Archive for the ‘Modern Monetary Theory’ Category

Options for an Independent Scotland

Michael Stephens | September 18, 2014

People in Scotland are heading to the polls today to decide the question of secession. One of the major policy questions for an independent Scotland is whether the country should attempt to keep the pound. As many have now begun to appreciate — with a little help from the eurozone spectacle — this would likely be a big mistake.

In “Euroland’s Original Sin,” Dimitri Papadimitriou and L. Randall Wray explained why a separation between fiscal and monetary sovereignty — when countries do not issue their own currency yet retain responsibility for fiscal policy — is the root of the problem in the eurozone. Any country with this setup will face budgetary constraints to which currency-issuing nations are not subject; the kind of constraints that can generate a sovereign debt crisis if, for instance, the country’s fiscal authority is forced to handle the fallout from a large banking crisis. This is a drum that many people affiliated with the Levy Institute have been banging for some time (well before the eurozone fell into its current mess).

Recently, both Paul Krugman and Martin Wolf  have written columns in which they make similar arguments in the context of Scottish independence (and the SNP’s ostensible plan to retain the pound). Philip Pilkington wrote a policy brief a few months ago in which he also argued, with the aid of an analysis of Scotland’s financial balances, that retaining the pound would leave the country open to a eurozone-periphery-style crisis. Pilkington’s story focuses on Scotland’s reliance on oil and gas revenues and the particular instability that could be generated, for a currency-using (vs. issuing) Scotland, by oil price fluctuations.

Although Pilkington suggests it might make sense to retain the pound in the short run (during which time he advocates the use of “tax-backed bonds” to limit instability, a proposal Pilkington originally developed with Warren Mosler [see here and here] for the eurozone), he argues that Scotland ultimately needs to move toward issuing its own freely-floating currency. The question is how to move from the first to the second phase with a minimum of disruption. The policy brief thus lays out a “dual currency” transition plan for Scotland: continue reading…

Comments


Can Fiscal Policy Stabilize the Economy?

Greg Hannsgen | September 10, 2014

 
[WolframCDF source=”http://multiplier-effect.org/files/2014/09/alternative-fiscal-policies.cdf” width=”397″ height=”448″ altimage=”http://multiplier-effect.org/files/2014/09/alternative-fiscal-policies.png” altimagewidth=”397″ altimageheight=”448″]
Here is a new Wolfram CDF, which I have constructed based on a macro model. The assumptions behind the model–other than the exact parameter values–are loosely stated in this list:

1) industries dominated by a handful of firms, rather than perfect competition
2) production technology that requires capital and labor inputs
3) chronic underemployment and less-than-full capacity utilization (percent of capital stock in use at a given time)
4) sovereign money and a policy-determined interest rate
5) two groups of households, only one of which has money to save
6) net investment a function of the profit and capacity utilization rates
7) budget deficits offset by the issuance of treasury bills and sovereign money
8) a government that employs workers to produce free public services
9) a fiscal policy rule with (a) a balanced budget target (labeled “0” in the CDF above) or (b) public production and capacity utilization targets (labeled “1” in the CDF above)
10) nonlinear functions that result in endogenous cycles in this figure for some parameter values and policy functions (try different parameter values with policy rule “1” for example)
11) gradual adjustment of public and private-sector output toward levels indicated by one of the two fiscal policy rules and output demand, respectively.

The arrows in the CDF show directions of movement in 2D space, where the two axes represent public production (horizontal) and capacity utilization (vertical). We got a different look at the same model in this previous post. In this new CDF, I have tried to improve on the realism of the parameter values. Here is a link to the download site at Wolfram for the needed CDFPlayer software.

The most serious omissions in the model above, by the way, are a foreign sector, a mechanism by which the broad price level can change over time, and commercial bank deposits and loans. As mentioned before, I am working on adding these and other new features to a larger version of the model depicted above for the upcoming International Post Keynesian Conference in Kansas City later this month. Any macroeconomic model, of course, is only an abstract and simplified version of a real economy. But the bottom line is that (1) guiding fiscal policy with a balanced-budget target leads to instability in all cases, while (2) the output-stabilizing fiscal rule generates a business cycle of varying size or convergence to a point.

Comments


A Fiscal Policy Rule Without Austerity

Greg Hannsgen | August 18, 2014

What will happen about fiscal policy after the tumultuous events beginning in 2010 or so in Europe and the end of Great-recession-era fiscal stimulus in the US? In the US, Paul Krugman and other economists debate the meaning of the CBO’s recent fiscal report, which, as Krugman points out, clearly show a drastic fall in the US deficit—to less than 3 percent of GDP at last check.

This brings us to the main subject of our post: an interesting article that seems to be out in the July issue of the Cambridge Journal of Economics (abstract—rather technical). I happened to run across this new study last week. It may be one of those cases in which an academic article has some implications for macro policy. The authors consider an inflation-targeting fiscal rule: they explore the outcome when government spending is always adjusted upward or downward, depending upon the actual inflation rate, according to an algorithm of sorts set in advance.

Before I go on, I should note the disclaimer that a paper of my own featuring fiscal targets also appeared last month in Metroeconomica, an international journal whose chief editors are based in Austria and Italy. I argue in the paper against deficit targets that restrict spending levels without regard to the strength of the economy. This notion that fiscal policy should aim for budget balance rather than good economic performance is the “Treasury view” lambasted, by the way, in another article in the same journal, penned by Suzanne Konzelman. I will try to outline the article on fiscal targets in terms of what I found in the process of working on my own paper. The post also includes an interactive model of how the rule in my own paper would work in a simplified version of the economy.

I am happy to see various parallels and hope the new piece is indicative of widespread interest in output-stabilizing policy rules, or at least non-austerity rules, and in stock-flow-consistent macro models, including the Levy Institute macro model. The differences between the policy rules and other assumptions in the two papers are numerous. Most importantly perhaps, Matthew Greenwood-Nimmo, the author of the new CJE article, considers a different type of rule. An inflation-targeting rule is the main fiscal policy rule considered in the paper. Inflation-targeting is certainly run-of-the-mill for monetary policy around the world, but as this IMF country-by-country list of fiscal rules now in force indicates, most actual rules simply specify low deficits or low ratios of the budget deficit to GDP.

The new CJE article notes, commenting on a fiscal policy rule from our former Distinguished Scholar Wynne Godley’s work with Canadian Marc Lavoie, that “it seems unlikely that the form of fiscal intervention advocated by Godley and Lavoie…could be fine-tuned to the degree required to achieve a point target in practice, as activating and deactivating public works projects, for example, is likely to generate a somewhat lumpy path of government spending [i.e., one that moved in big steps rather than smoothly]. For this reason, the use of a band target [a range, rather than a specific number] for fiscal policy seems more appropriate.”*

Specifically, Godley and Lavoie’s rule–published years ago in the Journal of Post Keynesian Economics and reprinted in 2012 and in a collection of papers by Godley —called for a level of government spending that would immediately fill the gap between actual and potential output—and hopefully keep unemployment low. In contrast, Greenwood-Nimmo adopts a rule with spending changes in specific amounts that go into force abruptly once inflation exceeds or drops below certain upper and lower bounds or thresholds.

continue reading…

Comments


A New Book on Money to Please Fans of Minsky and MMT

Greg Hannsgen | August 12, 2014

Opinions heard on the subject of money and the economy often seem uninformed or absurd. For a great book about money and monetary theory, I would strongly recommend Money: The Unauthorized Biography by Felix Martin, a 2014 book from Alfred A. Knopf. This book might just please students of history and finance and others who might already be familiar with one theory or another about the origins of money and ways of managing a monetary system. These and other readers might benefit from a readable account of these theories up to the current time and what they might have to say about the recent financial crisis and its roots in theory and practice.

Martin is critical of mainstream finance as well as orthodox macroeconomics, and friendly to points of view related to Hyman Minsky’s financial fragility hypothesis and other truly monetary forms of economics. The latter were introduced to the civilized world by John Maynard Keynes, Bagehot, Wynne Godley, James Tobin, our own Randy Wray, and others sometimes mentioned in this blog. But as the new book shows, their intellectual roots in monetary thought go deeper into the centuries. Martin’s accounts seems fair all around. I think it will be one of those books that offers almost everyone who reads it something surprising and of interest.  Nonetheless, the book is one of those many signs of widespread recognition that Keynes’s monetary production theory and related points of view offer a vantage point that the mainstream missed, helping to bring on the financial crisis. It is a fascinating and lucid read.

(By the way, the New York Times Book Review ran a favorable review earlier this year in an edition that covered many titles related to the theme of money–some not so good.)

As you may have guessed, I have been doing some reading of new books from a summer trip to my local bookstore and hope to get to more of them in posts in the near future.

Comments


Wray on Why Money Matters

Michael Stephens | July 21, 2014

Randall Wray did a guest post at FT Alphaville as part of a series devoted to the upcoming Mission-Oriented Finance conference.

In his post, Wray counters the conventional story about the nature and significance of money with an alternate view drawing on Schumpeter’s notion of bankers as the “ephors” of capitalism:

Bank and central bank money creation is limited by rules of thumb, underwriting standards, capital ratios and other imposed constraints. After abandoning the gold standard, there are no physical limits to money creation. We cannot run out of keystroke entries on bank balance sheets.

This recognition is fundamental to issues surrounding finance. It is also scary.

[…]

It is difficult to find examples of excessive money creation to finance productive uses. Rather, the main problem is that much or even most finance is created to fuel asset price bubbles. And that includes finance created both by our private banking ephors and our central banking ephors.

The biggest challenge facing us today is not the lack of finance, but rather how to push finance to promote both the private and the public interest — through the capital development of our country.

Read the post here.

Comments


To Consolidate or Not to Consolidate, That Is the Question (or maybe it isn’t)

L. Randall Wray | June 27, 2014

This is another short post on MMT, a sort of follow-up to my post from a couple of days ago. There was an interesting response to various comments on my piece, which was posted up on Mike Norman’s website.

We got the typical: “oh you MMTers always want to consolidate the Fed and Treasury, but really the Fed is a private institution that is not a part of government,” and “in reality the Treasury cannot spend unless the Fed will allow it to spend, otherwise it must get tax revenue before it can spend,” and hence “really, government spending is constrained by its revenue, just like a household or firm.”

In reality, what MMT has shown—from the very beginning of the creation of the approach—is that you can consolidate or deconsolidate and the balance sheets end up in exactly the same place. The MMT logic holds no matter how you do it: government creates a money of account, imposes a tax in that unit, spends currency denominated in the unit, and collects taxes paid in its own currency.

And, of course, the Fed is not a private institution but rather is a creature of Congress and no more independent of government than is the Treasury, the DOD, the DOT, or the IRS. The Fed is normally allowed to set the overnight interest rate target free from the everyday kind of politics—but all of these other branches of government also have some independence from party politics. Well, the IRS right now is being subjected to some of that.

Anyway, the response was by someone called Calgacus, who often makes quite interesting and thoughtful comments. I thought it would be worthwhile to repost the response here, along with a few comments of my own. The angle taken here on the “consolidation issue” is pretty novel. continue reading…

Comments


Tax Bads, Not Goods

L. Randall Wray | June 17, 2014

This is another installment in the series on the MMT view of taxes. I’m back from China, participating in the annual Hyman P. Minsky Summer Seminar at the Levy Economics Institute. Yesterday my colleague, Mat Forstater, gave a talk on the job guarantee and “green jobs.” Along the way he made two particularly insightful comments on MMT and taxes that I’ll use to introduce this installment.

First, he discussed the MMT view of “modern money”—that is to say, the money that has existed “for the past 4000 years,” at least, as Keynes put it in his Treatise on Money. The money of account is chosen by the sovereign and used to denominate debts, prices, and other nominal values. It is the Dollar in the US.

It is like the inch, the pound, the meter, the kilogram, the acre or the hectare—a unit of measure.

Mat put it this way: the sovereign can no more run out of “money” than it can run out of “acres” or “inches” or “pounds.” We can run out of land, but we cannot run out of acres. We can run out of trees but we cannot run out of the linear feet we use to measure them.

You cannot run out of a unit of measure!

The “dollar” is the measuring unit in which we keep our monetary records. We cannot run out.

Second, and more relevantly for our story today, Mat said that a guiding principle for choosing what to tax should be “tax bads, not goods.”

We’ve previously established that “taxes drive money.” We’ve also established that from the perspective of the sovereign that creates the money, the purpose of the monetary system is to move resources to the public sector.

Clearly we do not want to move all resources to the public sector; we want to leave some for the “private purpose.” Further, we want some “efficiency” (I’ll leave the definition of that vague for now) in this process, in the sense that while we want to move some resources to the public sector we do not want to discourage useful private sector activity.

It would be even better if this process of taxing to move resources to the public purpose actually encouraged more activity that was beneficial for pursuit of both public and private purposes.

So we need to think about what kind of tax can “drive” a currency, without diminishing private initiative.

For example: what if we taxed paid work at a rate of 15% in an effort to “drive the currency”? continue reading…

Comments


Creationism versus Redemptionism: How a Money-Issuer Really Lends and Spends

L. Randall Wray | June 10, 2014

MMT has emphasized that there is a close relation between sovereign power to issue a currency and its power to impose tax liabilities. For shorthand, we say “Taxes Drive Money.” I’ve dealt with that topic in the previous installments of this series on MMT’s view of taxes.

We’ve also demonstrated (as if it needed demonstration!) that sovereign governments do not “need” tax revenue in order to spend. As Beardsley Ruml put it, once we abandoned gold, federal taxes became “obsolete” for revenue purposes. I’ll have more to say about good old Beardsley in the next installment.

In today’s installment I want to step back a bit to ask a more fundamental question: does the issuer of a money-denominated liability need to obtain some of those liabilities before spending or lending them?

In this installment I will examine three analogous questions (each of which has the same answer):

1. Does the government need to receive tax revenue before it can spend?
2. Does the central bank need to receive reserve deposits before it can lend?
3. Do private banks need to receive demand deposits before they can lend?

If you’ve already answered “Of course not!”, you are probably up to speed on this topic. If you answered yes (to one or more), or if you haven’t a clue what the questions means, read on.

As we’ll see, these are reducible to the question: which comes first, Creation or Redemption? continue reading…

Comments


Taxes and the Public Purpose

L. Randall Wray | May 30, 2014

In previous installments we have established that “taxes drive money.” What we mean by that is that sovereign government chooses a money of account (Dollar in the USA), imposes obligations in that unit (taxes, fees, fines, tithes, tolls, or tribute), and issues the currency that can be used to “redeem” oneself in payments to the government. Currency is like the “Get Out of Jail Free” card in the game of Monopoly.

Taxes create a demand for “that which is necessary to pay taxes” (and other obligations to the state), which allows the government to purchase resources to pursue the public purpose by spending the currency.

Warren Mosler puts it this way: the purpose of the tax is to create unemployment. That might sound a bit strange, but if we define unemployment as a situation in which job seekers want to work for money wages, then government can hire them by offering its currency. The tax frees resources from private use so that government can employ them in public use.

To greatly simplify, money is a measuring unit, originally created by rulers to value the fees, fines, and taxes owed.

By putting the subjects or citizens into debt, real resources could be moved to serve the public purpose. Taxes drive money.

So, money was created to give government command over socially created resources.

As Warren puts it, taxes function first to create sellers of real goods and services, and have further consequences as well, including what falls under “social engineering,” which are political decisions—something we’ll discuss a bit more below.

This is why money is linked to sovereign power—the power to command resources. That power is rarely absolute. It is contested, with other sovereigns but often more important is the contest with domestic creditors. Too much debt to private creditors reduces sovereign power—it destroys the balance of power needed to govern. continue reading…

Comments


What Are Taxes For? The MMT Approach

L. Randall Wray | May 16, 2014

Previously we have argued that “taxes drive money” in the sense that imposition of a tax that is payable in the national government’s own currency will create demand for that currency. Sovereign government does not really need revenue in its own currency in order to spend.

This sounds shocking because we are so accustomed to thinking that “taxes pay for government spending.” This is true for local governments, provinces, and states that do not issue the currency. It is also not too far from the truth for nations that adopt a foreign currency or peg their own to gold or foreign currencies. When a nation pegs, it really does need the gold or foreign currency to which it promises to convert its currency on demand. Taxing removes its currency from circulation making it harder for anyone to present it for redemption in gold or foreign currency. Hence, a prudent practice would be to constrain spending to tax revenue.

But in the case of a government that issues its own sovereign currency without a promise to convert at a fixed value to gold or foreign currency (that is, the government “floats” its currency), we need to think about the role of taxes in an entirely different way. Taxes are not needed to “pay for” government spending. Further, the logic is reversed: government must spend (or lend) the currency into the economy before taxpayers can pay taxes in the form of the currency. Spend first, tax later is the logical sequence.

Some who hear this for the first time jump to the question: “Well, why not just eliminate taxes altogether?” There are several reasons. First—as we said last time–it is the tax that “drives” the currency. If we eliminated the tax, people probably would not immediately abandon use of the currency, but the main driver for its use would be gone.

Further, the second reason to have taxes is to reduce aggregate demand. If we look at the United States today, the federal government spending is somewhat over 20% of GDP, while tax revenue is somewhat less—say 17%. The net injection coming from the federal government is thus about 3% of GDP. If we eliminated taxes (and held all else constant) the net injection might rise toward 20% of GDP. That is a huge increase of aggregate demand, and could cause inflation.

Ideally, it is best if tax revenue moves countercyclically—increasing in expansion and falling in recession. That helps to make the government’s net contribution to the economy countercyclical, which helps to stabilize aggregate demand. continue reading…

Comments