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.

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.

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…

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…

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…

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…

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…

(Here is a presentation I gave at the University of Denver at the annual J. Fagg Foster honors ceremony. Most of you will not know of Foster, but you should. While he did not publish much, he was the professor of a number of prominent institutionalists who attended DU in the early postwar period. I was lucky to have studied with his student, Marc Tool, and was introduced to Foster’s work at the very beginning of my studies of economics. My presentation below is based on two of Foster’s articles: J. Fagg Foster (1981) “Understandings and Misunderstandings of Keynesian Economics,” JEI, vol XV, No 4, p. 949-957.; and (1981) “The Reality of the Present and the Challenge of the Future”, JEI vol XV, No 4, p. 963-968. Both are from 1966, republished in a special issue of the Journal of Economic Issues, 1981. You should read them.)

Is this the age of Keynes? That’s the question raised by Fagg Foster in 1966.

In the 1960s the answer seemed obvious. Keynes dominated economics—or, at least, macroeconomics—and Keynesianism dominated policy. And it worked! Or, so most thought.

Foster wasn’t sure. While he agreed that “[t]here probably has been no instance in history in which a pattern of ideas has had so much effect on the everyday life of everyone in so short a time,” he thought most of Keynes’s followers misunderstood his theory.

Further, Foster wasn’t convinced the theory provided a firm basis for policy.

Finally, he lamented that “among all post-Keynesian economists, the institutionalists seem to have been least affected by Keynes’s theory…. The institutionalists have not even contemplated the possibility of any generic relationships between the Keynesian theory and their own.”

A decade later, so-called Keynesian economics was in disarray, a casualty of the apparent failure of policy to fine-tune the economy. Stagflation at the end of the 1970s delivered the final blow, and fueled the rise of increasingly preposterous approaches such as Rational Expectations, Real Business Cycle theory, the Efficient Markets Hypothesis and hence on to DSGE with a single representative agent standing in for the whole economy.

In truth, even in the heyday of Keynesianism, policy was directed to stimulate the sentiments of business undertakers—precisely what Keynes recommended against—with supply-side tax cuts and a cornucopia of subsidies to the captains of industry.

While a parallel approach developed calling itself New Keynesian, the only thing new was the adoption of the craziest “new” orthodox ideas (witness rational expectations). And the only thing “Keynesian” was the presumption that sticky wages and prices prevent instantaneous market clearing—which was actually the old Neoclassical explanation of unemployment that Keynes had dispatched.

With friends like these, Keynes doesn’t need enemies.

In retrospect, Foster might have been a bit hard on the institutionalists. continue reading…

The funny-shaped surface in the Wolfram “CDF” below (software download link) depicts excess demand for goods. The flat one represents the zero line where supply and demand are equal. On each axis is a variable that affects the degree to which demand outpaces or falls short of supply: (1) firms’ share in the price of goods, after paying wages, which equals the pricing markup m divided by (1 + m); and  (2) the income and production generated by the private sector, measured by capacity utilization. The height dimension measures excess demand for goods.

The sliding levers at the top of the CDF allow one to change (1) (“chi”) the percentage of disposable income spent by the wealthy households who own most stock, as well as all government-issued securities; (2) the rate of production by the public sector, which hires workers to produce services; and/or (3) the annual compound real interest rate (yield) on government securities. All of the other parameters are held constant as you move the levers. Click on the “plus” sign next to a lever, and further information appears.

[WolframCDF source=”http://multiplier-effect.org/files/2014/04/3D-excess-demand-graphN5.cdf” width=”331″ height=”361″ altimage=”3D-excess-demand-graphN5.png” altimagewidth=”309″ altimageheight=”351″]

Click here for a much larger, easier-to-read version of this CDF on a webpage of its own.

At the curved line where the two surfaces intersect (the edge of the dark blue region when viewed from above), aggregate demand is just equal to private-sector output, and there is no tendency for capacity utilization to change. Finding this intersection gives us the set of combinations of output and the distributional parameter at which all newly produced units are being sold, and no new goods orders are stacking up unfilled. Experimenting with the CDF, one finds that capacity utilization is usually higher: (1) when the share of the “K-sector”, or capital-owning sector, (m/(1 + m)) is lower, (2) when that sector spends a greater percentage of its disposable income, or (3) when government production and payrolls are larger.

One should keep in mind the simplification required to construct such a “small” model, which in graphical form represents only an imaginary economy; the numbers are not intended to mirror those of any particular country or data set–but the economic  system portrayed in the CDF is meant to be similar in many of its essentials to that of large industrialized nations with their own currencies, huge companies, liquid securities markets, floating exchange rates, etc. Another possible way to interpret this highly “stratified” industrial system is as an entire global economy in a mere 3 sectors: workers; firms/wealthy households; and government/central bank.

A larger version of the model featured an unemployment benefits system. To come: a discussion of the movements over time that may or may not bring the economy closer to the line where excess demand just reaches the flat surface and no higher. The model still has only a rudimentary financial system, with no private borrowing. Hence, the interest rate lever acts upon the economy solely by changing the amount of interest payments from the government to households–a distributional and fiscal variable in its own right and an MMT insight. (Business investment depends on capacity utilization and the gross after-tax profit rate.) The model is drawn more or less directly from Levy Institute working paper 723 (see this previous post) as revised recently for the academic journal Metroeconomica.

I recently did an interview for Euro Truffa on six topics related to MMT. The website is here. They are transcribing my interview to Italian (I think that only two are up so far) and putting up the videos. They have also posted all of the videos to YouTube.

As you can tell, I did not realize they were recording the video—I might have tried to sit still if I had known. Also, the coffee had not quite kicked in so I was not entirely awake. Here are the links with just a brief indication of the topic for each.

The first two videos have already been embedded here. (1) The first one addresses all the (silly) (non)-controversy about “consolidating” the Government’s central bank and treasury for the purposes of analysis of fiscal and monetary policy operations. I provide three responses to the critics. (2) The second video tackles the belief that the Euroland crisis is due to current account “imbalances.” As I explain, the real problem is the abandonment of sovereign currency. No one describes the USA financial crisis as a problem of current account imbalances between, say, Alabama and New York. Why? We unified our currency—the dollar—but under Uncle Sam in Washington. The EMU only partially unified, without a central fiscal authority that issues the euro.

(3) In this one, I argue that a floating currency provides more domestic policy space. A country that floats does not need to accumulate reserves of foreign currency. Still, I do not argue that a floating exchange rate is always and everywhere the best strategy.

(4) This one addresses the Job Guarantee (or ELR) and questions about inflation and labor discipline. I argue that the JG provides a job to anyone who wants to work, but without sparking inflation or eliminating discipline. Note that Minsky, like Heinz, argues there are 57 varieties (I think I said 52—again, too early in the morning for me to be doing interviews) of capitalism and pickles.

(5) This segment continues discussion of the JG, arguing that it is morally reprehensible to keep people unemployed, poor, and hungry on the argument that this is necessary to avoid a trade deficit. I do not agree with Tom Palley, who objects to the JG on the argument that “the poor will want meals.” Give them jobs, let them eat. If you do not like trade deficits, then reduce imports of luxury goods bought by the wealthy.

(6) How to save the EMU? Some suggest a unified central bank system—like the Fed. I argue that the problem is fiscal policy, not monetary policy.

Here are the original questions, in English and Italian: continue reading…