Archive for the ‘Modern Monetary Theory’ Category

Monetary and Fiscal Operations in China, an MMT Perspective

L. Randall Wray | October 28, 2013

Here’s a piece I wrote with Yolanda Fernandez for the Asian Development Bank:

Monetary and Fiscal Operations in the People’s Republic of China: An Alternative View of the Options Available

Monetary and Fiscal Operations in the People’s Republic of Chi

You’ve no doubt read various analyses predicting the impending collapse of the Chinese financial sector, and arguments that China cannot continue to grow at a rapid pace. While we do think that China faces some challenges, we part company with the gloom and doom crowd. What most of them do not understand is that China is a sovereign country that issues its own currency. Affordability is not an issue. China has the fiscal capacity to resolve any financial crisis, and it can “afford” to grow fast if it chooses to do so.

Our paper examines the fiscal and monetary policy options available to the PRC as a sovereign currency-issuing nation operating in a dollar standard world. The paper first summarizes a number of issues facing the PRC, including the possibility of slower growth and a number of domestic imbalances. Then, it analyzes current monetary and fiscal policy formation and examines some policy recommendations that have been advanced to deal with current areas of concern. The paper outlines the sovereign currency approach and uses it to analyze those concerns. Against this background, it is recommended that the central government’s fiscal stance should be gradually relaxed so that local government and corporate budgets can be tightened. By loosening the central government’s budget but tightening local government and corporate budgets at a measured pace, the PRC can avoid depressing growth or sparking excessive inflation. Since the central government faces no financial constraints, shifting more fiscal responsibility to the center will reduce financial fragility.


Minsky Does Rio: Notes from a Conference

L. Randall Wray | October 14, 2013

I recently returned from a conference in Brazil jointly sponsored by the Levy Economics Institute, the Ford Foundation, and the Brazilian research group MINDS. It is part of a bigger project to take Hyman P. Minsky global. In my view, Minsky was hands-down the greatest economist of the second half of the twentieth century and he deserves the attention he’s getting. Watch for an upcoming film by Monty Python’s Terry Jones that will feature Minsky and his work. Minsky will even make an appearance—or, more accurately, a bigger-than-life Minsky puppet will be in the film. (Steve Keen and I were also interviewed.)

Minsky the puppet had to travel from England to NY for filming. Question: how do you transport a huge puppet across the Big Pond? Well, you buy him a seat, of course! It would have been worth the price of airfare to be on that flight, buying Minsky a drink.

In any event, I’m going to focus my comments around the conference’s kick-off presentation by the always entertaining Paul McCulley, formerly the brains behind PIMCO. I was sitting with Paul right before his talk, during which he apparently put the whole thing together. He asked for three fundamental principles to structure his presentation. In a matter of minutes he came up with three, fleshed them out, and then gave the kind of performance that only Paul can give. Herewith follows my recollection of his points along with my comments on each.

Principle 1: Microeconomics and Macroeconomics are inherently different disciplines. Macro is demand-side; micro is supply-side. For any practical time horizon, demand always drives supply.

For those who have been trained in economics, and then had to suffer through the mainstream preoccupation with the supposed “micro foundations of macro,” or even with the heterodox arguments for “macro foundations of micro,” Paul brilliantly cut to the chase: the twain do not meet in any way that matters. continue reading…


Reorienting Fiscal Policy and Understanding Currency Sovereignty

Michael Stephens | October 10, 2013

From Mariana Mazzucato’s “Rethinking the State” video series:

Pavlina Tcherneva discusses the implications of the Great Financial Crisis of 2007 for employment outcomes and fiscal policy. She argues that the current view of Keynesian fiscal policies is based on a misreading of Keynes. Simply boosting demand — through what should be understood as trickle-down fiscal policy — is not sufficient to promote inclusive growth. Keynes originally called for a more targeted approach, including “on the spot employment,” as the means to achieve full employment and equitable and sustainable growth.

[See also her recent working paper on this theme.]


L. Randall Wray argues that rethinking the State requires rethinking the relationship between the State and its currency. His analysis starts with the observation that money is based on State power (“currency sovereignty”): it is an “IOU” from the State — a liability — implying that fiscal constraints are in fact artificially created. In this sense, the State cannot run out of money, as it creates and enforces its own IOUs. Governments could — and should — afford to invest more in innovation and technology development to promote the capital development of the economy.



An Incomplete Defense of UK Austerity

Michael Stephens | October 6, 2013

Kenneth Rogoff placed an editorial in Wednesday’s Financial Times defending the Cameron government’s austerity policies as a kind of insurance against the possibility of investor flight from UK government debt.

He concedes that the specific form of austerity that was implemented in the UK was ill-advised — public investments in infrastructure, he says, can be stimulative and pay for themselves. Nevertheless, he argues that in retrospect austerity in general was wise because we couldn’t have known for sure that the markets wouldn’t have panicked and ceased purchasing UK debt if the government had run higher deficits.

Now, one thing we might want to recall is that the UK’s austerity policies have not been hugely successful at shrinking the debt-to-GDP ratio.

UK Debt to GDP Fail_Linden

What we’re looking at here is the “fiscal trap” phenomenon Greg Hannsgen and Dimitri Papadimitriou have written about. Austerity can be a pretty inefficient policy — assuming one’s goal is the reduction of debt ratios. (As Paul De Grauwe and Yuemei Ji recently found, this is clearly the case on the eurozone periphery: “more intense austerity programmes coincide with increasing government debt ratios.”)

But even if UK austerity were more successful at shrinking public debt ratios, we would want a better sense of the probabilities and downsides involved in Rogoff’s “you never know,” market panic scenario. Just how valuable is this insurance? Because we know pretty well what the costs of austerity are (a point Rogoff appears to concede) — high unemployment, heightened insecurity, and all the attendant deterioration in well-being.

What are the benefits? If we succeeded in reducing the UK’s public debt ratio by, say, 5, 10, or 20 percentage points, how significantly would that reduce the risk of market panic for a country that controls its own currency, according to this insurance theory?

More importantly, how disastrous would Rogoff’s market panic be if it came about? His story is that a collapse of the eurozone could have led financial markets to stop buying UK gilts, which would require immediate and harsh austerity (because the government would have to balance its budget absent the ability to borrow). But as Simon Wren-Lewis (no MMTer) points out, the UK already has an “insurance” policy against this kind of market revolt — namely, it issues its own currency:

… [the monetary authority] will buy any government debt that cannot be sold to the financial markets. Rogoff says that, if the markets suddenly forsook UK government debt “UK leaders would have been forced to close massive budget deficits almost overnight.” With your own central bank this is not the case – you can print money instead.

So we should really be comparing the costs of austerity to the costs of printing money in the event that markets turn on the UK (if we generously grant the premise that reducing public debt ratios in the near term would have any significant impact on diminishing the probability of such an event). Absent an explanation as to why printing money under such circumstances would be far worse than the damage already done by budget cuts, it’s hard to see why austerity is an insurance policy worth the hefty price.


Does the Fed Have the Tools to Achieve its Dual Mandate?

Michael Stephens | September 25, 2013

Stephanie Kelton recently sat down with L. Randall Wray to discuss, among other things, the news that the Federal Reserve will refrain for the time being  from tapering its asset purchases (QE).

Wray took the occasion to elaborate on his view that quantitative easing is ineffective as economic stimulus and that — given the tools at its disposal — the Fed can’t actually carry out its dual mandate (on employment and price stability).

One interesting wrinkle here is that Wray makes this case not just with regard to asset purchases — which even some QE supporters have admitted don’t accomplish much in and of themselves — but also the “expectations channel” (forward guidance).

Kelton and Wray also touch on the latest debt ceiling showdown and the future of retirement security programs.

Download or listen to the podcast here.


Money as Effect

Greg Hannsgen | September 24, 2013

Regarding spurious policy arguments about “excessive growth of the money stock”: Ed Dolan posts helpfully to Economonitor on the more realistic approach suggested by the theory of endogenous money. In particular, I took note of the following passage, which brings up a point that I wrote about recently:

 “Formally, a model that includes a minimum reserve ratio or target plus unlimited access to borrowed reserves would not violate the multiplier model, in the sense that at any given time, the money stock would be equal to the multiplier times the sum of borrowed and non-borrowed reserves. However, the multiplier would have no functional effect, since the availability of reserves would no longer act as a constraint on the money supply. Economists describe such a situation as one of endogenous money, by which they mean that the quantity of money is determined from the inside by the behavior of banks and their customers, not from the outside by the central bank.”

In this simplified setting, the constant known as the “money multiplier” becomes the “credit divisor,” a concept defined in a short article I wrote recently for the forthcoming Elgar volume Encyclopedia of Central Banking.

Using the divisor D, instead of

bank reserves ×  M = money,

one can write

credit/D = bank reserves.

The equation reflects a theory in which causality runs from left to right, reflecting the endogeneity of reserves.

Indeed, the divisor is far more realistic as a model of the money-creation process than the money multiplier. The collapsing money multiplier in the figure in Dolan’s post corresponds to a rapidly rising credit divisor.

The post also points out that after loan demand, “the second constraint is bank capital.” The post notes that when this constraint is binding, the idea of a “reserve constraint” is still more irrelevant. Also, a profitable and solvent bank that wishes to expand its lending can usually increase its capital by retaining earnings or by other moves, as Marc Lavoie and others have pointed out in the academic literature. Moreover, Lavoie observes that a commercial bank having difficulty raising capital might be able get the central bank to purchase its shares in some countries.  Lavoie’s account can be found in his fairly comprehensive essay, “A Primer on Endogenous Money,” in Modern Theories of Money, edited by Louis-Philippe Rochon and Sergio Rossi, Edward Elgar, 2003.

From a policy perspective, a fast-growing stock of money is not generally a “cause” of inflation, though it can be an effect of rising prices or economic activity. (Of course, interest rates that were low enough long enough could cause inflation in a situation in which there was a lack of unused productive capacity.) Central banks cannot fix the growth rate of money to achieve a desired inflation rate, by setting the growth rate of bank reserves. For, as the concept of the credit divisor illustrates, the latter are also endogenous in a modern banking system.


Another Way of Reading the CBO Report

Michael Stephens | September 20, 2013

On Tuesday, the Congressional Budget Office released its new projections (pdf) for the long-term budget. A Bloomberg article titled “CBO Says Short-Term Deficit Cut Won’t Avert Fiscal Crisis” provided a fairly typical summary:

[F]ederal spending will rise from 22 percent of GDP in 2012 to 26 percent in 2038 … The deficit [currently 3.9 percent of GDP] would be 6.5 percent of GDP in 2038, greater than any year between 1947 and 2008 … Even though tax receipts would grow …, the revenue increase wouldn’t be “large enough to keep federal debt” from “growing faster than the economy starting in the next several years,” according to the CBO report.

Here’s another way of presenting those CBO numbers. Spending on actual government programs is projected to fall from its current 19.5 percent of GDP to 18.8 percent in 2023, before rising to 21.3 percent in 2038. And revenues are also projected to rise, from 17 percent to 19.7 percent of GDP by 2038. The result, according to the CBO, is that the primary budget balance (that is, excluding interest payments) shrinks from its current level of -2.5 percent of GDP to -0.3 percent in 2023, and then grows to -1.6 percent of GDP by 2038.

In other words, a quarter-century from now, the primary deficit — the gap between tax revenues and the spending under Congress’s control — will be smaller than it is today, according to the CBO’s numbers. Here’s the relevant Table:

2013 CBO Long Term Budget_Table 1-2

Nonetheless, the CBO’s extended baseline tells us that debt will rise from its current 73 percent of GDP to 100 percent of GDP by 2038. The key here is the interest payments — CBO’s prediction of rising interest rates over the long term (and the near term, for that matter).

This is the sentence from the CBO report that tells you all you need to know about those predictions: “under the extended baseline, interest rates would exceed the growth rate of the economy” (p. 26). To see why that’s significant, look at this equation from Willem Buiter (or skip over it and wait for the explanation):

Buiter Debt Equation

What this means, as James Galbraith explained in this policy note, is that if the rate of interest on government debt (r) is above the rate of economic growth (g), then any primary budget deficit will lead to an “unsustainable” path for the debt over the long term — in the narrow sense that the debt-to-GDP ratio will rise without limit.

By contrast, if r is below g, then even what would normally be considered a “large” budget deficit (Galbraith uses the example of a continuous primary deficit of 5 percent of GDP — well above what CBO is projecting over the next few decades) will be “sustainable” over the long term, in the sense that debt will eventually stabilize as a percentage of GDP.

For most of the postwar history of the United States, with the exception of the 1980s and part of the ’90s, the rate of interest on government debt has tended to be below the rate of economic growth. Underlying the CBO’s projection of an ever-rising debt ratio is its assumption that over the next few decades, that will no longer be the case; that for some reason, the exception of the 1980s will become the rule.

DeLong_Historical Growth Rate greater than Interest Rate

(chart from Brad DeLong)


Work and Income as Economic Rights

Michael Stephens | September 10, 2013

In this video, Pavlina Tcherneva and Philip Harvey look at the job guarantee and basic income grant proposals in the context of a discussion of economic rights.

Tcherneva begins with the theory behind the job guarantee — a federally-funded (and in Tcherneva’s version, locally-administered) program that would offer a paid job to anyone willing and able to work — and then (16:10) turns to a real-world example that, while not quite a job guarantee, was in the family of direct job creation programs: Argentina’s Plan Jefes. (Tcherneva has a related working paper that analyzes the socially transformative potential of direct job creation, over and above its macroeconomic stabilization benefits, in the context of the alteration of Plan Jefes into a pure cash transfer program, Plan Familias.)

Philip Harvey (31:45) looks at the legal bases of the rights to work and income (beginning with US statutes) before moving on to a comparison of basic income guarantees with job guarantees:

This talk was delivered as part of Columbia’s “Modern Money” series; you can find links to background reading for this seminar here.


Modern Money Network

Michael Stephens | August 29, 2013

The Modern Money Network at Columbia University — heir to the “Modern Money and Public Purpose” seminar series — is starting up in September, with a pair of events that might be interesting to some of our readers:

1. Money as a Hierarchical System

Date: Thursday, September 12th, 6.15pm
Location: Room 104, Jerome Greene Hall, Columbia Law School

Moderator: Raúl Carrillo, J.D. Candidate (’15), Columbia Law School
Speaker 1: Christine Desan, Leo Gottlieb Professor of Law, Harvard Law School
Speaker 2: L. Randall Wray, Professor of Economics, University of Missouri-Kansas City
Speaker 3: Katharina Pistor, Michael I. Sovern Professor of Law, Columbia Law School & Director, Center on Global Legal Transformation
Speaker 4: Perry Mehrling, Professor of Economics, Barnard College & Director of Education Programs, Institute for New Economic Thinking

2. Central Banking in Theory and Practice

Date: Monday, September 23th, 6.15pm
Location: Room 103, Jerome Greene Hall, Columbia Law School

Moderator: Richard Clarida, C. Lowell Harriss Professor of Economics and International Affairs, Columbia University
Speaker 1: Lord Adair Turner, Senior Fellow, Institute for New Economic Thinking and former Director, U.K. Financial Services Authority
Speaker 2: James K. Galbraith, Lloyd M. Bentsen Jr. Chair in Government/Business Relations and Professor of Government, University of Texas at Austin
Speaker 3: Matias Vernengo, Associate Professor, Bucknell University & Senior Research Manager, Central Bank of Argentina

Livestreaming of these events will be hosted at the MMN website (seminar 1; seminar 2) — the site also links to background reading for each seminar.


Deficit Lovers?

L. Randall Wray | July 5, 2013

Here’s a piece from yesterday’s NYTimes by Annie Lowrey: “Warren Mosler, a Deficit Lover With a Following.”

In the piece, Lowrey quotes blogger Mark Thoma as follows:

“They [followers of MMT] deny the fact that the government use of real resources can drive the real interest rate up,” said Mark Thoma, an economics professor and widely followed blogger who teaches at the University of Oregon. After delving into the technical details of modern monetary theory for a few minutes, he paused, then added, “I think it’s just nuts.”

Thoma might have been misquoted, but the “real interest rate” is a compound term, comprised of the nominal interest rate and the rate of inflation. Technically, the real rate is the nominal rate less expected inflation. As we know, the Fed sets the overnight nominal rate. The real rate is then the Fed’s target rate less expected inflation.

Now, it is possible that “government use of real resources” might raise expectations of inflation. That is what gold buggism is all about. So let us say Ron Paul whips up inflationary expectations. What happens to the real rate? Well, we are subtracting a bigger expected inflation number from the Fed’s target rate. So the real rate goes down! Now, Thoma might think the Fed will also react to Ron Paul’s gold buggism and so increase its target rate. How much? Who knows. Is there any guarantee the Fed will raise it more than Ron Paul raises inflation expectations? I see no reason why one would jump to that conclusion. And historically, the ex post real rate does often fall when inflation rises (it even goes massively negative).

That is not proof that it is impossible for the real rate to rise when government uses real resources, but there’s no reason to think the real rate automatically goes up. It depends. On whether inflation expectations increase by less than the Fed raises the nominal rate target.

Finally, Warren and “Deficit Owls” are by no means “deficit lovers” – so Lowrey’s title is misleading. There’s a time for deficits, a time for balanced budgets, and even a time for budget surpluses. It all depends on the other two sectors (reminder: Government Balance + Private Domestic Balance + Foreign Balance = 0). A more accurate title would have been: Warren Mosler: Not Afraid of Deficits.