Archive for the ‘Modern Monetary Theory’ Category

On the Intellectual Origins of Modern Money Theory

Michael Stephens | February 19, 2016

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MMT and the New New Deal

L. Randall Wray | November 20, 2015

Yesterday, Senator Bernie Sanders gave an important speech in which he invoked President Roosevelt’s “Second Bill of Rights” in defense of his platform. As Bernie rightly pointed out, all of Roosevelt’s New Deal social programs to which we have become accustomed were tagged as “socialism”—just as pundits are branding Bernie’s proposals as dangerous socialist ideas. You can see Bernie’s prepared remarks here.

Just before Bernie’s speech, I was asked to do an interview with Alex Jensen, on TBS eFM’s “This Morning” English radio program in Seoul, Korea. I was sent a list of questions and jotted down very brief responses. Unfortunately, in our radio interview we were only able to get through a few of these. You can listen to the interview here (“1119 Issue Today with Professor L.R. Wray”).

As you will see, in addition to the subject of MMT and its critics, we talked about the platform of Senator Sanders and why his proposals have caught the imagination of the US population.

Here are some of the questions and my brief (written) answers. continue reading…

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Endogenous Financial Fragility in Brazil: Does Brazil’s National Development Bank Reduce External Fragility?

Michael Stephens | September 22, 2015

by Felipe Rezende

Introduction

The creation of new sources of financing and funding are at the center of discussions to promote real capital development in Brazil. It has been suggested that access to capital markets and long-term investors are a possible solution to the dilemma faced by Brazil’s increasing financing requirements (such as infrastructure investment and mortgage lending needs) and the limited access to long-term funding in the country. Policy initiatives were implemented aimed at the development of long-term financing to lengthen the maturity of fixed income instruments (Rezende 2015a). Though average maturity has lengthened over the past 10 years and credit has soared, banks’ credit portfolios still concentrate on short maturities (with the exception of the state-owned banks including Caixa Economica Federal [CEF] and the Brazilian Development Bank [BNDES]).

While there was widespread agreement that public banks, and BNDES in particular, played an important stabilizing role to deal with the consequences of the 2007-2008 global financial crisis, there is, however, less agreement on BNDES’ current role (de Bolle). BNDES has been subject to a range of criticisms, such as crowding out private sector bank lending, and it is said to be hampering the development of the local capital market (Rezende 2015). It is commonly believed that “development banks and other institutions in Latin America tend to replace markets rather than address collective action failures that lead to market incompleteness.” (de Bolle 2015). In particular, critics of Brazil’s national development bank have argued that large companies can borrow from private international capital markets and the bank extends credit to companies that have access to domestic capital markets.

Much of the policy discussion has been misplaced. Though the conventional belief assumes that capital markets are efficient and produce an optimal allocation of capital, this view is not supported by evidence. Free and competitive international capital markets have repeatedly failed to produce an optimal allocation of capital and privatized free-market banking systems have failed to assess risks properly thus misallocating resources (Kregel 1998, Wray 2011). Moreover, access to international capital markets has been based on the false premise of lack of domestic savings. As I have argued elsewhere (Rezende 2015) rather than justifying the existence of public banks —and BNDES in particular, based on market failures (Garcia 2011) — an effective answer to this question requires a theory of financial instability. continue reading…

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Reactions to S&P Downgrade: S&P Analyst Confirms There Is No Solvency Issue

Michael Stephens | September 17, 2015

by Felipe Rezende

In previous posts (see here and here), I discussed Standard & Poor’s (S&P) downgrade of Brazil’s long-term foreign currency sovereign credit rating to junk status, that is, to ‘BB+’ from ‘BBB-‘, and its decision to downgrade Brazil’s local currency debt to a single notch above “junk” status.

S&P hosted a conference call on Monday morning to explain its downgrade of Brazil’s credit rating (you can view the video webcast replay here). During the conference call I had the opportunity to ask a couple of questions.  My first question, to S&P analyst Lisa Schineller, at around the 41:53 minute mark, was the following:

Question: “Are there solvency risks associated with Brazil’s local currency debt? Brazil issues its own currency.”

[Lisa Schineller]: “We would not say there are solvency risks, we rate, for both local currency and foreign currency, our ratings are continuum. Yes, we lowered both ratings, we are by no means thinking about a solvency issue here and risks there. There is less policy flexibility at hand, these ratings for the local currency BBB- is still in the investment grade category and the foreign currency is at the high end of the speculative grade category. I think this is an important point to highlight. There is this increase in the stress in the economy, in the policy execution, but it is very different than talking a solvency issue.”

That is, as the S&P analyst confirmed, there are no solvency risks. In its sovereign ratings methodology S&P looks at “sovereign government’s willingness and ability to service its debt on time and in full.” Standard & Poor’s sovereign rating is:

A current opinion of the creditworthiness of a sovereign government, where creditworthiness encompasses likelihood of default and credit stability (and in some cases recovery). (Lisa Schineller)

As I explained in my previous posts (see here and here), there is no credit risk in obligations denominated in the domestic currency, that is, the risk of payments not being made on government debt denominated in Reais is zero. Why? Because Brazil’s local currency debt outstanding promise to pay Reais and the federal government is the monopoly issuer of currency (Rezende 2009).

My second question to Lisa Schineller, at around the 52:05 minute mark, was the following:

Question: What is the sovereign’s ability and willingness to its service financial obligations to nonofficial (commercial) creditors for a country that has more assets denominated in foreign currency than debt? The government can pay all of its obligations in foreign currency. continue reading…

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Credit Rating Agencies and Brazil: Why the S&P’s Rating of Brazil’s Sovereign Debt Is Nonsense

Michael Stephens | September 13, 2015

by Felipe Rezende

So S&P has downgraded Brazil’s rating on long-term foreign currency debt to junk and lowered its long-term local currency sovereign credit rating to ‘BBB-‘ from ‘BBB+’.

First, what are sovereign debt ratings? Standard & Poor’s sovereign rating is defined as follows:

A current opinion of the creditworthiness of a sovereign government, where creditworthiness encompasses likelihood of default and credit stability (and in some cases recovery).

So the ratings are related to “a sovereign’s ability and willingness to service financial obligations to nonofficial (commercial) creditors.”

What does this tell us? To begin with, credit rating agencies have repeatedly been wrong. The same agencies that rated Enron investment grade just weeks before it went bust, the same people that assigned triple-A rating to toxic subprime mortgage-backed securities are now downgrading Brazil’s sovereign debt. As the FCIC report pointed out, “The three credit rating agencies were key enablers of the financial meltdown. The mortgage-related securities at the heart of the crisis could not have been marketed and sold without their seal of approval.” (FCIC 2011)

After all, should you take the credit rating agencies seriously? The answer is no. Brazil is a net external creditor, that is, though the federal government has debt denominated in foreign currency, it holds more foreign currency assets (figure 1) than it owes in foreign currency debt (figure 2). Brazil’s public sector can pay all of its long-term financial obligations denominated in foreign currency. Moreover, Brazil’s federal government can never become insolvent on obligations denominated in its own currency (note that since 1999 Brazil maintains a floating exchange rate regime, which increases domestic policy space). continue reading…

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Second Edition of the Modern Money Primer

Michael Stephens | September 7, 2015

The second edition of L. Randall Wray’s Modern Money Theory: A Primer on Macroeconomics for Sovereign Monetary Systems, an updated and expanded version with new chapters on tax policy and inflation, is now available for order and will be released September 23rd:

Modern Money Theory Primer_2nd edition

“This book synthesizes the key principles of Modern Money Theory, exploring macro accounting, monetary and fiscal policy, currency regimes and exchange rates in developed and developing nations. Randall Wray addresses the pressing issue of how misunderstandings about the nature of money have caused the current global financial meltdown, and provides fresh ideas about how policymakers around the world should address the continued weaknesses in their economies.”

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S&P Threatens to Downgrade Brazil to Junk

Michael Stephens | July 30, 2015

by Felipe Rezende

S&P has issued a negative outlook regarding Brazilian sovereign debt. The S&P’s announcement stated that

Over the coming year, failure to advance with (on- and off-budget) fiscal and other policy adjustments could result in a greater-than-expected erosion of Brazil’s financial profile and further erosion of confidence and growth prospects, which could lead to a downgrade. The ratings could stabilize if Brazil’s political certainties and conditions for consistent policy execution–across branches of government to staunch fiscal deterioration–improved. It is our view that these improvements would support a quicker turnaround and could help Brazil exit from the current recession, facilitating improved fiscal out-turn and provide more room to maneuver in the face of economic shocks consistent with a low-investment-grade rating.

This warning has been echoed by other credit rating agencies threatening to downgrade Brazilian sovereign debt to junk. But, should anyone trust credit rating agencies? Once more, credit rating agencies are clueless in their assessments. They have specialized in making the wrong assessments regarding sovereign governments’ capacity to pay local-currency debts. They have downgraded sovereign governments like the US, UK, Japan, and now Brazil. Paradoxically, credit rating agencies, which have a track record ranging from arbitrary and imprecise to clueless (here, here, here, here), can still dictate the outcomes of the fiscal policies of sovereign governments.

Recent downgrade warnings by CRAs and market pundits have triggered discussions inside the Brazilian government to implement austerity measures, including welfare programmes and public investment initiatives.

President Dilma Rousseff won’t change course. She has reiterated that “[It] will last as long as necessary to rebalance our economy.” She has invoked the government-as-household analogy, stating that: “You who are a housewife or the father of a family know what this is … Sometimes we have to rein in expenses to keep our budget from going out of control … to ensure our future.” Rousseff is under pressure to impose a fiscal austerity agenda to avoid a downgrade by credit agencies.

The current direction of Rousseff’s policies has exposed its contradictory tendencies in combining austerity policies while trying to maintain or reclaim the pre-crisis progress. This combination leads to incoherent policy formulations and more drift, rather than embracing a demand-led strategy. continue reading…

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Deflation Über Alles

Michael Stephens | July 15, 2015

The “negotiations” that surrounded the latest Greek deal do not reflect well on the system (such as it is) of EMU governance. And there are no silver linings to be found in the outcome of this process. It is a testament to how far we are from “normal” that even the best-case scenario would have left little room for optimism. Even if Greece had received a sensible package — one involving debt restructuring and a pause in austerity — this would still have meant an intolerably long period of high unemployment. (“Even if the Greek economy were to miraculously bounce back to its precrisis growth rate, it would take almost a decade and a half to return to precrisis employment levels.” p. 3 [pdf])

Moreover, the particulars of the Greek situation aside, it is important to recall how far we are from a resolution of the broader eurozone crisis, which will arguably not end until the fundamentally flawed euro setup — of which the Greek crisis is a symptom — is addressed. In this vein, Pavlina Tcherneva recently spoke to Richard Aldous of The American Interest about the latest Greek deal and the “stateless currency” that is the euro (listen to the podcast here).

Tcherneva also touched on an aspect of this broader theme in her recent RT interview. In the clip below she links the “deflationary environment” in the eurozone to the absence of a central fiscal authority:

 

 

(See here for a proposal for Greece that aims to [temporarily] relieve the constraints rooted in the divorce of fiscal policy from monetary sovereignty: by funding a direct job creation program through the creation of a parallel currency.)

National animosities and idiosyncratic personalities aside, the blame for the underlying crisis ultimately falls on the very structure of the EMU. This is why it was possible for figures like Wynne Godley to have seen this coming decades ago.

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Fed Fiscal Policy, Treasury Monetary Policy

Michael Stephens | June 4, 2015

Don’t miss this post by Scott Fullwiler at New Economic Perspectives.

Fullwiler is reacting to Clive Crook’s Bloomberg column advocating “helicopter drops” (having the Fed simply send checks to households). Helicopter drops or “helicopter money” proposals are widely cast as monetary policy operations (Crook describes helicopter money as a monetary-fiscal “hybrid”) and defended as either preferable to fiscal stimulus or as the only remaining option in light of political obstacles to increasing government spending (to wit, the GOP Congress/Dem White House combination).

For Fullwiler, this way of framing helicopter money is problematic — and relies on a skewed understanding of our policy options:

I find it completely counterproductive to have a theory of macroeconomics in which we define fiscal policy and monetary policy based on who is acting. If the US Congress and Treasury choose to send $1 trillion to households without raising taxes, it’s called fiscal policy. But if the Fed does the exact same thing, it’s apparently called monetary policy. I think this only confuses our understanding of the macroeconomic policy mix and makes it more difficult to have an economics profession that can give good policy advice.

[…]

It seems much clearer to simply say that (a) the act of creating a deficit—raising the net financial wealth of the non-government sector—is fiscal policy, and (b) the act of announcing and then supporting an interest rate target with security sales (or purchases, or interest on reserves)—which has no effect on the net financial wealth of the non-government sector—is monetary policy. In the case of (a), whether the Treasury or the Fed cuts the checks, it’s fiscal policy, and with (b), whether the Treasury or the Fed sells securities, it’s monetary policy.

In other words, fiscal policy is about managing the net financial assets of the non-government sector relative to the state of the economy, and monetary policy is about managing interest rates (and through it, to the best of its abilities, bank lending and deposit creation) relative to the state of the economy. This is in fact how Randy Wray explained both in his 1998 book; it’s also how Warren Mosler explained them in his 1996 paper. That is, from the beginning, MMT has labeled monetary and fiscal policies by their functions, not by who was doing what.

I think this is a much more useful taxonomy because it makes clear from the start that (1) the currency-issuing government isn’t constrained while (2) the interest rate on the national debt is a policy variable. All kinds of human suffering the past 6+ years may have been avoided if those two basic points were widely understood.

Read it.

Fullwiler spoke at the last Minsky conference on issues related to central bank operations (actual, vs. textbook): you can hear his remarks here; slides here.

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A Cycle of Financial Fragility?

Greg Hannsgen | June 3, 2015

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(click image above to enlarge)

Can a bull market founded largely on credit survive? A forthcoming Levy Institute working paper I wrote with Tai Young-Taft of Bard College at Simon’s Rock (link for those interested) represents an attempt to deal with the role of financial instability—along with other sources of economic fluctuations—in the dynamics of the economy. Here, I’ll focus mostly on the role of margin loans that are used by many investors and traders to leverage positions in stock. The model developed in the paper includes a role for several policy tools that might be used in attempts to stabilize the economy: a fiscal-policy rule with public production and unemployment rate targets, along with public-sector R&D, financial supervision and regulation, and a target for the inflation-adjusted interest rate on government debt.

Now, for the current situation. The figure above highlights one potential threat to stability designed to arise spontaneously in runs of the model: surges in the use of margin debt to finance investments in stock. The chart shows that the amount of such debt outstanding in the US relative to GDP rose sharply during the tech bubble and the period leading up to the financial crisis and recession of 2007–09, achieving a new peak each time. Subsequent financial market collapses led to cyclical declines in the use of this form of leverage. On average, for the first quarter of 2015, this ratio stood at more than .028, suggesting that the stock market’s vigor again rests to a great extent on heavy borrowing (see figure). (Moreover, some different but closely related uses of credit, such as bond issues that wind up financing stock buybacks, have also contributed to the post-recession bull market.) This column from the New York Times’s Floyd Norris from a couple of years back discussed evidence that margin-credit cycles helped fuel cyclical movements in stock prices and the economy. His column displayed a longer but now outdated margin loan series.

In the model, margin loans can generate positive feedback effects: a cycle of increasing margin loan balances and rising stock prices, or vice-versa.  The story is similar to that of the “levered losses” in housing that took place in a number of countries earlier in this decade (see the recent book House of Debt for one account of the story, although even in this version of the story, I am inclined to see excessive optimism about the usual cure by wage and price adjustments); indeed, big, unsustainable run-ups in asset prices tend to be driven at least in part by credit booms. The situation shown in the figure is only one of many somewhat worrisome signs of market fragility. At the moment, fragility generally seems to be manifested most clearly in big increases in the quantities of various assets and liabilities relative to flow variables such as income and GDP, rather than in yield data.

More on the new paper and the model in it, for those inclined to look into it: continue reading…

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