[This is the fourth part of a series (1, 2, 3) on sovereign deficits and debt.  The series was started in response to Ed Dolan’s original post detailing agreements and possible disagreements with the MMT approach.]

To recap very quickly, we agreed that sovereign government cannot become “insolvent” and forced to involuntarily default on commitments in its own currency. We moved on to “math sustainability” and agreed that so long as the interest rate paid on sovereign debt is below the GDP growth rate, then government does not necessarily face explosive growth of deficits and debts. And we agreed that the overnight interest rate is a policy variable, so that the central bank could keep it below the growth rate if desired. And we agreed that Treasury could use a “debt management” strategy to ensure that its average rate paid would be “low”—near to the Fed’s target rate, and if the Fed was pursuing a low rate strategy then on likely growth rates usually used in these types of models then the Treasury’s rate paid could be kept below the growth rate.

(Of course in recession the growth rate can go below zero but the interest rate would remain at zero or above; however this argument about sustainability is about the long term, not about cyclical problems.)

Now that always leads to the question: but if the Fed did pursue such a low interest rate policy, we’d get inflation that would force the Fed to raise its target rate above the growth rate to fight the inflation. Here was my one sentence response from last week:

“Here’s the preview: if deficits increase inflation rates, then “g” (GDP growth rate) rises so that even if the Fed raises “r”, we can keep g>r.”

Ed Dolan responded in the comments section this way:

“I think the part that will be more interesting to me is coming in Part 4. It will need to explain two things:
1. Even if it is possible always to keep g>r (both nominal) as inflation accelerates, would we really want to do so? Is there always some steady rate of inflation that guarantees g>r, or does it take continuously accelerating inflation? Are there any conditions under which accelerating inflation itself can undermine real output growth?
2. Suppose inflation is initially triggered not by monetary policy, but by an exogenous shock to real output (say, a natural or man-made catastrophe), or by attempts by the government to increase spending even after the economy has reached full employment (as in the “mission to Pluto” example of your MMT text). How can we be sure that the monetary policy operations needed to hold interest rates at an arbitrarily low nominal level will not induce further inflation?”

So let us begin to answer these questions. Today I’ll tackle question #1, or at least part of that question. continue reading…

Update:  the transcripts were released this morning (Jan. 18) and are available here.

Any day now, the transcripts from the 2007 Federal Reserve Open Market Committee meetings will be released to the public (FOMC transcripts are withheld for five years).  These transcripts should give us some additional insight into the discussions that were occurring around the outbreak of the global financial crisis and help fill in our understanding of the reasoning behind the Fed’s initial response.  See here for the detailed breakdown of what we already know about the Fed’s “unconventional” lender-of-last-resort responses, including tallies of all the loans and asset purchases made under various special programs and facilities, and breakdowns of the support provided to major recipients.

The Federal Reserve operated with a large degree of discretion during the course of the crisis (under the auspices of Section 13(3) of the Federal Reserve Act) and Dodd-Frank allegedly places some new limits on those powers—while also enshrining new regulatory responsibilities for the Fed.  On net, what does this all mean for the Federal Reserve’s power and discretion in a post-Dodd-Frank era?  In a new one-pager, Bernard Shull assesses the question and expresses some skepticism about the idea that the Fed will be meaningfully constrained by the new rules.

For instance, about Dodd-Frank’s restrictions on the Fed’s ability to provide credit extensions to nonbanks Shull writes:

… it does not permit the Fed to target specific companies, as it did with AIG in the recent crisis. It does permit the extension of credit within a “broad-based” program, albeit with Treasury approval. However, this is a weak constraint. The Fed could circumvent this limitation by organizing private consortiums, as it did for Long-Term Capital Management in 1998. “Circumvention” may be the wrong word, as the executive branch has been at least as determined as the Fed to extend credit to nonbanks in the face of a systemic threat.

Read the one-pager here.  For a longer treatment, see Shull’s working paper.

So far, a large part of the discussion of whether the Treasury should mint (or convincingly threaten to mint) a trillion-dollar platinum coin in response to the congressional threat to refuse to raise the debt limit (see here for background) hovers around questions of legality or ill-defined “seriousness.”  (On the political front, the administration’s press secretary passed up an opportunity on Wednesday to explicitly rule out the idea.  On the legal front, Matthew Yglesias suggests a theory in which the government is not just permitted but obligated to mint the coin.)

But the platinum coin discussion actually touches on fundamental issues that go beyond legality or political decorum; issues about the understanding (and misunderstanding) of money.  (Recently, both Joe Weisenthal and Paul Krugman moved the conversation in this direction.)

One suspects that some objections to the large-denomination platinum coin on the grounds of “silliness” are motivated by simple incredulity about the nature of money.  Behind a lot of the Dr. Evil-themed snickering there lurks a very common “metallist” conception:  an insistence that money must always be backed by something like gold, or in the case of the trillion-dollar coin, that its value is given by the value of the platinum in the coin; something other than the mere fiat of government.  To those who are moved by the argument that the US government has “run out of money,” the reality of money, as laid bare by the platinum coin discussion, must appear deeply unserious and fantastical (we might as well just grab a bunch of sticks and call those money!).

For many people, these themes take us beyond the realm of reasoned argument and well into what Krugman called “a collision of worldviews.”  Or as Stephanie Kelton put it:  “Money scares the bejesus out of people.”  To Randall Wray, a deeply entrenched misunderstanding of money underlies a host of views about debt and the role of government; successfully confronting this constellation of beliefs and assumptions, he argues, requires an exercise in meme-building.

The platinum coin debate is helping lay bare a set of facts that is proving to be uncomfortable for many observers:  that the debt ceiling, and the rules requiring the US Treasury to issue debt rather than money when it spends more than it raises in revenue, are merely contingent rules, not reflections of the scarcity of some finite commodity.  But moving back to the level of operational end-arounds, we need not fixate on the platinum coin.  As Wray suggests, there is an additional way of getting past debt limit hostage-taking.  continue reading…

Amity Shlaes, whose main claim to fame is an allegedly new history of the Great Depression, thinks we may be in trouble as a result of the election. Looking beyond her alarmingly alliterative title (“2013 Looks to be a Lot Like 1937 in Four Fearsome Ways!”  Oooh! Scary!) she has some valid points. Of course she is talking about the stock market not the real economy, which produces the jobs and the economic benefits most people rely on for a living. And, unfortunately, she doesn’t realize where she is right.

But first, what are the four fearsome factors that will drive us to doom? First, a federal spending spree before the election. Shlaes uses “the old 19% rule” as a benchmark to argue that because federal government spending in 2012 “when the crisis was long past” was 24.3% of GDP, clearly the Obama administration was spending up a storm. To argue that the crisis is long past, one must be willing to ignore the employment crisis that still hasn’t left us, but let’s give her this one. Whether this is a problem given current economic conditions is another story. If it’s the debt implications you’re worried about, it is worth noting that revenues as a percentage of GDP are also quite low historically speaking, just over 15% for the last few years (see CBO’s historical budget data).

Shlaes’ second fear factor is a bath of cold water afterwards. Roosevelt restored budget balance in 1937 and since that very topic (and who David Petraeus was or was not sleeping with) is all people are talking about in Washington these days it seems likely we’ll get spending cuts and tax increases in the next budget. The “depression within the Depression” was the result of exactly this fiscal restraint. This is where Shlaes is quite right, though she doesn’t actually come out and say this: whether the President and Congress jump off the fiscal cliff together, which would reduce spending across the board, or avoid it by cutting spending on everything but defense instead, we are in for poor economic performance indeed.

Shlaes’ third scary thing is the fearsome attack on the status quo. In 1937, this meant raising the top marginal rate from 56% (where it had been raised by Hoover in 1932 from 25%) to 62% (this actually passed in 1936) and the undistributed profits tax. This, and Roosevelt’s attempts to pack the Supreme Court meant that (stock) markets “shivered.” Note that this year, Obama is talking about raising the top rate to, um, 39.6%, which is where it was before the Bush tax cuts. Remember how much markets were “shivering” in the 1990s? Me neither.

continue reading…

Randall Wray on quantitative easing and the accumulation of reserves:

When the Fed buys assets, it purchases them by crediting banks with reserves. So the result of QE is that the Fed’s balance sheet grows rapidly—to, literally, trillions of dollars. At the same time, banks exchange the assets they are selling (the Treasuries and MBSs that the Fed is buying) for credits to their reserves held at the Fed. Normally, banks try to minimize reserve holdings—to what they need to cover payments clearing (banks clear accounts with one another using reserves) as well as Fed-imposed required reserve ratios. With QE, the banks have ended up with humongous quantities of excess reserves.

As we said, normally banks would not hold excess reserves voluntarily—reserves used to earn zero, so banks would try to lend them out in the fed funds market (to other banks). But in the ZIRP environment, they can’t get any return on lending reserves. Further, the Fed switched policy in the aftermath of the crisis so that it now pays a small, positive return on reserves. So the banks are holding the excess reserves and the Fed credits them with a bit of interest. They aren’t thrilled with that but there’s nothing they can do: the Fed offers them a price they cannot refuse on the Treasuries and MBSs it wants to buy, and they get stuck with the reserves.

A lot of people—including policy makers—exhort the banks to “lend out the reserves” on the notion that this would “get the economy going.” There are two problems with that. First, banks can lend reserves only to other banks—and all the other banks have exactly the same problem: too many reserves. A bank cannot lend reserves to your household or firm. You do not have an account at the Fed, so there is no operational maneuver that would allow you to borrow the reserves (when a bank lends reserves to another bank, the Fed debits the lending bank’s reserves and credits the borrowing bank’s reserves). Unless you are a bank, you cannot borrow them.

The second problem is that banks don’t need reserves in order to lend. What they need is good, willing, and credit-worthy borrowers. That is what is sadly lacking. Those who are credit-worthy are not willing; those who are willing are mostly not credit-worthy.

And we should be glad that banks are not currently lending to the [non-credit-worthy]. Here’s why: that’s what got us into this mess in the first place.

Read the rest here.

We expect the unexpected at the Levy Institute. As followers of Keynes, most economists here, including this author, believe that one cannot assign exact probabilities to most important economic outcomes even, say, six months into the future.

On the other hand, thinking about the economic debate on job creation, and the recent release of new jobs data, I have not been very surprised at the gradual pace of progress in reducing the unemployment rate. In fact, we on the macro team have consistently called for more fiscal stimulus rather than less. The reason is that unemployment is a relatively slow-moving variable. As the chart at the top of this post shows, the unemployment rate (shown as a blue line) fell only rather gradually after each of the previous three recessions (shown as shaded areas in the figure). (Here, we count the double-dip recessions of 1980 and 1981–82 as one.) Hence, once the recovery began, we knew that with the unemployment rate at very high levels, it needed to fall unusually fast to be at reasonable levels by this point in the Obama administration.  Hence, since 2007, the team has advocated an easing of fiscal policy. Instead, especially after the 2009 ARRA, little action was taken by the government to stimulate the economy. Partly as a result of inaction on fiscal stimulus, government employment as a percentage of the civilian workforce (red line in the figure above) peters out after 2010.

At this point, we hope for legislation to moderate January’s expected “fiscal cliff”—which will lead to perhaps a $500 billion in reductions in the federal deficit in 2013 unless laws are changed, by CBO estimates.  (In its current form, the cliff would probably have a serious impact on all economic and demographic groups. Lately, I’ve been working on a model that incorporates the larger effects of an additional dollar of income on spending at lower income levels—not a simple task.)

In the figure, both lines are shown in the same units, namely percentages of the civilian labor force age 16 and above, though the two lines use different scales, one on each side of the figure.  For example, a one-unit change in the blue line represents the same number of workers as a move of one unit in the red line. A hypothetical jobs program or another spending measure that gradually increased government employment (red line) by, say, 1 percent of the total US workforce might easily have led to an unemployment rate (blue line) for last month of 1 to 3 percent less than the actual reported amount. But government does not seem to be expanding; in fact, the red line shows that government employment shrank at a time when more hiring from that sector would have been of great help to the economy. (The figures include employees of local and state governments, as well as those of the federal government. The smaller governmental units have seen the biggest cuts in payrolls.) continue reading…

On the surface, the data from Argentina look awfully good—among the top performers in the world over the past decade. And she’s apparently done it without a run-up of either private sector or government sector debt. In other words, Argentineans have bucked the trend among developed countries, that saw (mostly) tepid growth fueled almost entirely by debt.

And that seems to be at least in part due to a policy choice. Argentina had been the poster child for Neoliberal policies all through the 1990s—they adopted virtually the whole Neolib agenda lock-stock-and-barrel. They even adopted a currency board. And unlike Euroland (which also adopted something like a currency board as each member adopted a foreign currency—the euro), Argentina would have consistently met the tight Maastricht criteria on budget deficits and debts over that period. The main purpose of the austere budgets and currency board constraints was to kill high inflation. It worked. But, over that period unemployment grew and GDP growth was moderate. I won’t go further into the problems encountered at the turn of the new decade but the whole thing collapsed into a severe economic, financial, and political crisis. In a last desperation move, the government abandoned the currency board (or, you could say the currency board abandoned the government!), defaulted on its debt, and created a Jobs Guarantee program called Jefes.

(You can read more here and here; or if you want a first-hand account by Daniel Kostzer who played a major role in bringing Argentina out of crisis by helping to create and implement the Jefes program, read this.)

Starting from the depths of a horrible recession, then, Argentina climbed back to recovery—not only making up for ground lost in the downturn, but also in many ways by rectifying problems created by the Neoliberal experiment. continue reading…

Levy Institute scholars James Galbraith and Randall Wray presented at the annual conference held by the Central Bank of Argentina last week. Galbraith’s presentation began with the issue of the flexibility of central bank mandates and then turned to an account of the long-term evolution in the economy that prepared the groundwork for the recent global financial crisis. Randall Wray spoke on the theoretical and policy implications of a government’s ability to issue a sovereign currency.  Video and slides below the fold (full list of speakers here). continue reading…

Kevin Drum has excised another section of the now-famous leaked fundraiser video, and this time the GOP challenger is holding forth on quantitative easing and other subjects. Drum picks on Romney’s specific claim that the government is buying three-quarters of US treasury debt, but there’s something in this quotation that’s more fundamentally off:

We’re living in this borrowed fantasy world, where the government keeps on borrowing money. You know, we borrow this extra trillion a year, we wonder who’s loaning us the trillion? The Chinese aren’t loaning us anymore. The Russians aren’t loaning it to us anymore. So who’s giving us the trillion? And the answer is we’re just making it up. The Federal Reserve is just taking it and saying, “Here, we’re giving it.” It’s just made up money, and this does not augur well for our economic future.

The problem here is that Romney’s “fantasy” world, in which the government “makes up” money, is just a roughly accurate description of fiat money.  And if you’re rooting around in the text of Obama’s American Recovery and Reinvestment Act for the dastardly provision that created this new “feeyat” money thing, don’t waste your time—it’s been around for a long, long time.  If you’re interested in the actual history of money, as opposed to the “we used to have real money before January 2009″ version, this working paper gives a nice rundown of the anthropological and historical material and lays out the economic policy upshot.

Whether it’s buying three-quarters of new treasury debt or a tiny fraction, the Fed is always using “made up money.”  And in theory (which is to say, aside from the various legal obstacles placed in its way), the Fed can buy as much US treasury debt as it wants, because it can never exhaust its ability to “make up” more money.  Don’t believe me?  Ask Alan Greenspan:

To the extent that there’s a real policy limit to this, it’s not that the Fed will somehow run out of money, but that at some point, when the economy is closer to running at full capacity, buying US debt to keep interest rates low could lead to inflation.  But inflation, for now and the near future, just isn’t a significant problem.  (On the contrary, the current challenge is to figure out how to get more of it.)

There are plenty of things to worry about in our current economic situation.  Unemployment would be pretty close to the top of the list.  Fiat money should not be.

Who would have expected extreme thinking from central bankers? That is the theme of some coverage in the financial press over the past few weeks. For example, the Financial Times takes note that “a growing chorus of economists is saying central banks should take more radical steps, including buying assets other than government bonds.”

Some, if not all, of these steps are not so radical from a broad historical perspective. Following the recent bankers’ brainstorming session in Jackson Hole, Wyoming, Fed Chairman Ben Bernanke was said to be pondering various possibilities including (1) QE (quantitative easing) 3, (2) a lowering of the interest rate paid on banks’ reserve accounts at the Fed, (3) an extension until 2015 of the Fed’s low-interest-rate precommitment, and perhaps in the longer term, (4) adopting nominal GDP targeting, as endorsed, for example, by George Soros in a recent opinion piece on the eurozone and Germany in particular.

Today, the Fed announced that it would adopt options (1) and (3), purchasing $40 billion in mortgage-backed debt each month for an indefinite period and predicting that the federal funds rate would remain near zero through mid-2015 (see news article for more details).

Most of the measures being contemplated are portrayed as more radical than they actually are, in my view. For example, most of the actions being pondered by the Fed could not match the impact of the approximately $500 billion “fiscal cliff” due in January, or even the “fiscal clifflet,” the Economist’s phrase for the portion of the cliff that actually winds up going into effect, once the current Congress gets its last chance to pass legislation.  As a blog at that publication’s site puts it,

Even if the Bush tax cuts are extended and the sequester delayed, a huge amount of fiscal drag remains in place. They include the expiration of the payroll tax cut, the expiration of extended unemployment insurance benefits, imposition of a new 3.8% Medicare investment tax on the wealthy, and the bite to discretionary spending embedded in the Budget Control Act and prior continuing resolutions.

One novel and potentially effective Fed approach would be the monetary “helicopter drop” recently discussed in the full-page FT article and a recent column in the same newspaper. The idea would be for the central bank (the Fed in the US case) to send money to individuals, through direct deposits in Americans’ bank accounts or by distributing currency via the banking system. continue reading…