MMT

On Modern Monetary Theory and Some Odd Twists and Turns in the Evolution of Macroeconomics

Published by Anonymous (not verified) on Wed, 17/10/2018 - 2:41am in

Mainstream neoclassical economics is hooked on the idea of individual worker-savers as prime movers in capitalist market economies. As workers, individuals choose how much to work, determining the economy’s output; as savers, they determine how much of that output takes the shape of the economy’s capital investment. With banks as conduits channeling saving flows into investment, firms churn inputs into outputs that match worker-savers’ tastes. In this way, the neoclassical world gets shaped by what rational intertemporal utility-maximizing worker-savers wish it to be.

In its most fanciful version – erected on supposedly sound micro foundations and known as “real business cycle theory” (RBC) – the neoclassical fantasy world of intertemporally optimizing worker-savers is subject to exogenous shocks to tastes and technology. Random technology shocks may be either positive or negative, and as Edward Prescott—acclaimed RBC founding father, together with Fynn Kydland—famously explained, negative technology shocks arise whenever there is a traffic jam on some bridge (see Romer 2016). That’s truly creative: Imagine a couple of dancers receiving the Nobel prize in medicine for wildly hopping around a coconut tree while peeing on a rotten banana and screaming voodoo until they are blue in the face. Unlikely to happen in medicine, you might say, but in economics voodoo routines and hallucinations of this kind can still earn you a pseudo-Nobel prize properly known as “The Sveriges Riksbank Prize in Economic Sciences in Memory of Alfred Nobel.”

There also exists a “New Keynesian” variety of mainstream neoclassical economics that accepts the RBC framework as its core but adds some “frictions” to the modeled worker-saver paradise that hinder continuous and smooth full-employment equilibrium. Both camps share a common modeling technique (or speak the same language) known as “Dynamic Stochastic General Equilibrium” (DSGE) methodology. The only thing “Keynesian” about the New Keynesian variety is that it provides a rationale for government stabilization policies.

Hardcore (“New Classical”) RBC proponents interpret the Great Depression as a worker-saver mass movement into the world of leisure. By contrast, New Keynesians offer an apology for why market economies might take their time in returning to full employment. Regaining full employment may then be accelerated by government intervention, preferably to be enacted by an independent central bank – with central bank independence being re-interpreted as “rules rather than discretion” in another extraordinarily muddled piece of obscurantism by said RBC-duo Kydland and Prescott (1977) (see Bibow 2001).

Needless to say, and obvious to any serious economist, the worker-saver fantasy world depicted in DSGE models has little in common with capitalism as we know it on this planet. In fact, modern mainstream macroeconomics has completely unlearned the “Keynesian revolution” and essentially turned macroeconomics into an especially shoddy version of microeconomics.

Keynes identified two key flaws in the mainstream neoclassical economics of his time. The first was a fallacy of composition regarding the working of the labor market: while the individual worker may price themselves into employment by accepting a lower wage, workers in the aggregate can only price the macroeconomy into debt deflation by going down that route. Keynes observed that the only reliable expansionary effect of a falling wage level arises through competitiveness gains and net exports. Writing at a time when the world was engaging in “beggar-thy-neighbor” competitive devaluations, that seemed hardly a promising strategy to rely on.

The second flaw Keynes identified concerns the neoclassical capital market supposedly channeling worker-savers’ saving flows into investment, with banks collecting loanable funds as deposits which they then lend out to investing firms. Keynes exposes a fatal neoclassical confusion between money and saving (Bibow 2009). In capitalism nothing much happens without money, so it’s money first, then saving – if money can make James Meade’s (1975) investment dog smile and wag its tail. In Keynes’s vision of capitalism, entrepreneurial investors and their financiers emerge as the prime movers, while worker-savers are largely relegated to a more passive role. They, too, try to optimize – but under the macroeconomic constraint posed by the level of effective demand.

Interestingly, Schumpeter’s vision of capitalism is quite similar to Keynes’s, with entrepreneurial-investors driving the never-ending process of “creative destruction” and banks acting as “ephor” (gatekeepers) of capitalist development. Schumpeter, too, understood the money-first principle and saw banks as money producers rather than loanable funds conduits. Minsky stood on both giants’ shoulders, elaborating on the central role of finance in capitalism and the endogenous emergence of financial fragility as the driving force behind boom-bust cycles. However, Minsky clearly leaned towards the Englishman rather than the Austrian regarding the role of government as a player in its own right potentially stabilizing the macro economy.

It was Abba Lerner (1943, 1944), who pushed Keynes’s macroeconomic insights to its logical conclusion with regard to fiscal policy. Lerner’s “functional finance” approach proposes that the government, not facing the usual monetary constraints that can hold back private actors, should let its budgetary position passively adapt to whatever may be required to achieve macroeconomic equilibrium.

Keynes responded to Lerner’s functional finance as a “splendid idea” but had reservations as far as putting it into practice was concerned: “functional finance is an idea and not a policy; part of one’s apparatus of thought but not, except highly diluted under considerable clothing of qualification, an apparatus of action. Economists have to try to be very careful, I think, to distinguish the two.”

It is here that “Modern Monetary Theory” (MMT) comes into the picture. As a recent conference held in New York City made clear, MMT is a call for action. It is a program to alert policymakers and the public that decisions about, for instance, infrastructure, the environment, or progressive social programs are nothing but political choices within the fiscal powers of sovereign states.

MMT’s theoretical roots reach back to Keynes, Lerner, and a less well-known German political economist with the name of Georg Friedrich Knapp (1905). The latter is known for his “state theory of money” (or: “chartalism”) emphasizing that money is a creature of the state rather than a convenient market invention to reduce transaction costs.

MMT features the money-first principle: the state has to first issue its money, either by literally spending it into existence or by having its central bank purchase (“monetize”) assets, for taxpayers to then send it back to the treasury as taxes. Seen in this way, taxes do not “finance” government spending. Rather, they are a means to contain inflation depending on the economy’s real resource constraints (as made clear in Keynes’s [1940] “How to pay for the war”). Similarly, government bond issuance – supposedly collecting loanable funds from worker-savers – is not a means to “finance” government spending either, but an instrument to manage interest rates (as Keynes made clear in his reflections on monetary policy and debt management during WWII).

These insights into modern money and state power are inconvenient from the perspective of those who favor a small state and unfettered finance (i.e., the powers of wealth). It is therefore somewhat ironic to see that the current U.S. government has embraced MMT with much enthusiasm.

Recall that the Republicans in Congress opposed the “Obama stimulus” in 2009 when a second Great Depression was looming. Recall also that in 2011 a Republican Congress engineered a grossly premature turn to fiscal austerity that pummeled the still shaky recovery and forced the Federal Reserve into extended monetary overdrive. Officially, both acts of folly were made in the name of “fiscal responsibility.” But Republican Senate leader Mitch McConnell made it public that his primary ambition was to wreck the Obama presidency and limit it to one term. Attempting to sabotage his black president and unnecessarily putting the economy and the well-being of his American compatriots in jeopardy did not make him a traitor, as one would think, but a Republican hero masterminding plenty more dirty work on behalf of his subversive party rather than the nation.

And here we are today. Imagine a populist takeover of the nation by a gang of ruthless kleptocrats. Confronting a society botched with income and wealth inequalities similar in degree to the time before the Great Depression, they go about filling their own pockets by squandering tax cuts on the super-rich without paying any attention to the budgetary consequences. Fiscal responsibility was yesterday. Today is self-indulgence without fiscal worries of any tomorrow.

Ironically, certain conservative economists had remarkably clear foresight of modern developments under conservative government. James Buchanan’s vision of public policy was inspired by little else but fears of plundering kleptocrats. Milton Friedman favored fixed rules for public policy precisely because he feared discretion in the hands of incompetent and/or corrupt policymakers. It is difficult to deny today that they had a point.

Today’s political realities probably also play a part in explaining why there is significant popular interest in MMT at the other end of the political spectrum. The speech in NYC by Stephanie Kelton titled “Mainstreaming MMT” highlighted that MMT has indeed made important inroads into public life, the media, and academia (excluding the neoclassical economics mainstream of course). Participants and activists present at the NYC conference were equally enthusiastic about conceiving an active role for the state for progressive causes – unhindered by “sound finance” myths.

One can rest assured that conservatives will rediscover their love for fiscal responsibility as soon as they lose their reach to the public purse. Crying “socialism” whenever responsible fiscal action on behalf of society gets discussed, they will once again demand nothing but “sound finance.” It would be a shame if, for a third time in a row, a government inheriting Republican fiscal wreckage declared “sound finance” as their policy priority. Instead, the next government might be well advised to set out and prove Buchanan and Friedman wrong by showing that honest, responsible, and competent “government of the people, by the people, for the people” is actually possible.

Sadly, kleptocrats’ imaginative powers never reach beyond their own pockets. Imagine a government that really cares about the environment, good infrastructure, and a healthy and well-educated society, a government that understands these political choices are possible here and now – if only we as a society went for it.

 

Bibow, J. (2009). Keynes on Monetary Policy, Finance and Uncertainty: Liquidity Preference Theory and the Global Financial Crisis, Routledge.

Bibow, J. (2001). Reflections on the Current Fashion for Central Bank Independence, Working Paper No. 334, Levy Economics Institute of Bard College. Updated here: (2004). Cambridge Journal of Economics, Vol. 28, No. 4, pp. 549-576

Keynes, J.M. (1940). How to Pay for the War: A Radical Plan for the Chancellor of the Exchequer, Macmillan.

Knapp, G.F. (1905). Staatliche Theorie des Geldes, Munich and Leipzig, Duncker & Humblot.

Lerner, A.P. (1943). Functional Finance and the Federal Debt, Social Research.

Lerner, A.P. (1944). The Economics of Control, Macmillan.

Meade, J.E. (1975). The Keynesian revolution, in M. Keynes ed. Essays on John Maynard Keynes, Cambridge, Cambridge University Press.

Romer, P. (2016) The Trouble with Macroeconomics, Commons Memorial Lecture of the Omicron Delta Epsilon Society delivered on January 5, 2016, New York University, manuscript, September 14.

Kydland, F.E. and Prescott, E.C. (1977). Rules Rather Than Discretion: The Inconsistency of Optimal Plans, Journal of Political Economy, vol. 85, issue 3, 473-91.

On Modern Monetary Theory and Some Odd Twists and Turns in the Evolution of Macroeconomics

Published by Anonymous (not verified) on Wed, 17/10/2018 - 2:41am in

Mainstream neoclassical economics is hooked on the idea of individual worker-savers as prime movers in capitalist market economies. As workers, individuals choose how much to work, determining the economy’s output; as savers, they determine how much of that output takes the shape of the economy’s capital investment. With banks as conduits channeling saving flows into investment, firms churn inputs into outputs that match worker-savers’ tastes. In this way, the neoclassical world gets shaped by what rational intertemporal utility-maximizing worker-savers wish it to be.

In its most fanciful version – erected on supposedly sound micro foundations and known as “real business cycle theory” (RBC) – the neoclassical fantasy world of intertemporally optimizing worker-savers is subject to exogenous shocks to tastes and technology. Random technology shocks may be either positive or negative, and as Edward Prescott—acclaimed RBC founding father, together with Fynn Kydland—famously explained, negative technology shocks arise whenever there is a traffic jam on some bridge (see Romer 2016). That’s truly creative: Imagine a couple of dancers receiving the Nobel prize in medicine for wildly hopping around a coconut tree while peeing on a rotten banana and screaming voodoo until they are blue in the face. Unlikely to happen in medicine, you might say, but in economics voodoo routines and hallucinations of this kind can still earn you a pseudo-Nobel prize properly known as “The Sveriges Riksbank Prize in Economic Sciences in Memory of Alfred Nobel.”

There also exists a “New Keynesian” variety of mainstream neoclassical economics that accepts the RBC framework as its core but adds some “frictions” to the modeled worker-saver paradise that hinder continuous and smooth full-employment equilibrium. Both camps share a common modeling technique (or speak the same language) known as “Dynamic Stochastic General Equilibrium” (DSGE) methodology. The only thing “Keynesian” about the New Keynesian variety is that it provides a rationale for government stabilization policies.

Hardcore (“New Classical”) RBC proponents interpret the Great Depression as a worker-saver mass movement into the world of leisure. By contrast, New Keynesians offer an apology for why market economies might take their time in returning to full employment. Regaining full employment may then be accelerated by government intervention, preferably to be enacted by an independent central bank – with central bank independence being re-interpreted as “rules rather than discretion” in another extraordinarily muddled piece of obscurantism by said RBC-duo Kydland and Prescott (1977) (see Bibow 2001).

Needless to say, and obvious to any serious economist, the worker-saver fantasy world depicted in DSGE models has little in common with capitalism as we know it on this planet. In fact, modern mainstream macroeconomics has completely unlearned the “Keynesian revolution” and essentially turned macroeconomics into an especially shoddy version of microeconomics.

Keynes identified two key flaws in the mainstream neoclassical economics of his time. The first was a fallacy of composition regarding the working of the labor market: while the individual worker may price themselves into employment by accepting a lower wage, workers in the aggregate can only price the macroeconomy into debt deflation by going down that route. Keynes observed that the only reliable expansionary effect of a falling wage level arises through competitiveness gains and net exports. Writing at a time when the world was engaging in “beggar-thy-neighbor” competitive devaluations, that seemed hardly a promising strategy to rely on.

The second flaw Keynes identified concerns the neoclassical capital market supposedly channeling worker-savers’ saving flows into investment, with banks collecting loanable funds as deposits which they then lend out to investing firms. Keynes exposes a fatal neoclassical confusion between money and saving (Bibow 2009). In capitalism nothing much happens without money, so it’s money first, then saving – if money can make James Meade’s (1975) investment dog smile and wag its tail. In Keynes’s vision of capitalism, entrepreneurial investors and their financiers emerge as the prime movers, while worker-savers are largely relegated to a more passive role. They, too, try to optimize – but under the macroeconomic constraint posed by the level of effective demand.

Interestingly, Schumpeter’s vision of capitalism is quite similar to Keynes’s, with entrepreneurial-investors driving the never-ending process of “creative destruction” and banks acting as “ephor” (gatekeepers) of capitalist development. Schumpeter, too, understood the money-first principle and saw banks as money producers rather than loanable funds conduits. Minsky stood on both giants’ shoulders, elaborating on the central role of finance in capitalism and the endogenous emergence of financial fragility as the driving force behind boom-bust cycles. However, Minsky clearly leaned towards the Englishman rather than the Austrian regarding the role of government as a player in its own right potentially stabilizing the macro economy.

It was Abba Lerner (1943, 1944), who pushed Keynes’s macroeconomic insights to its logical conclusion with regard to fiscal policy. Lerner’s “functional finance” approach proposes that the government, not facing the usual monetary constraints that can hold back private actors, should let its budgetary position passively adapt to whatever may be required to achieve macroeconomic equilibrium.

Keynes responded to Lerner’s functional finance as a “splendid idea” but had reservations as far as putting it into practice was concerned: “functional finance is an idea and not a policy; part of one’s apparatus of thought but not, except highly diluted under considerable clothing of qualification, an apparatus of action. Economists have to try to be very careful, I think, to distinguish the two.”

It is here that “Modern Monetary Theory” (MMT) comes into the picture. As a recent conference held in New York City made clear, MMT is a call for action. It is a program to alert policymakers and the public that decisions about, for instance, infrastructure, the environment, or progressive social programs are nothing but political choices within the fiscal powers of sovereign states.

MMT’s theoretical roots reach back to Keynes, Lerner, and a less well-known German political economist with the name of Georg Friedrich Knapp (1905). The latter is known for his “state theory of money” (or: “chartalism”) emphasizing that money is a creature of the state rather than a convenient market invention to reduce transaction costs.

MMT features the money-first principle: the state has to first issue its money, either by literally spending it into existence or by having its central bank purchase (“monetize”) assets, for taxpayers to then send it back to the treasury as taxes. Seen in this way, taxes do not “finance” government spending. Rather, they are a means to contain inflation depending on the economy’s real resource constraints (as made clear in Keynes’s [1940] “How to pay for the war”). Similarly, government bond issuance – supposedly collecting loanable funds from worker-savers – is not a means to “finance” government spending either, but an instrument to manage interest rates (as Keynes made clear in his reflections on monetary policy and debt management during WWII).

These insights into modern money and state power are inconvenient from the perspective of those who favor a small state and unfettered finance (i.e., the powers of wealth). It is therefore somewhat ironic to see that the current U.S. government has embraced MMT with much enthusiasm.

Recall that the Republicans in Congress opposed the “Obama stimulus” in 2009 when a second Great Depression was looming. Recall also that in 2011 a Republican Congress engineered a grossly premature turn to fiscal austerity that pummeled the still shaky recovery and forced the Federal Reserve into extended monetary overdrive. Officially, both acts of folly were made in the name of “fiscal responsibility.” But Republican Senate leader Mitch McConnell made it public that his primary ambition was to wreck the Obama presidency and limit it to one term. Attempting to sabotage his black president and unnecessarily putting the economy and the well-being of his American compatriots in jeopardy did not make him a traitor, as one would think, but a Republican hero masterminding plenty more dirty work on behalf of his subversive party rather than the nation.

And here we are today. Imagine a populist takeover of the nation by a gang of ruthless kleptocrats. Confronting a society botched with income and wealth inequalities similar in degree to the time before the Great Depression, they go about filling their own pockets by squandering tax cuts on the super-rich without paying any attention to the budgetary consequences. Fiscal responsibility was yesterday. Today is self-indulgence without fiscal worries of any tomorrow.

Ironically, certain conservative economists had remarkably clear foresight of modern developments under conservative government. James Buchanan’s vision of public policy was inspired by little else but fears of plundering kleptocrats. Milton Friedman favored fixed rules for public policy precisely because he feared discretion in the hands of incompetent and/or corrupt policymakers. It is difficult to deny today that they had a point.

Today’s political realities probably also play a part in explaining why there is significant popular interest in MMT at the other end of the political spectrum. The speech in NYC by Stephanie Kelton titled “Mainstreaming MMT” highlighted that MMT has indeed made important inroads into public life, the media, and academia (excluding the neoclassical economics mainstream of course). Participants and activists present at the NYC conference were equally enthusiastic about conceiving an active role for the state for progressive causes – unhindered by “sound finance” myths.

One can rest assured that conservatives will rediscover their love for fiscal responsibility as soon as they lose their reach to the public purse. Crying “socialism” whenever responsible fiscal action on behalf of society gets discussed, they will once again demand nothing but “sound finance.” It would be a shame if, for a third time in a row, a government inheriting Republican fiscal wreckage declared “sound finance” as their policy priority. Instead, the next government might be well advised to set out and prove Buchanan and Friedman wrong by showing that honest, responsible, and competent “government of the people, by the people, for the people” is actually possible.

Sadly, kleptocrats’ imaginative powers never reach beyond their own pockets. Imagine a government that really cares about the environment, good infrastructure, and a healthy and well-educated society, a government that understands these political choices are possible here and now – if only we as a society went for it.

 

Bibow, J. (2009). Keynes on Monetary Policy, Finance and Uncertainty: Liquidity Preference Theory and the Global Financial Crisis, Routledge.

Bibow, J. (2001). Reflections on the Current Fashion for Central Bank Independence, Working Paper No. 334, Levy Economics Institute of Bard College. Updated here: (2004). Cambridge Journal of Economics, Vol. 28, No. 4, pp. 549-576

Keynes, J.M. (1940). How to Pay for the War: A Radical Plan for the Chancellor of the Exchequer, Macmillan.

Knapp, G.F. (1905). Staatliche Theorie des Geldes, Munich and Leipzig, Duncker & Humblot.

Lerner, A.P. (1943). Functional Finance and the Federal Debt, Social Research.

Lerner, A.P. (1944). The Economics of Control, Macmillan.

Meade, J.E. (1975). The Keynesian revolution, in M. Keynes ed. Essays on John Maynard Keynes, Cambridge, Cambridge University Press.

Romer, P. (2016) The Trouble with Macroeconomics, Commons Memorial Lecture of the Omicron Delta Epsilon Society delivered on January 5, 2016, New York University, manuscript, September 14.

Kydland, F.E. and Prescott, E.C. (1977). Rules Rather Than Discretion: The Inconsistency of Optimal Plans, Journal of Political Economy, vol. 85, issue 3, 473-91.

MODERN MONEY THEORY: How I came to MMT and what I include in MMT

Published by Anonymous (not verified) on Tue, 02/10/2018 - 11:16am in

My remarks for the 2018 MMT Conference September 28-30, NYC L. RANDALL WRAY I was asked to give a short presentation at the MMT conference. What follows is the text version of my remarks, some of which I had to … Continue reading →

The post MODERN MONEY THEORY: How I came to MMT and what I include in MMT appeared first on New Economic Perspectives.


Modern Money Theory: How I Came to MMT and What I Include in MMT

Published by Anonymous (not verified) on Tue, 02/10/2018 - 6:17am in

My remarks for the 2018 MMT Conference, September 28-30, NYC.

I was asked to give a short presentation at the MMT conference. What follows is the text version of my remarks, some of which I had to skip over in the interests of time. Many readers might want to skip to the bullet points near the end, which summarize what I include in MMT.

******************************************************************************

As an undergraduate I studied psychology and social sciences—but no economics, which probably gave me an advantage when I finally did come to economics. I began my economics career in my late twenties, studying mostly Institutionalist and Marxist approaches while working for the local government in Sacramento. However, I did carefully read Keynes’s General Theory at Sacramento State and one of my professors—John Henry—pushed me to go to St. Louis to study with Hyman Minsky, the greatest Post Keynesian economist.

I wrote my dissertation in Bologna under Minsky’s direction, focusing on private banking and the rise of what we called “nonbank banks” and “off-balance-sheet operations” (now called shadow banking). While in Bologna, I met Otto Steiger—who had an alternative to the barter story of money that was based on his theory of property. I found it intriguing because it was consistent with some of Keynes’s Treatise on Money that I was reading at the time. Also, I had found Knapp’s State Theory of Money—cited in both Steiger and Keynes—so I speculated on money’s origins (in spite of Minsky’s warning that he didn’t want me to write Genesis) and the role of the state in my dissertation that became a book in 1990—Money and Credit in Capitalist Economies—that helped to develop the Post Keynesian endogenous money approach.

What was lacking in that literature was an adequate treatment of the role of the state—which played a passive role—supplying reserves as demanded by private bankers—that is the Post Keynesian accommodationist or Horizontalist approach. There was no discussion of the relation of money to fiscal policy at that time. As I continued to read about the history of money, I became more convinced that we need to put the state at the center. Fortunately, I ran into two people that helped me to see how to do it.

First, there was Warren Mosler, who I met online in the PKT discussion group; he insisted on viewing money as a tax-driven government monopoly. Second, I met Michael Hudson at a seminar at the Levy Institute, who provided the key to help unlock what Keynes had called his “Babylonian Madness” period—when he was driven crazy trying to understand early money. Hudson argued that money was an invention of the authorities used for accounting purposes. So over the next decade I worked with a handful of people to put the state into monetary theory.

As we all know, the mainstream wants a small government, with a central bank that follows a rule (initially, a money growth rate but now some version of inflation targeting). The fiscal branch of government is treated like a household that faces a budget constraint. But this conflicts with Institutionalist theory as well as Keynes’s own theory. As the great Institutionalist Fagg Foster—who preceded me at the University of Denver–put it: whatever is technically feasible is financially feasible. How can we square that with the belief that sovereign government is financially constrained? And if private banks can create money endogenously—without limit—why is government constrained?

My second book, in 1998, provided a different view of sovereign spending. I also revisited the origins of money. By this time I had discovered the two best articles ever written on the nature of money—by Mitchell Innes. Like Warren, Innes insisted that the dollar’s value is derived from the tax that drives it. And he argued this has always been the case. This was also consistent with what Keynes claimed in the Treatise, where he said that money has been a state money for the past 4,000 years, at least. I called this “modern money” with intentional irony—and titled my 1998 book Understanding Modern Money as an inside joke. It only applies to the past 4,000 years.

Surprisingly, this work was more controversial than the earlier endogenous money research. In my view, it was a natural extension—or more correctly, it was the prerequisite to a study of privately created money. You need the state’s money before you can have private money. Eventually our work found acceptance outside economics—especially in law schools, among historians, and with anthropologists.

For the most part, our fellow economists, including the heterodox ones, attacked us as crazy.

I benefited greatly by participating in law school seminars (in Tel Aviv, Cambridge, and Harvard) on the legal history of money—that is where I met Chris Desan and later Farley Grubb, and eventually Rohan Grey. Those who knew the legal history of money had no problem in adopting the MMT view—unlike economists.

I remember one of the Harvard seminars when a prominent Post Keynesian monetary theorist tried to argue against the taxes drive money view. He said he never thinks about taxes when he accepts money—he accepts currency because he believes he can fob it off on Buffy Sue. The audience full of legal historians broke out in an explosion of laughter—yelling “it’s the taxes, stupid.” All he could do in response was to mumble that he might have to think more about it.

Another prominent Post Keynesian claimed we had two things wrong. First, government debt isn’t special—debt is debt. Second, he argued we don’t need double entry book-keeping—his model has only single entry book-keeping. Years later he agreed that private debt is more dangerous than sovereign debt, and he’s finally learned double-entry accounting. But of course whenever you are accounting for money you have to use quadruple entry book-keeping. Maybe in another dozen years he’ll figure that out.

As a student I had read a lot of anthropology—as most Institutionalists do. So I knew that money could not have come out of tribal economies based on barter exchange. As you all know, David Graeber’s book insisted that anthropologists have never found any evidence of barter-based markets. Money preceded market exchange.

Studying history also confirmed our story, but you have to carefully read between the lines. Most historians adopt monetarism because the only economics they know is Friedman–who claims that money causes inflation. Almost all of them also adopt a commodity money view—gold was good money and fiat paper money causes inflation. If you ignore those biases, you can learn a lot about the nature of money from historians.

Farley Grubb—the foremost authority on Colonial currency—proved that the American colonists understood perfectly well that taxes drive money. Every act that authorized the issue of paper money imposed a Redemption Tax. The colonies burned all their tax revenue. Again, history shows that this has always been true. All money must be redeemed—that is, accepted by its issuer in payment. As Innes said, that is the fundamental nature of credit. It is written right there in the early acts by the American colonies. Even a gold coin is the issuer’s IOU, redeemed in payment of taxes. Once you understand that, you understand the nature of money.

So we were winning the academic debates, across a variety of disciplines. But we had a hard time making progress in economics or in policy circles. Bill, Warren, Mat Forstater and I used to meet up every year or so to count the number of economists who understood what we were talking about. It took over decade before we got up to a dozen. I can remember telling Pavlina Tcherneva back around 2005 that I was about ready to give it up.

But in 2007, Warren, Bill and I met to discuss writing an MMT textbook. Bill and I knew the odds were against us—it would be for a small market, consisting mostly of our former students. Still, we decided to go for it. Here we are—another dozen years later—and the textbook is going to be published. MMT is everywhere. It was even featured in a New Yorker crossword puzzle in August. You cannot get more mainstream than that.

We originally titled our textbook Modern Money Theory, but recently decided to just call it Macroeconomics. There’s no need to modify that with a subtitle. What we do is Macroeconomics. There is no coherent alternative to MMT.

A couple of years ago Charles Goodhart told me: “You won. Declare victory but be magnanimous about it.” After so many years of fighting, both of those are hard to do. We won. Be nice.

Let me finish with 10 bullet points of what I include in MMT:

  1. What is money: An IOU denominated in a socially sanctioned money of account. In almost all known cases, it is the authority—the state—that chooses the money of account. This comes from Knapp, Innes, Keynes, Geoff Ingham, and Minsky.
  2. Taxes or other obligations (fees, fines, tribute, tithes) drive the currency. The ability to impose such obligations is an important aspect of sovereignty; today, states alone monopolize this power. This comes from Knapp, Innes, Minsky, and Mosler.
  3. Anyone can issue money; the problem is to get it accepted. Anyone can write an IOU denominated in the recognized money of account; but acceptance can be hard to get unless you have the state backing you up. This is Minsky.
  4. The word “redemption” is used in two ways—accepting your own IOUs in payment and promising to convert your IOUs to something else (such as gold, foreign currency, or the state’s IOUs).

The first is fundamental and true of all IOUs. All our gold bugs mistakenly focus on the second meaning—which does not apply to the currencies issued by most modern nations, and indeed does not apply to most of the currencies issued throughout history. This comes from Innes and Knapp, and is reinforced by Hudson’s and Grubb’s work, as well as by Margaret Atwood’s great book: Payback: Debt and the Shadow Side of Wealth.

  1. Sovereign debt is different. There is no chance of involuntary default so long as the state only promises to accept its currency in payment. It could voluntarily repudiate its debt, but this is rare and has not been done by any modern sovereign nation.
  2. Functional Finance: finance should be “functional” (to achieve the public purpose), not “sound” (to achieve some arbitrary “balance” between spending and revenues). Most importantly, monetary and fiscal policy should be formulated to achieve full employment with price stability. This is credited to Abba Lerner, who was introduced into MMT by Mat Forstater.

In its original formulation, it is too simplistic, summarized as two principles: increase government spending (or reduce taxes) and increase the money supply if there is unemployment (do the reverse if there is inflation). The first of these is fiscal policy and the second is monetary policy. A steering wheel metaphor is often invoked, using policy to keep the economy on course. A modern economy is far too complex to steer as if you were driving a car. If unemployment exists, it is not enough to say that you can just reduce the interest rate, raise government spending, or reduce taxes. The first might even increase unemployment. The second two could cause unacceptable inflation, increase inequality, or induce financial instability long before they solved the unemployment problem. I agree that government can always afford to spend more. But the spending has to be carefully targeted to achieve the desired result. I’d credit all my Institutionalist influences for that, including Minsky.

  1. For that reason, the JG is a critical component of MMT. It anchors the currency and ensures that achieving full employment will enhance both price and financial stability. This comes from Minsky’s earliest work on the ELR, from Bill Mitchell’s work on buffer stocks and Warren Mosler’s work on monopoly price setting.
  2. And also, for that reason, we need Minsky’s analysis of financial instability. Here I don’t really mean the financial instability hypothesis. I mean his whole body of work and especially the research line that began with his dissertation written under Schumpeter up through his work on Money Manager Capitalism at the Levy Institute before he died.
  3. The government’s debt is our financial asset. This follows from the sectoral balances approach of Wynne Godley. We have to get our macro accounting correct. Minsky always used to tell students: go home and do the balance sheets because what you are saying is nonsense. Fortunately, I had learned T-accounts from John Ranlett in Sacramento (who also taught Stephanie Kelton from his own, great, money and banking textbook—it is all there, including the impact of budget deficits on bank reserves). Godley taught us about stock-flow consistency and he insisted that all mainstream macroeconomics is incoherent.
  4. Rejection of the typical view of the central bank as independent and potent. Monetary policy is weak and its impact is at best uncertain—it might even be mistaking the brake pedal for the gas pedal. The central bank is the government’s bank so can never be independent. Its main independence is limited to setting the overnight rate target, and it is probably a mistake to let it do even that. Permanent ZIRP (zero interest rate policy) is probably a better policy since it reduces the compounding of debt and the tendency for the rentier class to take over more of the economy. I credit Keynes, Minsky, Hudson, Mosler, Eric Tymoigne, and Scott Fullwiler for much of the work on this.

That is my short list of what MMT ought to include. Some of these traditions have a very long history in economics. Some were long lost until we brought them back into discussion. We’ve integrated them into a coherent approach to Macro. In my view, none of these can be dropped if you want a macroeconomics that is applicable to the modern economy. There are many other issues that can be (often are) included, most importantly environmental concerns and inequality, gender and race/ethnicity. I have no problem with that.

Modern Money Theory: How I Came to MMT and What I Include in MMT

Published by Anonymous (not verified) on Tue, 02/10/2018 - 6:17am in

My remarks for the 2018 MMT Conference, September 28-30, NYC.

I was asked to give a short presentation at the MMT conference. What follows is the text version of my remarks, some of which I had to skip over in the interests of time. Many readers might want to skip to the bullet points near the end, which summarize what I include in MMT.

******************************************************************************

As an undergraduate I studied psychology and social sciences—but no economics, which probably gave me an advantage when I finally did come to economics. I began my economics career in my late twenties, studying mostly Institutionalist and Marxist approaches while working for the local government in Sacramento. However, I did carefully read Keynes’s General Theory at Sacramento State and one of my professors—John Henry—pushed me to go to St. Louis to study with Hyman Minsky, the greatest Post Keynesian economist.

I wrote my dissertation in Bologna under Minsky’s direction, focusing on private banking and the rise of what we called “nonbank banks” and “off-balance-sheet operations” (now called shadow banking). While in Bologna, I met Otto Steiger—who had an alternative to the barter story of money that was based on his theory of property. I found it intriguing because it was consistent with some of Keynes’s Treatise on Money that I was reading at the time. Also, I had found Knapp’s State Theory of Money—cited in both Steiger and Keynes—so I speculated on money’s origins (in spite of Minsky’s warning that he didn’t want me to write Genesis) and the role of the state in my dissertation that became a book in 1990—Money and Credit in Capitalist Economies—that helped to develop the Post Keynesian endogenous money approach.

What was lacking in that literature was an adequate treatment of the role of the state—which played a passive role—supplying reserves as demanded by private bankers—that is the Post Keynesian accommodationist or Horizontalist approach. There was no discussion of the relation of money to fiscal policy at that time. As I continued to read about the history of money, I became more convinced that we need to put the state at the center. Fortunately, I ran into two people that helped me to see how to do it.

First, there was Warren Mosler, who I met online in the PKT discussion group; he insisted on viewing money as a tax-driven government monopoly. Second, I met Michael Hudson at a seminar at the Levy Institute, who provided the key to help unlock what Keynes had called his “Babylonian Madness” period—when he was driven crazy trying to understand early money. Hudson argued that money was an invention of the authorities used for accounting purposes. So over the next decade I worked with a handful of people to put the state into monetary theory.

As we all know, the mainstream wants a small government, with a central bank that follows a rule (initially, a money growth rate but now some version of inflation targeting). The fiscal branch of government is treated like a household that faces a budget constraint. But this conflicts with Institutionalist theory as well as Keynes’s own theory. As the great Institutionalist Fagg Foster—who preceded me at the University of Denver–put it: whatever is technically feasible is financially feasible. How can we square that with the belief that sovereign government is financially constrained? And if private banks can create money endogenously—without limit—why is government constrained?

My second book, in 1998, provided a different view of sovereign spending. I also revisited the origins of money. By this time I had discovered the two best articles ever written on the nature of money—by Mitchell Innes. Like Warren, Innes insisted that the dollar’s value is derived from the tax that drives it. And he argued this has always been the case. This was also consistent with what Keynes claimed in the Treatise, where he said that money has been a state money for the past 4,000 years, at least. I called this “modern money” with intentional irony—and titled my 1998 book Understanding Modern Money as an inside joke. It only applies to the past 4,000 years.

Surprisingly, this work was more controversial than the earlier endogenous money research. In my view, it was a natural extension—or more correctly, it was the prerequisite to a study of privately created money. You need the state’s money before you can have private money. Eventually our work found acceptance outside economics—especially in law schools, among historians, and with anthropologists.

For the most part, our fellow economists, including the heterodox ones, attacked us as crazy.

I benefited greatly by participating in law school seminars (in Tel Aviv, Cambridge, and Harvard) on the legal history of money—that is where I met Chris Desan and later Farley Grubb, and eventually Rohan Grey. Those who knew the legal history of money had no problem in adopting the MMT view—unlike economists.

I remember one of the Harvard seminars when a prominent Post Keynesian monetary theorist tried to argue against the taxes drive money view. He said he never thinks about taxes when he accepts money—he accepts currency because he believes he can fob it off on Buffy Sue. The audience full of legal historians broke out in an explosion of laughter—yelling “it’s the taxes, stupid.” All he could do in response was to mumble that he might have to think more about it.

Another prominent Post Keynesian claimed we had two things wrong. First, government debt isn’t special—debt is debt. Second, he argued we don’t need double entry book-keeping—his model has only single entry book-keeping. Years later he agreed that private debt is more dangerous than sovereign debt, and he’s finally learned double-entry accounting. But of course whenever you are accounting for money you have to use quadruple entry book-keeping. Maybe in another dozen years he’ll figure that out.

As a student I had read a lot of anthropology—as most Institutionalists do. So I knew that money could not have come out of tribal economies based on barter exchange. As you all know, David Graeber’s book insisted that anthropologists have never found any evidence of barter-based markets. Money preceded market exchange.

Studying history also confirmed our story, but you have to carefully read between the lines. Most historians adopt monetarism because the only economics they know is Friedman–who claims that money causes inflation. Almost all of them also adopt a commodity money view—gold was good money and fiat paper money causes inflation. If you ignore those biases, you can learn a lot about the nature of money from historians.

Farley Grubb—the foremost authority on Colonial currency—proved that the American colonists understood perfectly well that taxes drive money. Every act that authorized the issue of paper money imposed a Redemption Tax. The colonies burned all their tax revenue. Again, history shows that this has always been true. All money must be redeemed—that is, accepted by its issuer in payment. As Innes said, that is the fundamental nature of credit. It is written right there in the early acts by the American colonies. Even a gold coin is the issuer’s IOU, redeemed in payment of taxes. Once you understand that, you understand the nature of money.

So we were winning the academic debates, across a variety of disciplines. But we had a hard time making progress in economics or in policy circles. Bill, Warren, Mat Forstater and I used to meet up every year or so to count the number of economists who understood what we were talking about. It took over decade before we got up to a dozen. I can remember telling Pavlina Tcherneva back around 2005 that I was about ready to give it up.

But in 2007, Warren, Bill and I met to discuss writing an MMT textbook. Bill and I knew the odds were against us—it would be for a small market, consisting mostly of our former students. Still, we decided to go for it. Here we are—another dozen years later—and the textbook is going to be published. MMT is everywhere. It was even featured in a New Yorker crossword puzzle in August. You cannot get more mainstream than that.

We originally titled our textbook Modern Money Theory, but recently decided to just call it Macroeconomics. There’s no need to modify that with a subtitle. What we do is Macroeconomics. There is no coherent alternative to MMT.

A couple of years ago Charles Goodhart told me: “You won. Declare victory but be magnanimous about it.” After so many years of fighting, both of those are hard to do. We won. Be nice.

Let me finish with 10 bullet points of what I include in MMT:

  1. What is money: An IOU denominated in a socially sanctioned money of account. In almost all known cases, it is the authority—the state—that chooses the money of account. This comes from Knapp, Innes, Keynes, Geoff Ingham, and Minsky.
  2. Taxes or other obligations (fees, fines, tribute, tithes) drive the currency. The ability to impose such obligations is an important aspect of sovereignty; today, states alone monopolize this power. This comes from Knapp, Innes, Minsky, and Mosler.
  3. Anyone can issue money; the problem is to get it accepted. Anyone can write an IOU denominated in the recognized money of account; but acceptance can be hard to get unless you have the state backing you up. This is Minsky.
  4. The word “redemption” is used in two ways—accepting your own IOUs in payment and promising to convert your IOUs to something else (such as gold, foreign currency, or the state’s IOUs).

The first is fundamental and true of all IOUs. All our gold bugs mistakenly focus on the second meaning—which does not apply to the currencies issued by most modern nations, and indeed does not apply to most of the currencies issued throughout history. This comes from Innes and Knapp, and is reinforced by Hudson’s and Grubb’s work, as well as by Margaret Atwood’s great book: Payback: Debt and the Shadow Side of Wealth.

  1. Sovereign debt is different. There is no chance of involuntary default so long as the state only promises to accept its currency in payment. It could voluntarily repudiate its debt, but this is rare and has not been done by any modern sovereign nation.
  2. Functional Finance: finance should be “functional” (to achieve the public purpose), not “sound” (to achieve some arbitrary “balance” between spending and revenues). Most importantly, monetary and fiscal policy should be formulated to achieve full employment with price stability. This is credited to Abba Lerner, who was introduced into MMT by Mat Forstater.

In its original formulation, it is too simplistic, summarized as two principles: increase government spending (or reduce taxes) and increase the money supply if there is unemployment (do the reverse if there is inflation). The first of these is fiscal policy and the second is monetary policy. A steering wheel metaphor is often invoked, using policy to keep the economy on course. A modern economy is far too complex to steer as if you were driving a car. If unemployment exists, it is not enough to say that you can just reduce the interest rate, raise government spending, or reduce taxes. The first might even increase unemployment. The second two could cause unacceptable inflation, increase inequality, or induce financial instability long before they solved the unemployment problem. I agree that government can always afford to spend more. But the spending has to be carefully targeted to achieve the desired result. I’d credit all my Institutionalist influences for that, including Minsky.

  1. For that reason, the JG is a critical component of MMT. It anchors the currency and ensures that achieving full employment will enhance both price and financial stability. This comes from Minsky’s earliest work on the ELR, from Bill Mitchell’s work on buffer stocks and Warren Mosler’s work on monopoly price setting.
  2. And also, for that reason, we need Minsky’s analysis of financial instability. Here I don’t really mean the financial instability hypothesis. I mean his whole body of work and especially the research line that began with his dissertation written under Schumpeter up through his work on Money Manager Capitalism at the Levy Institute before he died.
  3. The government’s debt is our financial asset. This follows from the sectoral balances approach of Wynne Godley. We have to get our macro accounting correct. Minsky always used to tell students: go home and do the balance sheets because what you are saying is nonsense. Fortunately, I had learned T-accounts from John Ranlett in Sacramento (who also taught Stephanie Kelton from his own, great, money and banking textbook—it is all there, including the impact of budget deficits on bank reserves). Godley taught us about stock-flow consistency and he insisted that all mainstream macroeconomics is incoherent.
  4. Rejection of the typical view of the central bank as independent and potent. Monetary policy is weak and its impact is at best uncertain—it might even be mistaking the brake pedal for the gas pedal. The central bank is the government’s bank so can never be independent. Its main independence is limited to setting the overnight rate target, and it is probably a mistake to let it do even that. Permanent ZIRP (zero interest rate policy) is probably a better policy since it reduces the compounding of debt and the tendency for the rentier class to take over more of the economy. I credit Keynes, Minsky, Hudson, Mosler, Eric Tymoigne, and Scott Fullwiler for much of the work on this.

That is my short list of what MMT ought to include. Some of these traditions have a very long history in economics. Some were long lost until we brought them back into discussion. We’ve integrated them into a coherent approach to Macro. In my view, none of these can be dropped if you want a macroeconomics that is applicable to the modern economy. There are many other issues that can be (often are) included, most importantly environmental concerns and inequality, gender and race/ethnicity. I have no problem with that.

Paying for Hurricanes

Published by Anonymous (not verified) on Tue, 18/09/2018 - 11:50am in

By J.D. ALT What you believe America can build—or rebuild—as a collective society hinges on how you answer one fundamental question: When the U.S. government issues a treasury bond, is it “borrowing” money that must be repaid with future tax-dollars—or … Continue reading →

The post Paying for Hurricanes appeared first on New Economic Perspectives.


Jayadev/Mason Article On MMT

Published by Anonymous (not verified) on Mon, 10/09/2018 - 10:37am in

Tags 

MMT

Arjun Dayadev and J.W. Mason recently published "Mainstream Macroeconomics and Modern Monetary Theory: What Really Divides Them?", which suggests that the gulf between Modern Monetary Theory (MMT) and mainstream macroeconomics is smaller than suggested, that MMT is much closer to orthodoxy than is normally portrayed.

I have been battling with installing a locking floating floor, which is an engineering task that I discovered that my doctorate in engineering provided little training. As a result, I have been somewhat distracted, and only quickly read the article.

I am unsure how the academic MMT community will view the paper; being portrayed as orthodox is perhaps not the way that they think of themselves. Furthermore, some of the theoretical points run into the thorny questions of academic originality. As an ex-academic, I understand concerns about originality and distinctiveness. Since I only browse the economic academic literature looking for useful tidbits, I cannot comment on the academic originality of MMT.

From my decidedly ex-academic perch, I am open to the idea that the gulf between the mainstream and MMT in policy terms is more a question of political economy and terminology. If mainstream economists actually paid attention to the mathematics that they say is so important, a lot of the distinctions with MMT would disappear. Essentially, they have built qualitative folklore around not particularly useful mathematics. Modern Monetary Theory is battling with the folklore, not the mathematics.

I just want to comment briefly on a few points that I saw some disagreements. (These are the points that stuck out to me when I was sprawled on top of a pile of building materials, and are not necessarily the most important parts of the paper.)
InflationThey state the following:

Output below this level implies unacceptably high unemployment and perhaps deflation; output above this level implies unacceptably high and/or rising inflation. This assumption can be represented as a Phillips curve, the same general form of which is used by MMT as in conventional textbook presentations. A corollary is that policy affects inflation only via the level of output.

From what I have seen, the MMT story on inflation is more complex than that text suggests. The "nominal price level anchor" provided by the Job Guarantee wage is constantly emphasised. My interpretation of the Functional Finance part of MMT as suggesting that "large enough" fiscal loosening leads to inflation -- but until we hit that "large enough" level, inflation may do whatever it does. The psychological anchoring of wages relative to a Job Guarantee wage may be far more effective tool for inflation stability than changing the overnight rate on risk-free collateral.

If the MMT inflation story was as simple as just a Phillips curve, why don't they say that themselves?
Aggregate Demand ManagementThe article was premised entirely on aggregate demand management. And MMT economists have discussed such aggregate management with respect to current events. However, the emphasis in MMT is on using a decentralised automatic stabiliser -- the Job Guarantee. The key advantage of the Job Guarantee is that it is spatially targeted at the areas of greater need.
The Debt Ratio (My Perspective...)

We noted above that while MMT advocates would probably agree that the debt ratio should not rise without limit, in general, they do not see the debt ratio as an important target for policy. 

I cannot speak for MMT academics, but I am far more worried about a Martian invasion than a country's debt ratio rising without limit.

If we start from a stock-flow consistent modelling perspective, we assume that the stock of private sector wealth enters into consumption decisions. As the government debt ratio rises, by definition, private sector wealth is rising. Eventually, the drawdown from saving will dwarf spending out of income if it is not otherwise budging. The increased spending creates a circular flow of income, driving nominal GDP above expectations. Since the duration of government debt is not zero, the debt-to-GDP ratio will fall -- as exactly happened in the post-war uplift in inflation.

As always, inflation is the limit for fiscal policy.

This allegedly does not happen in mainstream DSGE models, mainly because the mainstream economists make no real effort to solve the models. If they actually did the math, they would probably see the same effect.

(c) Brian Romanchuk 2018

Japan And The Costs Of Bond Yield Control

Published by Anonymous (not verified) on Thu, 06/09/2018 - 12:03am in

Tags 

Japan, MMT

 10-year JGB Yield
The dangers of distorting free market interest rates is one of the bits of market folklore that keeps getting passed around. There is actually not a whole lot of data to defend this view; it is best viewed as faith-based reasoning. This topic is particularly interesting in the case of Japan. I am somewhat agnostic on this issue; I do not see particular risks from manipulating the yield curve in the current environment, yet I can see some plausible dangers.

This article was triggered by the article "Bank of Japan once again shows who calls the shots," by Bill Mitchell, one of the leading Modern Monetary Theory (MMT) economists. In addition, I had a discussion about this topic with someone doing some research awhile ago. Rather than re-hash Professor Mitchell's points from the MMT perspective, I will put on my "generic market analyst" hat and give a description of the issue from a more theory-agnostic perspective. This article probably covers topics I have already covered, but I am still recovering from the Banjo Bowl disaster on the weekend (plus I am now doing more home renovations).
Mainstream Macro TheoryI do not want to get involved in the great mainstream-heterodox mud-slinging match right now. However, it would be crazy to ignore the distinction in views when discussing this topic. The standard view is that interest rates are critical for determining economic outcomes, and so any manipulation of the yield curve is extremely important.

Standard mainstream macro -- and even offshoots, like Austrian theory -- assume that interest rates are critical for all economic decisions. The reason being is that everyone buys all products in spot and forward markets extending over all time horizons. Interest rates are assumed to be important for the relative prices between spot and forward.

For fixed income markets, interest rates and forward purchases obviously matter. Furthermore, there are some flexprice commodities (oil, grains) that are bought/sold forward. However, these markets are a small subset of all market transactions in the economy. So it is very much unclear how applicable the assumption that interest rates are paramount really is.

From what I have seen of the mainstream empirical literature (which is admittedly a small portion), the analysis bakes the assumption that interest rates matter into the cake; there is literally no way of falsifying the thesis that interest rates matter or not. From my perspective, the interesting observation is that I cannot think of any empirical observations that confirms the conventional view of the effectiveness of interest rates, beyond the Volcker episode. Being able to point to one data point -- at a period of history when there was a lot of economic policy shifts -- is not the most impressive defence of a theory.

I am not going to resolve that debate herein. All I can say is that if one is not willing to assume that small changes to interest rates are of critical economic importance, we need to dig further into what the costs to yield curve manipulation are (which is what will be discussed in the remainder of this article).
Costs to Yield Curve ManipulationThe Mitchell post explains why the government can set the entire yield curve. I will instead focus on the potential risks to such a posture.

  • Losing the ability to influence the economy via setting interest rates.
  • The political cost of changing bond prices.
  • The loss of market information.
  • Political cost of interest expense.

I will cover these in turn.
Influencing the EconomyFrom a real world political perspective, the dominance of conventional thinking about the effects of interest rates on the economy makes this the primary practical concern. However, since I am skeptical about the ability of the central bank to control the economy with interest rates, I will dig further into the topic from this vantage point.

Even if "control" of the economy with interest rates might be far less feasible than mainstream thinking suggests, it seems reasonable to argue that interest rates can be useful to influence it under certain circumstances. For example, higher interest rates will eventually curtail real estate speculation. Admittedly, this is not a big worry in Japan right now.

An alternative use of high interest rates is of more interest: attempting to defend the value of a currency in foreign exchange markets. I am unconvinced that a high policy rate will necessarily help defend the value of the currency, but I am almost certainly in the minority with that view. If enough market participants believe that high interest rates boost a currency's value, that is what we should expect to happen. (This is perhaps a better topic for anthropology than economics.)

For Japan, defending the yen in a reasonable concern (if we put aside Japan's rather sizeable foreign exchange reserves). Japan is an island nation in a rather awkward geopolitical neighbourhood, and is dependent upon various imported raw materials. The Japanese government can certainly always buy domestically produced goods and services with yen (as per MMT arguments), but import requirements need to take into account the external value of the currency.*

Another practical problem is the design of pension systems. Pension systems were designed on the assumption that it would be possible to eventually meet actuarial cash flows with assets with a positive real rate of return. Locking bond yields at a negative real rate represents a serious incoherence in policy design. This is a problem for Japan, as well as elsewhere.

If everyone switched over to a MMT-ish world view, concerns about the loss of interest rate control might disappear. However, this has not happened yet.

The remaining sections of this article are based on the assumption that interest rates can change in the future; if they are locked at 0% permanently, they are moot.
Political Cost of Changing Bond PricesIf the central bank changes the policy rate, it is changing the pricing of an overnight instrument -- with a duration remarkably close to zero. If it changes its target for bond yields, it is handing capital gains/losses on long duration instruments.

This will cause annoyance among bond holders, and creates a huge potential for shenanigans. We live in a world where there is a revolving door between governmental posts and the private sector, and I am unsure whether there is a widespread belief that this revolving door should be closed. (I am a prairie populist, and not a fan of these revolving door arrangements. However, I recognise that my view is in the minority.) Even if there are no shenanigans, the suspicion that they exist will always be there. If I were a central banker, I certainly would not want a system that induces people to assume that central bankers are corrupt.
Loss of Market InformationAnyone from the Chicago School, or of an Austrian bent, will be quite adamant about the importance of market information. By pegging bond yields, policymakers have destroyed the information content of the yield curve, which is one of the most reliable recession indicators (in the United States; ZIRP destroyed the information content of the JGB curve).

I am highly skeptical with regards to the importance of the loss of market information for the private sector. In the real world, people do not plan all consumption decisions in hypothetical forward markets that use the risk-free rate as a discounting instrument. Meanwhile, changing the risk-free rate will not greatly influence lending decisions: the private sector lends on a spread basis. Government interference in private lending only matters if they are distorting credit decisions -- exactly like the CMHC in Canada. Otherwise, we are just back to the debate around the importance of the level of the risk-free curve for the economy, as discussed earlier.

Where the loss of information might matter is for policymakers. If we believe that policymakers can fine tune the economy with interest rates, the signal provided by the yield curve presumably gives them some information from private sector market participants. The exact value of the information can be debated. If one believes that the term premium tears around in a random, unpredictable fashion, the curve is not going to contain a lot of information. Furthermore, the market consensus can be quite wrong, particularly in the early parts of expansions.

Policymakers could turn to other markets for information, such as the inflation-linked market. (My book on which is supposed to be nearly done...) All they need to do is avoid destroying the information available in the market by passing it through an affine term structure model, or by pinning those prices as well. (In the same fashion that Market Monetarists insist that central bank can set the level of nominal GDP by buying or selling hypothetical GDP futures, one could imagine the New Keynesian brain trust arguing that inflation rates can be set by pegging inflation breakeven rates.)
Political Costs of Interest ExpenseOne of the side effects of central bank yield curve control is that it cannot force people to buy long maturity bonds at the price it sets. Eventually, it will run into a situation where it owns most of the long end of the yield curve.

If we consolidate the central bank with the Treasury (which we should), this creates a situation that is economically equivalent to replacing long maturity debt with short maturity paper. As a result, changes to interest rates will immediately change fiscal interest expense, whereas a long-duration debt structure will insulate overall interest expense for years.

Financial commentators, mainstream economists, and politicians have a well-recorded tendency to scream about rising interest costs. Since there is no chance of a competent currency sovereign going bankrupt, these concerns are meaningless. However, in the real world, we have to deal with people who indulge in magical thinking (as I believe most anthropologists would attest).

Although it would be great if everyone were willing to think sensibly about government finance. I am not going to hold my breath waiting for that to happen. From my perspective (which I believe would not be shared by Bill Mitchell and other MMTers), I would not want to waste political capital walking into an obvious trap.

Returning to Japan, I see very little risk of rising inflation on any reasonable horizon, outside the possibility of some form of energy price shock. However, I see the risk of the Bank of Japan robotically raising rates in response to some inflationary shock. This will create a feedback loop to fiscal policy, with rising interest spending creating the spending power to sustain higher prices. (This was a common view in the inflationary 1970s, which disappeared after the consensus decided that high interest rates suppressed inflation.) A short maturity debt structure allows for such a feedback loop; if interest costs are largely fixed, this effect cannot kick into gear. In other words, a long maturity debt structure helps prevent the economy from being blown up by pro-cyclical policies by mainstream central bankers (again).

The relatively high debt-to-GDP ratio of Japan makes this more than a theoretical corner case. It would not be hard to craft a "Japan is doomed!" narrative based on post-Keynesian theory, and assuming that Japanese policymakers follow the mainstream script to the letter.
Concluding RemarksAustrian economics is far more influential in market commentary than it is academia. As a result, we should expect complaints about the dangers posed by distorting the yield curve to continue. That said, there is not a great deal of evidence that it actually matters.

Footnote:

* Some Post-Keynesians go on about the "external constraint" when discussing MMT. For floating currency sovereigns, the "external constraint" is really just the external value of the currency. A falling currency value should probably be lumped in with "inflation," which is already discussed in Functional Finance. In other words, people who are concerned about "the external constraint" are more worried about semantics than the operational effects of policies.

(c) Brian Romanchuk 2018

Miscalculating Medicare-for-all

Published by Anonymous (not verified) on Mon, 20/08/2018 - 7:07pm in

By J.D. ALT A report from the Mercatus Center at George Mason University calculating the “cost” of Medicare-for-all has received much attention recently—first, because Bernie Sanders claimed the report concluded that Medicare-for-all would save the American people $2 trillion over … Continue reading →

The post Miscalculating Medicare-for-all appeared first on New Economic Perspectives.


How big does the fire need to be?

Published by Anonymous (not verified) on Mon, 13/08/2018 - 7:11pm in

By J.D. ALT I have written about this before, but it bears repeating now—and perhaps it bears repeating every week until somebody with more leverage than me picks the message up and carries it a step further: America (and the … Continue reading →

The post How big does the fire need to be? appeared first on New Economic Perspectives.


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