Some propositions for chartalists (wonkish)

I’ve been asked quite a few times about chartalism and its recent rebadging as modern monetary theory (MMT). My answer has been that I really should get around to looking into this. However, the issue came up again at Crooked Timber following my post on hard Keynesianism. Looking around, I drew the conclusion that an attempt to define and assess the various versions of MMT would take more time than I had available. So, instead, I thought I would draw up a set of propositions bearing on the claims I made about hard Keynesianism and invite comment from MMT advocates and others as to whether they disagree.  Here they are

1. Except during the period since the GFC, money creation has not been an important source of finance for developed countries

2. Except under extreme conditions like those of the GFC, money creation cannot be used as a significant source of finance for public expenditure without giving rise to inflation and (if persisted with) hyperinflation

3. Government deficits must be financed primarily by the issue of public debt

4. The ratio of public debt to GDP cannot rise indefinitely, since governments will ultimately find it impossible to borrow

5. The larger the deficits governments want to run during deficits, the larger the surpluses they must run in booms

Now some justification for these claims:

On point 1, the US monetary base has expanded from $800 billion to $2400 billion since the beginning of the crisis. Prior to that, growth was roughly in line with nominal GDP, that is, around 5-6 per cent per year or additions of $50-60 billion.

My take on this:  Quantitative easing and similar operations since 2008 have created money equal to around 15 per cent of GDP or around 5 per cent per year, without obvious inflationary consequences. We can conclude (assuming the inflation doesn’t materialise) that, in a liquidity trap, there is substantial capacity to use direct money creation as a source of finance.

Pre-GFC, seignorage/base money creation was a minor source of finance for the US government (about 0.5 per cent of GDP, consistent with money base being about 10 per cent of GDP). And, I’m confident the same is true for all developed countries except maybe Japan, which has been in a liquidity trap for a long time.

On point 2, there are plenty of examples of governments trying to finance their operations through the printing press, and the outcome is always the same: inflation at first, then hyperinflation, then the end of the currency. Zimbabwe, which now has no currency of its own, is just the latest example. There are various possible mechanisms by which this outcome occurs, but the central point is that the monetary base is typically around 10 per cent of GDP, which presumably reflects people’s desire to hold money.  Any substantial increase in the monetary base can be sustained only if interest rates are pushed down to low levels, ultimately to zero. And, except in crisis conditions like those of the present, zero interest rates will lead fairly rapidly to inflation in asset prices and ultimately in consumer prices.

Point 3 follows from point 2.

Point 4 like point 2 has been verified by sad experience many times.And its obvious that, the higher the debt ratio, the stronger the incentive for the government to default or inflate their way out of trouble, and therefore the higher the interest rates they will face. At some point the capacity to borrow runs out.

Point 5 follows from Point 4.

So, there are my propositions. Feel free to comment.

127 thoughts on “Some propositions for chartalists (wonkish)

  1. Last word ?

    I’ve just finished trawling through the comments on CT that spawned this thread.

    Before the CT thread was closed one commenter, Sebastian, repeatedly claimed that the employment boom that followed Clinton’s surpluses disproved a fundamental tenet of MMT (and presumably Keynesianism).

    Joseph Stiglitz who was there at the time explained in his book “The Roaring Nineties” that the unusual outcome was due to an unusual event (a “lucky mistake”), the relaxing of accounting rules that allowed banks to hold long term government bonds as risk free securities (that is, no reserve back-up).

    When interest rates subsequently fell the S&L’s were left with huge windfall profits from their holdings of high coupon long term bonds and that fueled a lending boom.

    So AD was maintained in the face of budget surpluses by private deficits. The sectoral balance identity holds.

  2. Prof. Quiggin – First, let me commend you for your work on Zombie Economics. I found the book extremely informative and helpful for understanding the mess we’re facing right now. In my opinion, the book should be mandatory reading for all economics undergraduates, as well as regulatory analysts working on financial regulation. I’ve recommended it to several people, some of whom are currently in the field of public policy.

    That being said, I wish to simply bring to you attention the following point relating to this discussion on chartalism: the endogenous nature of money. To get a good grasp of circuitist/chartalist monetary economics, it’s important to keep in mind that the money supply is determined by the demand for bank credit (loans). A bank will create a loan when the borrower is creditworthy and has adequate collateral. Even economists at the Bank for International Settlement have concluded that is the case. Here’s an excerpt of a paper by P. Disyatat:

    “…since banks are able to create deposits that are the means by which the non-bank private sector achieves final settlement of transactions, the system as a whole can never be short of funds to finance additional loans. When a loan is granted, banks in the first instance create a new liability that is issued to the borrower. This can be in the form of deposits or a cheque drawn on the bank, which when redeemed, becomes deposits at another bank. A well functioning interbank market overcomes the asynchronous nature of loan and deposit creation across banks. Thus loans drive deposits rather than the other way around.” (p.7)

    Post-Keynesian economists Randy Wray and Basil Moore are mentioned in the BIS paper. Although post-Keynesians have been saying this for years, it is only recently that mainstream monetary economists and central bankers have realized this fact.

    Why is this important? Briefly, I will give you three reasons.

    First, it means that, contrary to what we’ve all been taught, it is investment undertaken by firms that creates savings. Investment doesn’t require prior deposits or prior savings to come about. This is a significant point to remember in this discussion on modern money.

    Second, it also means that the money multiplier does not exist. The size of the monetary base does not impact the supply of money. Actually, it is the other way around: banks seek reserves to comply with reserve requirements after they have created the loans and deposits.

    Third, it means that inflation is not the result of an expanded monetary base. In fact, it is the increase in prices that drive the bank to seek additional reserves (as a result of demand-pull or cost-push inflation). The implications for economic policymaking are significant.

    For those who are interested, here are some good, short quotes from Basil Moore’s classic work “Horizontalists and Verticalists”:

    “Banks do not wait for excess reserves before providing new loans to the public. Nor are new loans made at the initiative of the banks themselves. Banks are essentially in the business of selling credit . As with all firms the amount of goods and services they can sell depends ultimately on the demand for their product.” (p.46)

    “In a world of credit money and central banks, interest rates can never be endogenously determined solely by market forces. The authorities cannot choose not to affect interest rates.” (p.254)

    In other words, the exogenous nature of money taught in macro textbooks is another zombie idea…

    Thanks for the opportunity to comment.

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