are absolutely not arguing for a substantial relaxation of fiscal policy in the face of a stock market bubble. Again, that would be ridiculous and it should go without saying (particularly for someone who claims to have read so much MMT).

At any rate, while Clinton and most everyone else were cheering on the surpluses and the predicted retiring of the national debt by 2010 or whatever it was, MMT’ers were pointing out that the surpluses were the result of massive fragility in the financial positions of the non-govt sector and that a severe change of course overall was imminent–far better to change course on our own before it was forced upon us, we said. Again, the call for deficits here was in the context of a desire for an entirely different fiscal/monetary/regulatory mix, not for a fiscal relaxation in the face of very strong AD and low unemployment. If you actually read the literature of the time, that’s pretty clear.

Apologies for probably repeating myself several times in the past few paragraphs–it’s late here, or at least I have to get up early so it’s as if it were late.

Best,
Scott

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Martin Bento 04.29.11 at 4:47 am

John,what about nations that have no significant debt not in their own currency?. Do any of the classic hyperinflation-from-printing-money cases fall into this category? It may be that not many nations in recent history fall in this category, but the US is one.

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Scott Fullwiler 04.29.11 at 4:48 am

Sebastian . . .regarding this:

“Yes that is indeed the question, and the case for “more deficits over the long run in the US” is pretty darn hard to make, and I haven’t seen the MMT advocates make a very good case for it. So make it if you think it is a good one. Argue that say 1980-1990 the US would have been better off with larger deficits. Argue that 1990-2000 was ruined because of the lower deficits. Argue that 2000-2010 would have been better with larger deficits. Those are very counter-intuitive arguments, and MMT advocates only seem willing to make them theoretically, not actually say “Reagan deficits should have been bigger, Clinton shouldn’t have tried for surpluses, Bush II should have had more deficits.””

Again, you’re taking all this out of context and basically building a straw man, as others have noted.

First, it’s not about the deficits, but the results of the deficits–that’s the definition of fucntional finance, which is the core MMT fiscal strategy. If deficits worsen the situation, then MMT wouldn’t be in favor of them. Period. Otherwise, you are in violation of functional finance. You’re incorrectly assuming MMT’ers always want deficits. As I explained above, this is a misinterpretation . . . completely. What we want is full employment and price stability. Even our preferred policy–the job guarantee-isn’t about deficits whatsoever; a job guarantee might even be paired with smaller deficits (see Pavlina Tcherneva’s papers at Levy for a thorough explanation).

Second, as I explained above, any call for larger deficits by MMT’ers must be understood within the fiscal/monetary/regulatory context. If one doesn’t seriously incorporate Minsky into the analysis, for example, then it’s not MMT. Larger deficits in the 80s, 90s, 00s, or whenever may or may not be desirable depending on a number of factors–there’s no inconsistency there with MMT. These in fact are all periods of rising financial fragility over the business cycle expansion, each more severe than the one it follows. The core issue is that, from a Minskyan perspective, it is generally desirable for the domestic private sector to net save. The question is how to get there. Under some circumstances a larger deficit could do it; but sometimes the larger deficit is not desirable absent other policy/regulatory changes since in that case it would simply encourage more AD and potentially raise inflation (in violation of functional finance principles).

OK, now I REALLY need to stop.

Best,
Scott

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Sebastian 04.29.11 at 5:46 am

“There is NO suggestion in MMT that the govt should run deficits all the time. The point is to adjust AD to get to full employment, not to run deficits regardless of the macroeconomic context. That’s so basic it’s ridiculous that it even needs to be defended or repeated.”

Well it might be ridiculous to you, but you either aren’t explaining it well or you aren’t understanding the implications of your own arguments. If you should be running deficits *until you get full employment*, the real world implication is that you should be running massive deficits nearly all the time.

“We argue that, ON AVERAGE (i.e., NOT NECESSARILY EVERY YEAR), the domestic private sector (households mostly, if you look at the data) will desire to net save. Absent a trade surplus, by accounting identity, the only way for this to happen (for the domestic sector as a whole) is for a govt deficit.”

See I’m not strawmanning, you actually said that in the very next paragraph.

“If the current account is positive, it is by accounting identity possible for the govt sector to run a surplus while the domestic private sector still net saves. Again, there is no requirement in MMT that the govt run deficits all the time.”

Well that certainly doesn’t apply very often, right? And can’t possibly apply to every nation of course. So we’re back to large deficit spending in practical reality right?

“The MMT argument here is for an entirely different fiscal/monetary/regulatory regime (again, recall the Minskyan influence) in which the pvt sector net saves, likely via govt deficits. This means that MMT’ers are absolutely not arguing for a substantial relaxation of fiscal policy in the face of a stock market bubble. Again, that would be ridiculous and it should go without saying (particularly for someone who claims to have read so much MMT).”

Yes, MMT assumes a natural enormous desire for net private savings. Which rather conspicuously does not appear to exist in most non-Japanese 1st world countries. Now MMT blames this on the government, but that certainly isn’t clear from a psychological or economic point of view. And of course, ESPECIALLY in the Clinton run-up it wasn’t entirely clear that we were in a stock market bubble.

“If one doesn’t seriously incorporate Minsky into the analysis, for example, then it’s not MMT.”

Minsky very famously did not believe that economic behavior could be easily reduced into simplistic analysis structures and equations. MMT on the other hand claims to get nearly everything out of the accounting identity (G-T) = (S-I) – NX. Trying to incorporate Minsky’s ideas about fragility without considering his understanding about the siren call of overworking the equations seems to be a fundamental misunderstanding of Minsky. I suspect that MMT is like a lot of things: a good initial insight taken WAY too far. In times of low inflation, or in political situations where people can be moderate about government spending, small to medium deficits can be beneficial. [Which of course Keynes says too]. But you shouldn’t be like a supply sider who always thinks he is on the right side of the Laffer curve. MMT suggests deficits in almost every real world situation in which you find less than full employment. Full employment is EXTREMELY rare. So most of the time MMT is suggesting deficits. And ones *larger* than we have previously seen in 1st world countries, because almost no 1st world country has maintained a long period of full employment under their already highish deficit levels.

Now my understanding of MMT comes from Bill Mitchell’s blog, as read probably a year or so ago. So if that is a bad source, let me know.

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sg 04.29.11 at 10:38 am

wouldn’t the issue with the clinton deficits, and the failure of US deficits over the past 30 years to produce full employment, be that the deficits were being used for the wrong purpose? I.e. they were funding military build up and targeted concessions to the rich, rather than being used to create work?

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Scott Fullwiler 04.29.11 at 12:01 pm

“Which rather conspicuously does not appear to exist in most non-Japanese 1st world countries”

Um, go look at the data. It’s pretty much non-stop everywhere, actually.

You clearly haven’t understood Mitchell’s blog. And we’re misinterpreting Minsky? That’s rich!

At any rate, if you actually read Mitchell’s blog and MMT literature, you would see that we do not favor traditional Keynesian “pump priming” to get to “full employment,” because we don’t think you could ever do it that way–or at least it would be rare–without triggering demand-pull inflation (kind of sg’s point). Wray wrote in 2000, “how many bombs do you have to build before you create 1 job in Harlem?” So, as I was explaining, it’s not about deficits, per se, or bigger ones, or whatever. It’s about the effects. MMT policy proposals could result in smaller deficits than what has actually occurred. Our proposals, compared to the financial bailouts and Obama stimulus, for instance, would likely have resulted in smaller deficits, or at least a quicker recovery and smaller deficits sooner. Certainly, a more MMT-like regime would have avoided the 2000s bubble and resulted in substantially lower deficits than we currently have now. At any rate, I’ve provided sources above that explain the MMT view. You clearly don’t want to accept this because it would contradict your earlier points and you would have to admit you were wrong.

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Detroit Dan 04.29.11 at 12:51 pm

Thanks Scott. And thanks to John for raising the subject of MMT and engaging in a open-minded discussion of MMT. I’ve learned a thing or two as a result.

I still think the discussion of specific cases of severe inflation could be useful. We probably all have other things to do though. I know I do.

Anyway, best to all…

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Scott Fullwiler 04.29.11 at 2:12 pm

Sorry for any less than polite language. I shouldn’t have written so quickly and so early.

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Scott Fullwiler 04.29.11 at 2:13 pm

Dan,

Cullen Roche did a good post on severe inflation at Pragmatic Capitalist.

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wh10 04.29.11 at 2:15 pm

Scott, do you have any comments for John Quiggin at 49, particularly regarding your ELR paper?

“As I said first up, the problem seems to be that according to MMT, the economy is almost never at or above full employment, which (as Martin Bento spells out) should imply that we will never see inflation. As Martin says, based on the last thirty years, that claim looks pretty good. Older readers may have a slightly different view of things.

In that context, I found the Fulwiler paper pretty disappointing. The data period goes back to 1952, but the results reported are all for the “Great Moderation” period post-85, which isn’t very interesting. What do MMT theorists say about stagflation?

On the other link, I couldn’t follow the Fulwiler response to Krugman at all – Krugman seemed to me pretty convincing, and Fulwiler just waffled, in both US and Australian senses of the word.”

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wh10 04.29.11 at 2:16 pm

@ Scott 141

Yup, posted it at 129:

“Also those examples violate a central tenet of MMT- you can’t apply MMT to monetary regimes which are not fully sovereign! Here’s Bill Mitchell on Zimbabwe http://bilbo.economicoutlook.net/blog/?p=3773 . Cullen Roche also addresses this issue http://pragcap.com/hyperinflation-its-more-than-just-a-monetary-phenomenon

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Sebastian 04.29.11 at 3:22 pm

“At any rate, if you actually read Mitchell’s blog and MMT literature, you would see that we do not favor traditional Keynesian “pump priming” to get to “full employment,” because we don’t think you could ever do it that way—or at least it would be rare—without triggering demand-pull inflation (kind of sg’s point).”

Your apparent insistence that I haven’t read Mitchell’s blog isn’t helping things. And I’ve fully admitted that his is the only source of MMT literature I’ve read though he seems to be the guru most referred to. His apparent clarity to believers doesn’t mean that questions from other people are clearly explained to them (see d-squared and Quiggin above, both of whom have perfectly acceptable economics brackgrounds). I don’t believe you’ll be able to find a post where I’m attributing pump priming to MMT, one of its distinguishing characteristics is that it seems to advocate deficit spending in a large number of cases where traditional Keynesian analysis does not. I fully understand that fact, and it is indeed what worries me. Deficit spending even in an alleged Keynesian framework has led to enormous debt, and I worry that a relatively simplistic framework which encourages even more deficit spending could tend to be worse. You’ll respond that it would lead to less in the long run by virtue of the accounting identity creating savings and more stable private investment, but that is theoretical not actual, and the evidence for it doesn’t seem nearly as strong as you assert. (Again see counter-example Clinton years, counter-example Bush I, lack of full employment despite enormous deficit spending).

Mitchell seems quite willing to distinguish the Zimbabwe case, because it is an easy strawman, but not willing to engage for example the stagflation case, which is more of what worries people in the real world. (Also note the Brazil case, in which deficit spending *on jobs* was enormous, and inflation causing). The response to Brazil appears to be that it was all caused by foreign debt, but that sidesteps the fact that large deficit spending appears to have caused large inflation in circumstances that MMT does not predict. (Unless MMT asserts that the large inflation was caused BY the foreign debt, which would be interesting but require much more explanation than is typically forthcoming).

“And we’re misinterpreting Minsky? That’s rich!” Have you read Minsky or have you just read interpretations of Minsky? He HATES the type of reductionist and simplistic economic analysis which simplifies everything to something like the accounting identity which Mitchell uses for nearly every discussion and which Mitchell thinks answers all the major questions. Again and again he says that reducing analysis to simplistic equations is impossible in economics. Now you can think Minsky is wrong. But claiming to be his heirs while avoiding his most pertinent critiques about the dangers of simple economic reductionism seems an unfair use of his name.

“wouldn’t the issue with the clinton deficits, and the failure of US deficits over the past 30 years to produce full employment, be that the deficits were being used for the wrong purpose? I.e. they were funding military build up and targeted concessions to the rich, rather than being used to create work?”

I don’t believe so, no. The accounting identity central to MMT analysis doesn’t change just because the deficits are used for ‘bad purposes’. Now of course it could be better for the society as a whole to use them for good purposes, but that doesn’t change the equation they use so far as I can tell. And you are misunderstanding the clinton point. The problem is that the best employment years in recent US history came during Clinton’s NON-Deficit years.

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studentee 04.29.11 at 3:49 pm

“He HATES the type of reductionist and simplistic economic analysis which simplifies everything to something like the accounting identity which Mitchell uses for nearly every discussion and which Mitchell thinks answers all the major questions.”

no, prof. mitchell doesn’t think that the accounting identity ‘answers all the major questions.’ but if you don’t have the accounting right, you can’t build the fancy models on top of it. much of neoclassical economics does not get the accounting right

“The problem is that the best employment years in recent US history came during Clinton’s NON-Deficit years.”

you’re being obtuse. mmt argues that the ‘best employment years’ during the clinton period were *unsustainable*. this was clearly the case.

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studentee 04.29.11 at 3:57 pm

“Again and again he says that reducing analysis to simplistic equations is impossible in economics. “

once again, mmt is not reducing analysis to simplistic equations. but if you can’t get the most simplest of equations correct (the gov’t deficit accounting balance), then any complexity layered on after is probably useless. scott’s going back to first principles: holding the foreign sector constant in deficit, a net deficit position by the federal government results in a net savings position by the private domestic sector. and the current political climate arguing for reduced deficits wants to shrink the deficit position of the fed gov’t, so therefore the size of the net savings position of the domestic private sector must correspondingly shrink. this is simple, and true. but! mmt does not stop there. analysts must look closely at how the mechanisms of this shrinking process works, which sectors are going in to debt, how does this effect investment, consumption etc. this is where minsky enters (probably elsewhere as well): he, along with mmt’ers believe this process is often unsustainable, particularly during a balance sheet recession

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Sebastian 04.29.11 at 4:27 pm

“you’re being obtuse. mmt argues that the ‘best employment years’ during the clinton period were unsustainable. this was clearly the case.”

“This was clearly the case” doesn’t have to be an MMT argument. We can argue the proposition that the Clinton success was unsustainable without resorting to MMT at all. The problem for MMT is that it predicts higher employment with large deficits (up to the point of full employment which as we know is very rare), and more unemployment with deficit reduction and government surpluses (up to the point of full employment which as we know is very rare).

So the problem that the Clinton years poses is the fact that the job situation got MUCH better as the BUSH I deficit reduction went into place, and then MUCH MUCH better after the government went to smaller and smaller deficits and then surpluses, finally reaching full employment as the government was in surplus. This is not what the general model of MMT would predict. It doesn’t think that the government should be running surpluses almost ever, and it doesn’t think that deficit reduction almost ever leads to lower unemployment. In fact the accounting identity they suggest between government deficits and private savings suggests that the middle Clinton years (intentional deficit reduction with large strides made against unemployment) should be very difficult to achieve if not impossible. But in fact it happened, and apparently without tricky ways of avoiding the accounting identity. Now it is *theoretically possible* that the counter-trending of unsustainable growth was so strong that it swamped even MMTer’s normal assumptions. But that would tend to suggest that the ‘real’ sustainable growth in the Clinton years was negative which so far as I know, no one is proposing.

So far as I can tell, the Clinton years require extensive explanation in order to fit well into the MMT model, but what we are getting here is instead platitudes that it should just be dismissed out of hand, or that it was ‘unsustainable’ without dealing with how the actual job situation is problematic for MMT. MMT claims to be largely about how the economy works when in and out of full employment. If the largest example of full employment occurs in opposition to what MMT expects with respect to deficits, that is a problem with MMT’s explanations NOT a problem with the existence of the facts of what happened in the real world.

As Quiggin said above “The proposition, advanced in different ways by supply-siders and MMTers that (the right kind of) deficits will pay for themselves, and therefore we need not be concerned about budget balance. I don’t buy this, and I don’t find an appeal to (most of) the last three decades in the US very encouraging”.

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Kevin Donoghue 04.29.11 at 5:15 pm

#129: By the way, as an MMT advocate, I find the whole concept of a liquidity trap ludicrous.

If you find that concepts which are taken seriously by the likes of John Hicks and Paul Krugman are just ludicrous, it might be an idea to sit back, close your eyes and take slow, deep breaths, before setting yourself the task of writing down just where you think these guys have gone wrong. It’s quite possible that they have gone wrong, but it’s also possible that there is more to economic analysis than you suppose.

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chris 04.29.11 at 5:56 pm

Clearly the idea that under some conditions some people/corporations will sit on large stockpiles of cash refusing to either spend or lend it (or, in the case of corporations, pay it out as dividends) is not ludicrous, since it has in fact happened. So if you don’t think “liquidity trap” is a sensible description of such behavior or the conditions that evoke it, how would you describe them?

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Detroit Dan 04.29.11 at 8:09 pm

Kevin @129 — Good point. I actually have reflected on those words I wrote, and came to the conclusion that they were the best I had written. Just reading Krugman’s column today in the NYT reinforces my belief that his time has passed…

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Detroit Dan 04.29.11 at 8:11 pm

Anyway, I understand that I may be wrong, and wish the best to Krugman and all…

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Scott Fullwiler 04.29.11 at 8:45 pm

Hi WH10,

Regarding the ELR paper . . .

The first set of simulations are for 1985-2005, true. The point there was to show the logic of an ELR program with real world shocks (and note that there are supply shocks during this period, such as the late 1980s with the first Gulf War). But it is incorrect to suggest that the paper go back further than this. The second set of simulations–the stochastic simulations– compares the ELR strategy to three other policy rules–quoting from the paper: “The period for historical error draws is 1954:1 to 2005:3, or 207 quarters in length, which means there are 207 vectors of 30 residuals from which to draw.” Perhaps Prof. Quiggen didn’t read that far.

Further, if anything, these simulations are more significant because the policy rules are exposed to shocks above and beyond what actually occurred during the historical period simulated (1994-1998, I believe, though the period selected is actually irrelevant in these simulations), again drawn from the 1954-2005 period. In those simulations, the ELR strategy compared favorably to the Fed’s interest rate rule, a tax rate rule, and a transfer payment rule. This is so, even though these simulations are biased a bit against ELR since the Fairmodel’s price level equation is affected by the unemployment rate. That is, the ELR program allows the unemployment rate–in the case of ELR, the size of the ELR buffer stock–to vary, stabilizing total employment, whereas the other rules stabilize the unemployment rate. A price level equation based on, say, an output gap would be less biased against ELR–demonstrated by the fact that ELR was the best of the four rules at stabilizing real GDP at the pre-shock value.

Regarding Krugman . . .

In that piece, I argued that Krugman’s critique was based on 3 assumptions. I showed how virtually every line in his posts was based on at least one of these 3 assumptions. And I explained why these three assumptions were false. One is certainly free to critique my argument there, but to suggest I “waffled” is far too general to be of any use to me or anyone else. As the professor himself admits, he clearly didn’t understand my post.

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Scott Fullwiler 04.29.11 at 9:01 pm

Dan . . . you’re right. Paul Davidson, Randy Wray, Jan Kregel, Basil Moore, Marc Lavoie, and Mario Seccareccia (and several others) all have your back on this one.

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wh10 04.29.11 at 9:12 pm

Great thanks for the response Scott. I, obviously, thought your reply to Krugman was fantastic.

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Detroit Dan 04.29.11 at 9:59 pm

Clearly the idea that under some conditions some people/corporations will sit on large stockpiles of cash refusing to either spend or lend it (or, in the case of corporations, pay it out as dividends) is not ludicrous, since it has in fact happened. So if you don’t think “liquidity trap” is a sensible description of such behavior or the conditions that evoke it, how would you describe them? [Chris @149]

Well stated. I would say that is a stagnant economy, recession, or depression. “Liquidity trap” unfortunately carries additional baggage with regard to interest rates and monetary policy which are useless, in my opinion. Krugman’s column today exemplifies this. He blames the Fed for not fixing unemployment, as if more QE would do any such thing. What would Krugman have the Fed do now that we are in “liquidity trap”? But wait, we can’t be in a liquidity trap, because the stock market is soaring and consumer spending is rising. But we must be in a liquidity trap because interest rates are at 0% and it’s okay to monetize the debt when we’re in a liquidity trap as Krugman apparently advocates we continue.

For anyone interested (if not please ignore): How would you define the term “seignorage”? How does it apply to our current situation?

Thanks for questions and comments. I’m glad someone is reading and responding…

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Detroit Dan 04.29.11 at 10:17 pm

Why is issuing cash considered seignorage, but issuing Treasury bonds not considered seignorage? Federal deficits can be financed by issuing either cash or by issuing cash and then exchanging the cash for Treasury bonds. In one case you increase the supply of cash in the economy. In the other, you keep the supply of cash constant, while issuing notes that promise to inject cash + interest,/i> for years into the future. Arguably, the issuance of Treasury bonds is more inflationary because of the interest. To say that the financing deficits with Treasury bonds is sustainable but financing deficits with cash is inflationary makes no sense to me. And hiding all this black magic behind the term seignorage doesn’t help…

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studentee 04.29.11 at 10:28 pm

“It doesn’t think that the government should be running surpluses almost ever, and it doesn’t think that deficit reduction almost ever leads to lower unemployment.”

yikes. i’m done. you aren’t even trying. and you don’t know what the word ‘platitude’ means, and apparently ‘sustainable’

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Kevin Donoghue 04.29.11 at 10:28 pm

Dan: I actually have reflected on those words I wrote, and came to the conclusion that they were the best I had written.

If you say you haven’t written anything better, far be it from me to dispute that.

Scott Fullwiler (#153) cites Jan Kregel in support of Dan’s claim that the whole concept of a liquidity trap is ludicrous. Kregel’s paper on the subject suggests to me that he doesn’t consider the concept ludicrous at all. It is well worth reading in any case.

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Sebastian 04.29.11 at 11:01 pm

I’m not one to overly invoke burden of proof, but if you have an opinion that goes well against the majority of experts in your field, and which has very counterintuitive suggestions, if you want to talk to non true believers, might want to explain yourself clearly. So far as I can tell, none of the MMTers here have not done so vis-a-vis the Clinton years, or the stagflation years. I don’t claim to be an expert on MMT, but I am trying to state my understanding (poor as it may be), clearly. You could for example outline the numerous (real world) occasions where MMT doesn’t like deficits if you think my characterization is incorrect. So far as I know, the main one is “once full employment is achieved”, which is to say pretty much never. You could also outline the real world occasions (other than full employment, which pretty much never happens) where MMT would predict that reducing deficits would lead to increased employment. So far as I can tell, I’ve made accurate if broad generalizations in those two statements.

If your position was the well accepted position, you could afford to be dismissive with “you aren’t even trying” because you could expect me to do some normal research into what everyone already knows. But MMT is not a well accepted position and I’ve stated what appears to be its default position on full employment and deficits. It is a very narrow minority position. If you want to convince people of its rightness (those who don’t already follow your guru, Mitchell) try explaining it. If the stagflation years and the Clinton years really do work in the theory, explain how.

Because it isn’t obvious, and that isn’t just me.

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Detroit Dan 04.29.11 at 11:48 pm

Thanks for tip, Kevin, and thanks also to Scott for the feedback on my comment regarding the concept of the liquidity trap.

I’ve gotten as far as the abstract of the Kregel paper Kevin recommends, and it highlights one of the problems with the concept of a liquidity trap, i.e.

Paul Krugman has argued that Japan is in a liquidity trap and that it can recover only if the central bank there follows a policy of “credible inflation.” This paper argues that Krugman’s proposal, which is similar to what Fisher proposed during the depression, is based on a different interpretation of the liquidity trap from that proposed by Keynes and as a result his policy recommendations can result in neither the elimination of the trap nor in Japan’s economic recovery.

So maybe what I find ludicrous is Krugman’s use of the concept.

Anyway, I look forward to reading the paper and thanks for the reference.

And I meant that that was best writing in that particular sitting. My all time best was when I called Ben Stein an idiot

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Detroit Dan 04.30.11 at 12:11 am

Sebastian– There a lot of people like me who may claim to be MMT advocates but are just amateurs doing our best to make sense of a confusing world. I certainly have said things on behalf of MMT that are wrong or stupid, and I’m sure that goes for others. Plus the MMT principles overall are evolving rapidly as more people join the discussion and discussions such as the one we are having here force us to address additional concerns and perspectives. Finally, the MMT community is getting larger and larger and consequently not all statements of MMT views are consistent.

So you may well be right in recognizing inconsistencies. But the people here have done a good job of addressing the issues you raise, if not in a bullet-proof, doctrinaire way…

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Andrew 04.30.11 at 12:50 am

I think this is a really interesting idea, but my question is: can it credibly be implemented in a way that allows escape from immediate doubts as to the security of the PIGS?

What would be the timeline for implementing this new supervisory authority while putting in place the short-term solution you propose, in a manner that would not cause investors to suspect that the supervisory authority won’t happen while the short-term costs certainly will?

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Senexx 04.30.11 at 12:53 am

A small correction to Studentee above, MMT doesn’t explain stagflation as cost-push. It is addressed through the supply-side causes of inflation (via cost shocks) which I guess simulates cost-push but is not cost-push.

Thanks to all for allowing this digression from the initial post and participating in a discussion of MMT.

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Kevin Donoghue 04.30.11 at 10:09 am

Dan: There a lot of people like me who may claim to be MMT advocates but are just amateurs doing our best to make sense of a confusing world.

Fair enough (and I’m no professional either). But I see a danger of ‘MMT’ becoming nothing more than a flag around which people rally, with nothing much in the way of a shared viewpoint other than the fact that they have a vague attachment to Chartalism and feel slighted by orthodox economists. To see where that leads, look at any blog where ‘Austrians’ show up regularly. I think we have a better chance of making sense of the world if we focus on relatively narrow questions about models (Nick Rowe’s blogging is a good example) rather than broad generalisations about competing schools of thought, which invariably litter the ground with chopped straw.

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vimothy 04.30.11 at 11:13 am

“no, prof. mitchell doesn’t think that the accounting identity ‘answers all the major questions.’ but if you don’t have the accounting right, you can’t build the fancy models on top of it. much of neoclassical economics does not get the accounting right”

Excuse me, but how do you know that “much of neoclassical economics does not get the accounting right”? Presumably you’re extremely well read in all fields: IO, labour, macro, applied and theory, etc, etc, etc. Give us misguided fools the benefit of your wisdom and point to some specific examples where this wrongness manifests.

This is my biggest beef with MMT. Someone like Scott is very smart and I know from past experience that we agree more than disagree, but one direct consequence of MMT’s political project is its comments horde: a bunch of people whose knowledge of economics is thin at best, but who have nevertheless decided that everyone else working in the discipline or drawing on it knows nothing—or, equally ridiculous, if they do know something, are hiding it, for sinister reasons.

Ben Bernanke is an idiot. Joe Stiglitz can’t do economics. Paul Krugman doesn’t know what he’s talking about. Bob Lucas speaks with a forked tongue. V.V. Chari can turn into a bat. And on. And on.

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Detroit Dan 04.30.11 at 6:30 pm

@Kevin #164–

Thanks. You make a good point…

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studentee 05.01.11 at 4:21 am

“Someone like Scott is very smart and I know from past experience that we agree more than disagree, but one direct consequence of MMT’s political project is its comments horde: a bunch of people whose knowledge of economics is thin at best, but who have nevertheless decided that everyone else working in the discipline or drawing on it knows nothing—or, equally ridiculous, if they do know something, are hiding it, for sinister reasons.”

i don’t deny my vulgar mmt roots. i’m not writing papers or participating in symposiums. i’m posting on blogs because i think the stakes are high (the us is about to dismantle the social contract and that orthodox economists are egging them on), and i think that mmt offers a perspective for addressing those high stakes

i know, vimothy, that you are a professional economist. and i know it frustrates you that there’s some upstart school that says you’re full of it. my best advice: ignore it! if you really don’t think mmt has the goods, let it die a pathetic death! there aren’t that many of us, yet you seem to spend a lot of time on the blogosphere tracking down posts about mmt to lord your orthodox bona fides over us. ignore it, and if it’s as irrelevant as you say, it will die.

also, i have a ba in economics. i’m reasonably familiar with the basic arguments you are working from. orthodox economics clearly did not have the monetary multiplier accounting correct. orthodox economists have failed miserably in explaining most of the macroeconomic events in the past twenty years. these are my jumping-off points

i have yet to see you actually win an argument with a lowly mmt comment horde-member either. and i’m pretty open-minded

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studentee 05.01.11 at 4:51 am

@kevin

it depends. there are more knowledgeable mmt-sympthatisizers who have some level of graduate work in monetary economics, or are professors, or something, that are great candidates for communicating with the like of nick rowe, waldmann, etc. on the other hand, there are mongrels like myself, who are mostly reacting to the relentless push towards austerity that we believe is misguided at best and destructive at worst.

but yeah, not being a cult is a good thing :)

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studentee 05.01.11 at 5:07 am

“So far as I can tell, none of the MMTers here have not done so vis-a-vis the Clinton years, or the stagflation years.”

the reason i said i was ‘done’ (and lied about it :) ) was because, yes, we did explain what happened during the clinton years. i attempted to explain it, and scott explained it. you seem to be under the impression that mmt believes that gov’t deficit = low unemployment, gov’t surplus = high unemployment. no! it is a dynamic system, in which gov’t shrinking the size of the deficit removes net financial assets from the domestic private sector (either purposefully or automatically to an increase in private sector demand), and gov’t increasing the size of the deficit adds net financial assets to the domestic private sector are done in response (either purposefully or automatically to a decline in private sector demand). during the clinton years, the us removed nfa’s from the domestic sector (or they removed themselves, via automatic taxing stabilizers) in the face of the dot-com boom. of course, that dot-com thing was in fact a boom, and thus was unsustainable

“You could also outline the real world occasions (other than full employment, which pretty much never happens) where MMT would predict that reducing deficits would lead to increased employment.”

a corresponding and favorable increase in the current account would suffice for this. i don’t believe there’s no obvious link between the two. i think you are still mixing up forceful austrian reductions of the deficit and natural reductions of the deficits that result from increased tax revenues and fewer welfare payments

re: stagflation: send warren mosler an email (he’s a really nice guy), i bet he will respond. or look elsewhere, i’m sure there’s an mmt-esque explanation of stagflation somewhere. also, thanks to senexx for his correction, perhaps he can provide a link

as for an example of a country that shouldn’t be running federal deficits: norway, or any country with a current account surplus. maybe china, but i haven’t thought about it

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studentee 05.01.11 at 6:13 am

“Excuse me, but how do you know that “much of neoclassical economics does not get the accounting right”? Presumably you’re extremely well read in all fields: IO, labour, macro, applied and theory, etc, etc, etc. Give us misguided fools the benefit of your wisdom and point to some specific examples where this wrongness manifests.”

this is the vimothy approach in a nutshell

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BT 05.01.11 at 10:03 am

Time to summarize this thread.

@ Sebastian. The term ‘full employment’ does not actually mean zero unemployment, just low unemployment, which has been achieved by many modern economies.

@ John Quiggin. Well done for being open minded about MMT. There is indeed very little difference in policy prescriptions between MMT and Keynes.

@ Scott Fullwiler. People like Krugman criticize MMT because it talks a lot about ‘vertical’ money creation (government deficits and central bank operations) without talking enough about ‘horizontal’ money creation (the bank credit system).

For MMT to go mainstream, it needs to openly accept these three facts:

1. If the central bank purchases large amounts of government bonds in the open market it will lower interest rates, which can be inflationary in an economy at full capacity.

2. If the government abandons the bond system altogether and just allows deficit spending to produce a private sector ‘net savings’ surplus and consequently excess reserve accumulation in the banking system, it essentially frees the government from a long-established political limitation on its power by the private sector.

3. It is not proven that the private sector has a *desire* to net save which then requires deficits (ignoring the foreign sector). The causation could run the opposite way, government deficits simply add deposits to the banking system, which leads to a private sector net surplus.

The sectoral balance view is useful, but it’s not everything. Bank balance sheets can expand without any net surplus. Economic recovery can come entirely from increased private sector borrowing rates over repayment rates, boosting the stock of credit and debt that fuels investment and job creation. Government deficits are needed when the private sector is paying down debt more rapidly than it borrows – which is the situation the western world is facing now thanks to years of leveraged speculation.

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wh10 05.01.11 at 3:37 pm

You talk of “facts.”

Per 1, long rates after QE2 actually went up.

2. What political limitation? Bond sales are a private market activity. All they do are drain or add reserves, allow the Fed to hit its target rate, and gives the private sector an opportunity to earn interest on otherwise non-interest bearing reserves/deposits. I don’t think you understand MMT yet.

3. The US has run a deficit every year since its beginning except 6 times, and a bond auction has never failed. It’s a strong argument that people desire to net save, but I guess it isn’t proof?

Your last paragraph makes sense.

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Scott Fullwiler 05.01.11 at 4:08 pm

BT,

MMT’ers Randy Wray, Eric Tymoigne, and Bill Black have all written entire books on the credit system (Wray’s first book in 1990–“Money and Credit in Capitalist Economies”; he also edited a book in 2004 titled “Credit and State Theories of Money”). Bill Black has written dozens of blogs on the credit system. Jan Kregel has done probably a few dozen papers in the past 2-3 years alone on the credit system at levy.org. Bill Mitchell did several seminal blog posts on the credit system that he links to on a regular basis. Warren Mosler’s paper on vertical AND horizontal money is linked to all over the place and is in his mandatory readings on his blog. There are literally dozens of papers by MMT’ers at cfeps.org and levy.org on the credit system. If it appears MMT’ers haven’t dealt enough with horizontal money, then that just means one isn’t paying attention to what MMT’ers are actually saying.

Your last paragraph could have been written by an MMT’er. Point?

Best,
Scott

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Sebastian 05.02.11 at 12:31 am

“@ Sebastian. The term ‘full employment’ does not actually mean zero unemployment, just low unemployment, which has been achieved by many modern economies.”

No, according to Mitchell it means about 2% unemployment, which most certainly has not been achieved by many modern economies. (And we were talking about the Clinton years as being effectively full employment and that was still a little less than 5% unemployment.) In fact I’m pretty sure that the number of modern economies which have achieved a 2% unemployment rate on a sustained basis is equal to zero. And the number of modern economies which have achieved even the unemployment levels of the Clinton years on a basis of more than ten years is probably zero as well.

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Martin Bento 05.02.11 at 2:01 am

Detriot Dan, it was actually me who brought up MMT, but I haven’t had time to keep up with the discussion. I hope I don’t get thwacked for derailing the thread. I want to thank everyone for their contributions and links; it all looks interesting, and I hope to get back to this this evening, but want to respond quickly to a point Sebastian was making upthread.

Sebastian, if you try to make a coherent account of how deficits affect employment, looking only at those two variables over the last 30 years of US history, I think the only possible outcome is fail. The two strongest exemplars, Reagan and Clinton, point in opposite directions. Late Clinton had the highest employment levels, running modest surpluses at the time. Late Reagan had the second highest, running the 20th century’s highest deficits outside the world wars. Clinton increased employment while eliminating the deficit; Reagan did so while increasing it. I see two possible explanations: 1) the deficit does not affect employment. This strikes me as very unlikely. 2) Other factors are majorly at work. In fact, 1 would still imply 2, so we need a broader analysis regardless.

It seems you are allowing a lot to hinge on the concept of “full” employment, rather than lesser or higher levels of employment, which seems to limit the discussion to late Clinton. What is “full” employment? Colloquially, we may suppose it means that everyone who wants to and can work is working. To their credit, I think the MMTers have a definition something like this. But this has never existed in the past 30 years, even under Clinton, who came the closest. I would have had no trouble, in 1998, driving you through the ghettos and showing you involuntarily unemployed people. .The prevailing definition of “full” employment is the highest level consistent with low inflation according to prevailing economic theories (which do posit high inflation, and possibly an inflationary spiral, with very high levels of employment). Late Reagan was regarded as full employment at the time, partly because it was accompanied by 4% inflation, as much as the Masters of the Universe felt like tolerating in those days, twice the Fed’s current official target, and 4 times their current actual target (based on Delong’s interpretation of their behavior, rather than their statements). Since Clinton provided an employment fuller than Reagan’s, with less inflation, this claim regarding Reagan has grown retrospectively muted. But if full employment exists whenever economists declare it so, Reagan and Clinton both achieved it, and if it means what it sounds like it means, neither did.

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Sebastian 05.02.11 at 4:01 am

“Sebastian, if you try to make a coherent account of how deficits affect employment, looking only at those two variables over the last 30 years of US history, I think the only possible outcome is fail.”

Sure, and I don’t claim that deficits are one of the biggest factors in unemployment. I’m not even totally sure that is an MMT claim, though they do broadly hint in that direction. But they strongly predict that taking large deficit reduction steps should increase unemployment, and THAT is where the Clinton years are problematic for them. The reason we aren’t talking about the Reagan years is because it fits their model that high deficits reduce unemployment and is thus non-problematic for them.

The reason I’m talking about “full employment” (which I perfectly well know doesn’t mean every single human being who wants to work) is because that is the inflection point where allegedly their predictions take a different turn. (one of the few places where they are regularly ok with intentional deficit reduction). My point is that full employment (especially under their guru Mitchell’s definition of 2%) doesn’t happen pretty much ever. So when they were attacking me for suggesting that they almost never want deficit reduction and will almost always suggest largish deficits, I didn’t think it was appropriate for them to suggest “oh no, in full employment we don’t” as a way of getting off the hook. Full employment pretty much never occurs. So if your theory thinks that large deficits aren’t a problem that need to be dealt with until then, “you are for deficits both in recession and in expansion” is a pretty fair statement.

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Sebastian 05.02.11 at 4:09 am

Put more simply, Keynesian theory and MMT both agree about what to do during a deep recession–government deficit spending. They diverge dramatically about what to do during an expansion. In an expansion Keynesian theory suggests that you should reduce government spending. MMT suggests that generally you should not unless you have already achieved full employment. This is because according to their theory, reducing deficits should increase private savings and drive up unemployment. This seems to be the exact opposite of what happened under Bush I and Clinton. That fact suggests that there is either something wrong with their concept of how deficits work, or something wrong about how private savings work, or both.

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studentee 05.02.11 at 4:55 am

“This is because according to their theory, reducing deficits should increase private savings and drive up unemployment.”

i won’t address any of your other points, because people have already done so, or they’re ridiculous (2% unemployment or bust!) but this sentence here shows that you haven’t been listening. an increase in savings is precisely the opposite of what mmt would predict

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Martin Bento 05.02.11 at 10:14 am

OK, let me see if I got this. I’m just looking into MMT, so I claim no expertise, but am just trying to figure it all out. According to MMT, it’s not that government deficits necessarily generate employment, at least not in the short term. It’s that they generate net private sector savings, other things equal. The idea being that these savings [can] become productive capital? For example, the Reagan deficits spawning the Silicon Valley venture capital industry, something like this?

I can see that point that the Clinton surpluses were associated with an unstable increase in private sector debt, but why was that increase then not reversed by Bush II’s return to deficits? It seems like we had huge deficits, prosperity, and a bubble (S & L) under Reagan; surpluses, greater prosperity and a bigger bubble under Clinton; and huge deficits, little prosperity, and the biggest bubble of all under Bush II. Can MMT make sense of this?

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BT 05.02.11 at 11:18 am

@Martin Bento

What matters for employment is the total stock and flow of money in the economy, which needs to grow with the population and productivity – otherwise you have recession.

The stock of money is mainly the deposits on the liability side of bank balance sheets. These deposits are created when banks make loans (credit creation). Deposits are also created when banks buy government bonds and these deposits are effectively funnelled through government deficit spending (fiscal policy).

In a recession, the stock of money can fall because the private sector pays down more debt than it borrows (i.e.: credit is destroyed faster than it is created and bank balance sheets shrink). In this case, the government can use fiscal stimulus (larger deficits) to maintain the stock of money – and hence the flow of money – in the economy to maintain employment.

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john c. halasz 05.02.11 at 7:04 pm

Sebastian:

You should check out the U.K. UE rates between, say, 1943 and 1975.

And it’s already been explained to you that it’s the set of inter-sectoral balances, not just the public deficit/surplus that’s the issue and that the Clinton decrease in the deficit/debt ratio was due to high levels of dis-saving by both private households and private businesses, though unsustainably so.

Nor is it claimed that deficits automatically produce full employment, independent of everything else, but rather the matter is always context-specific in terms of inter-sectoral balances. And dynamically speaking, debt/GDP ratios will decrease as full employment is approached and tax revenues rise. The only difference between New Keynesians and MMTers there is that the former project on a comparative statics model and not on a dynamic basis and that the latter don’t think surpluses rather than just reduced deficits need to be attained at full employment. As well as, maybe, that direct debt monetization would be preferable to the ineffective indirect monetization involved in QE.

(I’m not an MMTer exactly, having indicated some of my “substantive” reservations above, though I do think that a public employment program would be a good idea under the circumstance, just not a panacea and self-sufficient systemic anchor. But full employment and a distribution of income to sustain adequate effective wage-based demand, rather than to maximalize the rate-of-profit and the “value” of capital, are the relevant policy goals. I think you’re just taking umbrage here, on account of your Toryish priors).

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Laura 05.03.11 at 4:06 am

2% frictional unemployment could be the goal of a JG or ELR, if one were implemented. Current government policy defines full employment as the NAIRU.

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Laura 05.03.11 at 4:34 am

I forgot to add: Bill Mitchell’s proposal would replace the NAIRU with the NAIBER (Non-Accelerating-Inflation-Buffer-Employment-Rate).
A recent post to Bill’s blog mentioned a jobs program started by Jimmy Carter called CETA (Comprehensive Employment and Training Act). I don’t know if this program is comparable with the Job Guarantee.

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Sebastian 05.03.11 at 4:40 pm

Actually I think that the one thing the MMTers definitely get right is that an increased focus on unemployment rather than a laser-like focus on inflation would be a more appropriate method of deciding how government tinkering with the market should work.

Their goal is better, and I’d be happy to see a shift in that direction, but I’m deeply suspicious of their methods. Ultimately it sounds too much like a perpetual motion machine (if I can get away with a physics analogy). You don’t have to know exactly where they went wrong to suspect that a scientist isn’t right when he says he has a perpetual motion machine. Now maybe it turns out that their off-beat predictions re what to do in expansions really work. But it seems to me that there are some hard and obvious questions which they are skating over.

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Laura 05.03.11 at 8:52 pm

Sebastian,
Bill has written on many occasions that there are real resource limits to government spending. To push beyond them is to invite inflation. At full employment, production of goods and services, income distribution and purchasing power are maximized. As always, consumption cannot exceed production. In the real world, solvency is measured by the availability of resources, labour and time.

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chris 05.03.11 at 9:09 pm

You don’t have to know exactly where they went wrong to suspect that a scientist isn’t right when he says he has a perpetual motion machine.

Yes, but we have lots and lots of very strong confirmation of the laws of thermodynamics. No “law” of economics is anywhere near as well-supported.

Bill has written on many occasions that there are real resource limits to government spending. To push beyond them is to invite inflation.

Why? Can’t it simply trigger a shift from private-sector spending to public-sector spending? Something like the WWII economy of rationing in service to an overarching public goal?

That’s not a prescription I would advocate all the time, certainly, but it’s one path that could be taken that wouldn’t necessarily involve inflation (and, IIRC, didn’t, when it actually happened).

Unless you’re saying that the government can’t spend more than 100% of total output, which is certainly true but seems rather trivial.

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Laura 05.04.11 at 4:50 am

Rationing is an alternative mechanism, I suppose it could be an option towards achieving full employment. To my knowledge Bill has not mentioned it – maybe he believes it would not be necessary or treats it as a last resort.

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John Quiggin 05.04.11 at 5:46 am

Some numbers while I have them handy. Monetary base expanded from $800 billion to $2400 billion since the beginning of the crisis.

http://www.economagic.com/em-cgi/data.exe/fedstl/ambns+1

Prior to that, growth was roughly in line with nominal GDP, that is, around 5-6 per cent per year or additions of $50-60 billion.

My take on this: Pre-GFC, seignorage/base money creation was a minor source of finance for the US government (about 0.5 per cent of GDP, consistent with money base being about 10 per cent of GDP).

QE and similar operations since 2008 have created money equal to around 15 per cent of GDP or around 5 per cent per year, without obvious inflationary consequences. We can conclude (assuming the inflation doesn’t materialise) that, in a liquidity trap, there is substantial capacity to use direct money creation as a source of finance.

So, US experience (and I think that of other developed countries in this period) doesn’t tell us much about the implications of using money creation to finance government operations under non-liquidity trap conditions.

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Martin Bento 05.04.11 at 6:39 pm

John, I don’t think I’ve seen anyone assert that monetized debt is never inflationary because it has been non-inflationary recently. Rather you have argued the opposite: without a liquidity trap, it would be inflationary. Of course, lack of inflation in a liquidity trap doesn’t prove presence of inflation when one if absent. The question is under what conditions is it inflationary and what are the trade-offs. If recent experience, as you say, doesn’t tell us much about other situations, then it doesn’t support your argument,

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Walt 05.04.11 at 7:12 pm

John, if you still have MMT in mind, I don’t think that’s what they’re arguing. Imagine the way government financed worked was like this: at the beginning of each year, the government paid for everything by printing money. At the end of the year, the government took the money back in the form of taxes. If the government wanted to deficit spend, it just printed a little bit extra money. If it wanted to quell inflation, it raised taxes to take money out of circulation. In this, there’s no implication that the government is relying on seignorage; it’s relying on taxation to control the money supply. In some ways (and this is why the MMT people make a big deal out of the specific mechanisms used by the US government), this is in fact how it works. The US government routinely spends money, and then comes up with the funding later, either through tax payments or through bonds. MMTers argue that the function of the tax payments or bond sales is to control inflation. So if that’s the case, then the government should make that its objective, rather than worrying about the current level of debt.

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