Archive for the ‘Modern Monetary Theory’ Category

Replacing the Budget Constraint with an Inflation Constraint

Michael Stephens | January 13, 2015

by Scott Fullwiler

Tim Worstall has a post decrying the dangers of MMT ever being used in the real world—even as he recognizes or at least suggests that it might be the correct description of how the monetary system works—and is particularly concerned about Stephanie Kelton’s new appointment as Chief Economist on the Senate Budget Committee. (Note: Randy Wray also posted a critique of Mr. Worstall’s post.)

Mr. Worstall’s main issue is one we’ve heard hundreds of times before—because MMT explains that currency-issuing governments operating under flexible exchange rates and without debt in a foreign currency do not actually have budget constraints, this opens the door to all sorts of problems if put into practice. We can’t trust our government with this information, in other words—it must be required to match spending with revenues over some period (whether each year, over the business cycle, etc.) or at least plan over some period of time to not allow the debt ratio to rise beyond a modest level.**

Mr. Worstall notes the frequently heard MMT argument that the point of taxes is to regulate the economy—and takes particular issue with the view that taxes can be increased/decreased in real time. Note, though, that this is simply a metaphorical or simplified explanation—it blends the Chartalist argument that “taxes drive money” with the functional finance view of using the outcomes of the government budget position as the criterion by which to judge it (rather than the state of the budget position itself). It is not intended as a literal point—no MMTer has ever made a specific proposal for raising/lowering income tax rates in real time to manage the economy. (Though Ray Fair does offer a sales tax proposal and shows that it would be stabilizing here—I simulated it along with the Job Guarantee and another transfer payment rule here.)

As argued bazillions of times, the real point MMT is making is that the government’s budget constraint is the wrong constraint—the correct constraint is whether or not a particular budget position will raise inflation beyond an official target rate (say, 2%, which seems to be the choice of most central bankers).

Let me explain to Mr. Worstall and others how this could work rather easily—just as the CBO and OMB now evaluate government budget proposals regarding their effects on the budget stance, the CBO and OMB could instead shift focus on evaluating these proposals against the inflation target (I argued the same thing here, printable version here). Much like how policy makers supposedly take estimates of effects on the budget position rather seriously in making budget conditions, they could replace these with projections of inflationary effects. An inflation constraint provides more fiscal space than a budget constraint, but in no way does it provide unlimited fiscal space (again, as we’ve always argued).

We could add quite a bit of detail here if we want, but I’ll just say a few more things. First, it’s quite clear that economists don’t have much expertise modeling how to use the government’s budget stance to manage the macroeconomy via a functional finance rule—but this is largely because they have come to view monetary policy as the main macroeconomic policy tool, not because it’s not possible.

Note, though, that functional finance isn’t less specific than, say, the Taylor Rule—Taylor’s Rule says to adjust the interest rate to manage the macroeconomy; functional finance says to manage the budget position to do this. Consider the never ending debate among policy makers at the Fed, Fed watchers, and economists on what the Fed should do next, when it should do it, how it should communicate what it’s going to do, and so on. If Taylor’s Rule were really that useful, we wouldn’t need most of this debate and there wouldn’t be so much disagreement among the various parties.

Second, concerns that government policymaking is necessarily less “efficient” than monetary policy are unpersuasive to me (even aside from my view that monetary policy traditionally understood as manipulations of the overnight rate isn’t a good idea). What if some of the thousands of economists currently working on understanding monetary policy started to try and understand how to build automatic stabilizers? They might help us understand which taxes (or tweaks to them, like indexing marginal tax rates to the inflation target rather than inflation) or spending priorities (or tweaks, like indexing spending to the target rate) are most consistent with functional finance—we don’t need to adjust tax rates in real time as much as build in a significant amount of stabilization automatically (i.e., more than we already have). MMT has its own proposal—the Job Guarantee—which we have argued in dozens if not hundreds of publications possesses macroeconomically significant stabilization properties if well designed.

For sure, times like the last several years may call for more than just automatic stabilizers (or it may instead call for better financial regulation to avoid a speculative bubble and then a deep recession in the first place). However, while I am under no illusions that we could ever get totally rid of some of the messy politics of fiscally-driven stabilization, it’s not as if monetary policy even when set by a small group of “experts” (like the FOMC) has been apolitical (and, as noted above, it’s been highly contentious among even the true believers in monetary policy which strategy is/was the appropriate one).

In sum, let’s stop pretending that replacing a budget constraint with an inflation constraint is so hard. It involves a change in perspective, nothing more and nothing less. It doesn’t give license to policy makers to do whatever they want. It does mean CBO will finally be doing something useful with its deficit projections—namely, building models to understand how deficits will affect the macroeconomy (while its current practice is to assume an economy at full employment and warn of impending financial ruin as a result of deficits). Stephanie’s appointment gives reason to hope at least a little that this change might actually one day be possible, for the benefit of all of us (including Mr. Worstall).

**The latter is actually what neoclassical economics argues—contrary to popular understanding, there are no economic theories that require the government to ever balance its budget. What they argue is that the government must eventually keep its debt ratio at a modest level, which does allow modest deficits on average forever. What this does require is primary surpluses (i.e., budget position before accounting for debt service) to offset primary deficits if the interest on the national debt is above the economy’s growth rate. In fact, though, this condition hasn’t been met on average in the post WWII period; only the 1979-2000 period saw average interest on the national debt rise above the economy’s growth rate.

(cross-posted from New Economic Perspectives)

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Oh Me Oh My! MMT Is About!

L. Randall Wray | January 12, 2015

Here’s an unintentionally hilarious piece by Tim Worstall at Forbes. Watch out, he warns, MMT has come to Washington! Our nation’s capital! No doubt ruin and wastage will follow.

Why? Well. Nothing wrong with the theory of Modern Money Theory, he admits.

“It’s not actually that I disagree very much with the economics that is being laid out in MMT: indeed, I’m terribly tempted to agree that they’re actually correct in much of what they say.”

He admits that MMT is right on budgets:

“It’s most certainly not obvious that MMT proponents are all barking mad or anything. Jamie Galbraith (who I’ve had one or two very limited interactions with) is certainly a reasonable guy. And his insistence that a budget surplus, despite the ribbing he gets about it, is in fact economically contractionary doesn’t seem to have anything wrong with it. Budget deficits are fiscally expansive, a surplus is fiscally contractionary, if there’s any one statement at the heart of Keynesianism that’s it.”

And it is right on money:

“And their basic outline about money creation is true as far as I can see. If you’re a country with your own central bank you can print as much money as you like.”

And really nothing wrong with the policy, either. No, it is all politics.

What he’s afraid of is that if politicians understood that they cannot run out of money, they’d spend like they cannot run out of money. And off we’d go to Weimar and Zimbabwe land.

It is the same line that Paul Samuelson took, when he argued that the job of an economist is to lie. Or, better, to preach the old time religion and superstition. Put real fear into the politicians and the voters they represent.

Government is just like a household, you know. Careful, Gov, you’ll run out of money. You’ll have to go hat-in-hand to Bond Vigilantes when you run out. Uncle Sam will have to go to the Salvation Army for a cup of soup.

It is the same old fear mongering by someone who does not trust the democratic process and does not understand budgeting.

The way we ensure that policymakers don’t run up the spending to create hyperinflation is by subjecting them to the budgeting process, and then holding the administrative branch to approved budgets. It isn’t religion, superstition, or fear mongering that forestalls accelerating inflation. It is accountability.

And where-O-where do our blogging pundits get the idea that all politicians always and everywhere are pushing for hyperinflation? I see exactly the opposite.

(cross-posted from EconoMonitor)

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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…

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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.

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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…

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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.

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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.

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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…

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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…

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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…

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