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. John, I would be interested in your views on the risk of quantitative easing. It seems highly experimental. Isn’t the plan to attempt to reduce the monetary base quickly by putting the process into reverse if inflation starts to happen? And if inflation does start what sort of disruptions might happen if the process is put into reverse? If inflation does start with such an expanded monetary base, again, what are the risks if the process cannot be quickly reversed? I suppose another question is, are their things they ought to be putting in place now, some regulation on bank lending, for example, to prepare for the possibility of the ‘extra’ money in the monetary base coming to life? Could some controls provide them time to reverse the QE?

    One thing about QE, you would think that given what has happened so far, those who refused to believe in the possibility of a liquidity trap would have changed their ideas. But history tends to show evidence is neither necessary nor sufficient for that process, and I doubt many have changed their view.

  2. I basically agree with your propositions. Gee, you must really care about my opinon! 😉

    I have some questions though. In points one and two, by “money creation” I assume you mean “government (fiat) money creation”? However, isn’t “money creation” by the private enterprise banks also an issue? I mean money created by issuing debt via loans. This also creates inflation. Witness the assets (especially housing) inflation in Australia.

    Don’t you also agree that “The ratio of private debt to GDP cannot rise indefinitely, since private debtors will ultimately find it impossible to keep borrowing and/or to repay and thus will begin deleveraging or defaulting.

    Of course, you may not disagree with me. You may have talking solely with the government aspects in mind.

  3. @Ikonoclast
    I agree entirely on private debt. Private “money creation” is a bit more complicated, and I don’t want to get into pointless debates about the definition of money, but I agree with your substantive point.

  4. @Freelander
    There’s nothing radically innovative about QE – it’s what used to be called “open market operations” when I was a student. But there’s no doubt that in trying to make policy with zero interest rates, central banks are sailing in uncharted waters.

  5. Yes. What’s radical is to be doing it and nothing happening, that is, doing it on such a big scale in a liquidity trap. I suppose the other change is in just what they are buying. Given that what they are buying is different, who they are buying from is probably different. Would that be making any difference?

  6. 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.

    For me, Bob Dylan probably said it correctly:

    “Don’t speak too soon for the wheel’s still in spin…”

    The global “obvious inflationary consequences” are brewing so we will just have to wait and see.

  7. “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”

    But who said MMT would monetise the deficit in a way that causes hyperinflation?

    “Modern Monetary Theory says that, even though deficits are not “financially” constrained, they face real constraints in available resources, capacity utilization, the unemployment level, the exchange rate, the external balance, and inflation rate.”

  8. John, Scott Fullwiler has written a couple of papers on fiscal sustainability from the MMT perspective that you might want to take a look at.

    Scott T. Fullwiler, Interest Rates and Fiscal Sustainability (July 2006). From “Concluding Remarks,” “The sustainability of fiscal policy as determined via the orthodox IGBC framework is irrelevant for understanding the workings of a modern money economy.”

    Fullwiler, Sustainable Fiscal Policy and Interest Rates under Flexible Exchange (July 2008). “The purpose of this paper is to demonstrate that key assumptions made by many applying the IGBC – most importantly the notion that interest on the national debt is set in private credit markets – in fact are not applicable to governments issuing their own currencies while operating under flexible exchange rates.”

  9. @Lord Keynes

    But who said MMT would monetise the deficit in a way that causes hyperinflation?

    Not me, at any rate. I specifically said I wasn’t going to define MMT or impute particular propositions to MMT advocates. I simply observe that monetising debt is (except under the extreme circumstances of a liquidity trap) not a feasible policy option. If that’s agreed all round, so much the better.

  10. Mr Quigin said: “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.”

    MMT understands banking system much better than you. The QE was printing RESERVES, these are like a separate banking currency, they don’t leave tha banking system, printing them funds nothing. They were printed in false belief that banks lend out reserves, which they do not. These reserves simply sit in the banking system. If bonds pay positive interest (which in normal times they do) the banks are very interested in swapping these non-interest-paying reserves into bonds, so in normal times there are no “excess reserves”. If inflation increases and bonds will start paying substantial interest, the banks will try to get rid of these reserves, but they cannot be lent out, they can be exchanged for bonds with the fed. There will be no hyperinflation. Hyperinflation fears rest on belief that money is exogenous, that some apparatchik at the Fed can pull a lever and make banks lend by giving them reserves. The reality is that money is endogenous: the economy decides how much money it wants to borrow, and banks get the necessary reserves LATER. The money multiplier effect is simply not there.

    Start here:

  11. “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.”

    Both Zimbabwe and Weimar already had triple-digit inflation before the money supply was expanded. In both cases the problem was caused by substantial supply shocks

    – for Weimar the germans lost posession of the Ruhr valley which had 40% of it’s industrial capacity, coupled with import/export controls making it dificult to adapt, and the subsequent increase in the money supply just made it worse.

    – for Zimbabwe, they gave farmland to people who did not know how to farm it, and lost about 50% of the main industry, agriculture, causing a food supply shock. Bans on exchanges with foreign currency made it impossible to adapt and printing money was just the final mistake.

    This “printing money is inflationary” only made sense under a gold standard or pegged currency – with a floating exchange rate and no gold, this idea no longer applies.

    Further, a “stock” of money cannot contribute to inflation, only a “flow” of spending can. How can government spending (without debt issuance) be automatically inflationary, when net-bank-lending is not?

  12. # 1 is true for the US government, certainly.

    # 2/3 is false. Governments with floating fiat currencies have the strategic/structural option of deficit spending with payment settled by issuing central bank reserves with interest, instead of issuing bonds. This captures deficit financing entirely within the banking system, and removes entirely the issue of bond vigilantism. Paying interest on reserves maintains monetary policy continuity.

    # 4 see Fullwiler on fiscal sustainability.

    # 5 absolutely not.

  13. I think when you talk about interest rates going up or down it is important for clarity to specify which interest rate you mean. The interest rate on treasury bonds is not the same as the overnight interbank lending rate. In Greece last time I looked banks were still lending to well collateralised Greek individuals at rated well below what the government is having to pay. Part of why I think default is superior to inflation as a cure for excessive government indebtedness is that inflation is lousy for the private sector and debases the returns received by responsible lenders (ie those that didn’t lend to an over indebted government).

    As for quantative easing unguided by interest rates (due to rates being stuck at zero and unable to go negative) this is only problematic if the monetary authority ignores all the other price signals that are highly responsive to currency creation. If they want a barometer to guide such policy they can watch commodity prices and exchange rates. That gold is through the roof and the US dollar is down relative to other currencies is and indication that US currency creation has been excessive.

  14. Both Zimbabwe and Weimar already had triple-digit inflation before the money supply was expanded. In both cases the problem was caused by substantial supply shocks

    So rather than inflation being due to an increase in the “supply” of currency it was due to a destruction of “demand” for currency. That is a decline in economic activity. If you then compound the error with a false belief that economic activity can be restored via loose money they you are primed for hyperinflation. Yet what did the USA do recently when faced with declining economic activity, it created excessive currency. Lucky for them a lot of it sloshes abroad.

  15. On your claims/discussion about the the expansion of the monetary base: yes, but almost all of this expansion is being held as excess reserves. This is why there is no inflation — it is akin to printing money and then burying it in the garden.

  16. The fact that large scale resort to the printing press only happens when the situation is already bad means that we don’t have the evidence we would like regarding a decision by governments to rely on money creation as a revenue source under normal conditions. However, we do have

    1. The experience of the 1970s and 1980s which certainly exhibits the combination of fiat currencies, rapid monetary growth and high inflation. Attempts to explain this by cost-push theories failed (I was around at the time, so I saw them unravel) and all the surviving explanations are consistent with my point #2.

    2. The basic economic logic spelt out in my post, that, under normal conditions, the money base people actually want to hold is only around 10 per cent of GDP. So, if you want to increase this substantially you need to explain why people won’t seek to reduce their money balances, for example by buying bonds denominated in foreign currency.

  17. A situation where banks don’t lend out their reserves is a liquidity trap. That’s the situation now, and that’s why the big expansion in money creation hasn’t generated any inflation

    But as I’ve pointed out, except in the QE period, the issue simply hasn’t arisen, since money creation (cash + reserves) has been negligible. Under normal conditions, there is nothing stopping people spending cash and nothing stopping banks lending against their reserves.

    So, except in a liquidity trap, the idea that governments can create money and then “bury it in the garden” makes no sense. If it isn’t available to be spent/lent it doesn’t create any command over real resources, and therefore can’t finance public expenditure.

  18. Well the government isn’t burying it a garden the banks are. Banks hold treasuries. Fed prints money. Fed buys treasuries. Banks now hold money. Banks keep money as excess reserves — which now pay interest (at the overnight rate I think).

    But is it liquidity or solvency that is behind the non-lending? Even though banks off loaded a lot of junk to the Fed in QE1 they are probably still in poor shape due to the double dip in US housing. They are protected from insolvency by a change in accounting rules 2 years ago so they don’t have to mark to market. So I guess I’m saying that QE1 and QE2 has little to do with stimulating the economy, which it clearly isn’t doing, and more to do with repairing balance sheets than financing public expenditure.

    Additionally US consumers are still delevering (which you sub out student loans).

  19. Part of the “argument” between Quiggin’s brand of Keynesianism and some versions of Chartalism (MMT) is a mere matter of accounting terms and emphasis.

    1. Money, as fiat money, is in a sense a totally arbitrary construct. Governments can in theory do anything they like with fiat money and make as much or as little of it as they like. In practice, there are real constraints. The first is inflation / deflation and the second is the floating exchange rate.

    2. A common naive misconception is that governments (with a fiat money system) have to tax to spend and that a national budget must be balanced just like a household budget. Taxation can be viewed simply as a way to reduce private expenditure to make “room” for public spending without excessive inflationary pressure. It’s not that public spending under a fiat money system is directly tied to taxation. Deficit spending is always possible.

    Government bonds can function somewhat like taxation. The money “withdrawn” from the private economy and locked up in bonds “allows” public expenditure. Of course, there is a difference too in that bonds pay interest and the principal must eventually be returned. Taxes also can be said to pay “interest” in the form of public infrastrutuce, welfare and so on.

    3. Some monetary policy implementations like higher interest rates could also be partially mimicked by higher taxes. For example, instead of raising interest rates (which hits the spending power of mortgage holders and business loan holders) the government could take stronger control of the reserve, hold interest rates steady and implement tax rises. In the computerised age, mechanisms could be set up to reset tax withdrawal rates on GST and PAYE at say two monthly intervals if and when necessary. Of course, governments prefer that banks be blamed for monetary policy impacts.

    4. The real truth is that all the elements mentioned above are invented levers which have real effects in the current system. The real evils are the “flations” inflation/deflation (beyond mild “flations”) and unemployment. All levers should be manipulated in whatever arbitrary manner actually achieves mild “flation” and true low unemployment (about 2%) of the frictional variety only.

    5. Some of the real policy evils are negative gearing, business subsidies and the power of private banks to create money. All money creation of both the fiat variety and debt creation variety should be under government control.

  20. I agree with Peter, that John Quiggin does not understand how modern monetary systems operate. The set of propositions that he has drawn up gives the game away, and reveals his ignorance most clearly. In a pure fiat monetary system, central government spending does not need to be “financed” (as arguably it did when we had a gold standard). The purpose of taxation and bond selling is not to secure government revenue for spending purposes; it is carried out for the purpose of manipulating aggregate demand in order to keep a lid on inflation. This is consistent with the fact that money paid to the tax office in fulfilment of a tax obligation is always cancelled from the money supply. And even the associated reserves disappear from the financial system whenever Treasury makes a deposit in the central bank. The reality is that, for a sovereign government in control of the issue of its own currency, so-called public debt is not really debt at all – other than in a purely accounting sense. The real problem that sovereign nations need to address is the inadequately regulated growth of private debt.

  21. I agree with Peter, that John Quiggin does not understand how modern monetary systems operate.

    Perhaps but I think he is closer than you. And your outline of how it “works” is more about how you prefer to frame it rather than some meaningful insight. More a normative reframing than positive statement.

  22. @Jack

    Jack’s criticism of JQ illustrates my argument that Keynesians and Chartalists are closer than they might think. In a pure monetary/fiscal policy sense government spending does not have to be “financed” by taxes and bond selling (as the govt can create money by fiat or deficit spending) but it has to be “supported” by useing taxes and bond selling to “keep a lid on aggregate demand” which means to keep a lid on inflation. Whether you call it “financing” government spending or “supporting” it by keeping private demand (and aggregate demand) down is in the end a pure semantic argument.

    Jack is quite right that the inadequately regulated growth of private debt is the problem particularly currently in Australia. It does not follow from that the government “debt” or “deficit spending” or “excess fiat money creation” (whatever you call it is semantics) is never a problem. This is a problem too if it becomes excessive.

  23. IANA Chartalist economist, just interested, so I may be flat wrong in my attempts to answer John’s propositions – the people to ask are Bill Mitchell and the folks at UKMC.

    I have found chartalism very useful in explaining the economic history of colonies, where the colonial power needs to draw the subject people into its economic system and usually does so by imposing a tax payable in the colonial currency, which can only be earned by working in plantations, selling desired cash crops, etc. Australia did it in PNG. A similar process seems to have brought about the original creation of money in the archaeological record. So the basic proposition of chartalism, that currency is given value by taxation, seems to stand up from a historical POV.

    Points 1-3 My understanding of MMT’s “ethnographic” account of central bank operations, as given in L Randall Wray’s “Money and Credit in Capitalist Economies” is that all money spent by a sovereign currency-issuing government is “created” and all money taken in by governments in the form of taxes, fines, etc is “destroyed”. The money only exists as numbers in reserve bank ledgers which are added to and subtracted from as the government goes about its business. This is quite separate from the amount of cash in the economy. There’s no scrooge mcduck (McSwan?) building full of money at Treasury upon which the treasurer rolls around cackling insanely, though the idea is oddly compelling.

    AFTER the government has credited and debited bank accounts, it currently chooses to issue bonds equal in value to the difference between the two numbers. It does this in order to a) drain private sector cash stocks so that government spending on top of the private sector doesn’t cause inflation and b) to provide a risk-free asset for the banks and the FIRE industry to invest in; this is shown by, inter alia, the fact that Costello still issued government bonds even when the budget was in surplus, in order to provide a price for risk-free investments upon which the FIRE sector could speculate.

    It follows that assertions about “money creation” and “government deficits MUST be financed by issuing public debt” are misunderstanding the nature of a fiat currency; all money is created, there is no law of conservation of money at work, and there are a variety of ways which government can keep inflation under control by draining money from the whole system, of which issuing bonds is only one method, and one that grossly favours the rentier classes at that. There is therefore no particular concern about governments finding it “impossible to borrow”, because they don’t need to borrow in the first place. (see point 4) What they need to do is carry out their programs without causing inflation or killing the private sector (e.g. through mass nationalisation).

    The purpose of government macroeconomic policy, say the MMTers, following Lerner’s “Functional Finance”, is not to balance the government’s accounts but to balance the accounts of the whole economy: if the private sector is in deficit (spending more than it saves) then the government has to draw money out; if the private sector is saving more than it spends, then the government has to put money in (external trade balances also come in here, but I won’t go into them because I always seem to get that bit wrong). Given that the economy also has to expand, if the private sector is not to have an ever-increasing debt load then the government “deficit” has to constantly expand; but since this is just an arithmetic construct, it has no particular consequences, unlike for the private sector which cannot create money without creating debt.

    On point 5, In practice MMT policy (as opposed to theory) would be little different to “Hard (New) Keynesianism” IF there was full employment (by which Mitchell, Mosler, Wray et al mean 2% unemployment, of the kind we had 1946-1972). Because the unemployed are an un-used resource, MMTers argue an expansion of government spending to bring them into the workforce would not cause inflation any more than expanding government spending in a recession causes inflation; both are mobilising unused real resources which then back the currency. Provided that the unemployed are employed by the government at minimum wage and have to get a private sector job if they want higher wages, this should not cause a wage-price spiral. Once there is full employment I think MMTs would advocate a small ongoing deficit which matched economic growth, so that the real economy and the base money supply keep in step.

    In a full employment situation where private sector spending was expanding, MMTers might well advocate running a surplus to prevent inflation; the ones I’m aware of argue that this is best done through targetted fiscal policy, particularly taxes on the massive rentier sector, rather than interest rates, which are a blunt tool which causes unemployment. In the current circumstances, however, running a surplus will drain demand which could be putting people to work, and trying to run surpluses in places like the UK and USA with massive demand deficiencies is a) criminal and b) won’t work because revenues will be hit even harder than government cutbacks. I think “Hard Keynesians” would agree with these points.

    MMT argues that current interest rate and unemployment policy misprioritises the balance between inflation and unemployment, because the real damage from unemployment is much higher than the nominal loss from inflation, and that unemployment is suffered to run as high as it does as a method of weakening workers bargaining position, as laid out by Kalecki in “the political aspects of full employment”. As Marx would put it, they are a reserve army of the unemployed. There are many other ways to control inflation, but unemployment places the cost of doing so on the poor rather than the rich.

    I hope I’ve reported the MMT position accurately. I’ve read some of Professor Quiggin’s interesting papers on the real costs/benefits of high unemployment creating microeconomic “reform” in Australia, and I think there is a convergence of interests here.

  24. I can’t make much sense of TerjeP’s entirely negative comments.

    I agree with Ikonoclast that all money creation should be under government control. However his belief that the difference between “financing” and “supporting” is merely semantic requires further comment. The reason why the difference is more than semantic is because the issue of causality is involved.

    It is true that when central government spends, Treasury’s account with the central bank is reduced accordingly, and new reserves are created by the central bank in order to accommodate that spending. However this is little more than an accounting exercise. Treasury has a line of credit with the central bank, and the last thing any sovereign government needs to worry about when it spends is “where the money will come from”.

    The accounting operations associated with government spending are voluntarily imposed, according to conventions which predate the termination of the gold standard in the early 1970s. Under the gold standard the government had to borrow in order to finance itself, however the ties to gold were severed when the Bretton Woods system collapsed and we now operate with a pure fiat money system.

    From my perspective the existing conventions cannot disguise the causal relationship – that government spending comes first, while some combination of taxation and the issue of government bonds (to the private sector) follow in its wake. This has profound implications for the manner in which economic policy is conducted.

    Incidentally I did not say or imply that excess fiat money creation would not be inflationary. That inference is unjustified.

  25. @Jack

    Points taken. Again, I think that Jack’s comments show that Chartalists and Keynesians are not that far apart. Jack might disagree with me on that, I don’t know. Perhaps Chartalists are more honest and more willing to call a spade, a spade, and money, creation money creation. But this is probably only in relation to crude, populist economic rationalists and outwardly simplistic arguments from Gillard and Abbott. (Who knows what they really think and or know about economics.) It is probably not true to call Chartalists more honest than well-versed Keynesians.

    In a strict theoretical sense, fiat money creation has primacy and thus perhaps causality. But in the real, ongoing world does it not have a bit of a chicken and egg aspect to it? The roundabout of the sytem has been turning for a long time. Each creation of money is now a new push but not in itself the sole primary cause of the entire momentum of the system. Does that analogy make sense?

  26. As an MMTer, I don’t find any of Quiggin’s five “propositions” incompatible with MMT. I.e. there is not much to comment on.

    E.g. take proposition No. 2. This basically claims that if a government uses the printing press in an irresponsible manner, inflation ensues. Everyone, MMTer or not, is aware of that.

    The basic difference between MMT and the conventional wisdom lies in how to deal with recessions. The conventional wisdom sides with Keynes’s “borrow and spend” idea, while MMT sides with Abba Lerner’s “print and spend” idea. (Though Keynes did not vigorously oppose the “print and spend” idea.)

    The superiority of the Lerner/MMT view has been beautifully vindicated in the current recession. That is, the economic illiterates in Congress and other elected bodies (plus most economists) think that because national debts are too high, therefore further stimulus is difficult, if not possible. This is nonsense: assuming inflation is sufficiently subdued, further stimulus can perfectly well be effected by a “print and spend” policy.

    And if that looks like stoking inflation in two or three years, do what Lerner advocated, i.e. rein in money and “unprint” it.

    Moreover, given that economists cannot agree on how far crowding out stymies “borrow and spend”, it strikes me that borrow and spend is a daft policy.

    Also, Quiggin seems to be confused as to the difference between creating money by QE and creating it Lerner-wise. (That’s in the passage starting “Quantitative easing and similar operations since 2008 have created money…”). Lerner never advocated QE, except as a means of controlling interest rates.

    QE (arguably) creates no extra money at all, in that government bonds are virtually a form of money. In contrast, an unfunded deficit boosts the sum of “monetary base plus national debt”.

  27. I would say it is more appropriate to describe these positions in terms of perception and belief, rather than honesty (one usually assumes honesty in any civilised discourse). There is in practice an element of chicken-and-egg, as you say. However it seems to me that this is attributable to a voluntary adherence to well-established conventions.

    Little, if any, attention seems to have been paid to the logical implication of a belief that spending by a sovereign government needs to be “funded”. That is to say, if in the fiscal cycle it is held that raising revenue is the primary cause, and that spending is secondary, then any spending program laid out for the forthcoming financial year would need to be “paid for” from revenue collected in the previous financial year. Strictly speaking, foward revenue estimates are irrelevant.

  28. with all the angst about falling house prices in America,it seems that prices that were over the top and locked young home buyers out of the market,are now at entering the range known as affordable. l

    a segment of economic activity that was moribund has become active?
    (if i was looking for an affordable home at the moment i’d be rapt.)

    so the liquidity provided by govt prevented cash rich from capitalising on an expected outright property collapse and slowed the “collapse” to a gentle crumble that is firming up to uninflated tradable value?

    probably OT an way out of my league,but JQ seems to put up with it.

  29. I’ll try my best to summarise MMT, though with the disclaimer that I am only a student.

    The essential points of MMT are:

    1. Money is financial asset and liability (credit). All entities can create money, but not all entities can get their liabilities accepted. Entities make their liabilities more acceptable (marketable) by declaring that it is convertible into another entity’s liabilities, or a commodity, etc. This convertibility is a financial constraint

    2. the state (if it has the political power) can get around this by declaring that the population has to pay its taxes in the state’s liabilities.

    3. If the state is operating in a floating-exchange rate system, then the state faces no financial constraint in its spending (its currency is fiat currency, redeemable only into itself), it is a currency monopolist.

    4. When the government is the currency monopolist the function of taxes and bonds change:

    Taxes: primarily function to make government currency acceptable, but also to regulate demand.

    Bonds: Whenever the government spends it is effectively crediting private sector bank accounts, which creates exchange reserves (exchange settlements). If the government runs a deficit (surplus) then there is the potential for the private sector to have excess (deficient) reserves, because the banking sector cannot create or destroy reserves, means that overnight rate drops to zero (due to excess reserves) or upward (due to deficient reserves, which the banking system cannot clear) (there’s a great quote by Ian Macfarlane on this that I can dig up). The consequences of government spending on the overnight rate have been labelled ‘reserve effects’.

    The situation described above assumes that the treasury and central bank have no offset the impact. In reality the central bank and the treasury are coordinating and timing the flows to and from the treasury by ensuring that there is no ‘reserve effect’ (arguably having Interest on excess reserves and discount rate alleviates these impacts). Bonds function to drain excess reserves from the system and allow the central bank to hit its overnight rate.

    At the end of the day the following point stands: the ability to pay taxes and purchasing government bonds requires that either the treasury spend first or the central bank to issue a loan (MMT consolidates the central bank and treasury balance sheets into the ‘consolidated government’). From this we can state that (logically) before taxes can be paid and bonds purchased the government has to issue a liability upon itself.

    The only constraints upon government spending are political and real. The former is in terms of the institutional arrangements or rules which we impose upon the state when it spends (state must issue bonds equal to deficit, or a bureaucrat must run from Canberra to Sydney every time a thousand dollars are spent). These are political constraints imposed upon the state and do not represent actual finance constraints. The latter, real constraints, relates to the productive capacity of the economy as well as the economy’s dependence on importing real goods such as food, etc. There is a threshold where the economy can no longer absorb government spending by increasing production, and prices must start adjusting.

    John Quiggin said: “banks don’t lend out their reserves is a liquidity trap”

    MMT follows Post Keynesians and don’t agree with the conventional loan creation theory. They argue that firstly, loans create deposits and secondly, banks are not constrained by the quantity of reserves, but by the price of obtaining those reserves. A bank can be deficient in reserves and still make a loan. They interpret the money multiplier as an ex post accounting identity, and an ex ante constraint. Furthermore central banks are naturally defensive and accommodate the demand for reserves, firstly because central banks have a monopoly on reserves, and are targeting a price, and hence the quantity must adjust, and secondly because not doing so risks causing extreme volatility in the other night rate. Post Keynesians point to the early 1980s (Volcker experiment) as proof that central banks cannot control the quantity without causing a recession due to a collapse of the payment system).

    Sorry for the length and typos and grammar, had to write this in a rush!

  30. Okay, I couldn’t help myself.

    Re Quiggin’s points:

    1. Not entirely sure what the MMTer’s would say here.

    2. I assume by ‘money creation’ that you mean ‘printing money’. MMTer’s would argue that so long as the state operates in a float exchange rate system, then it is is impossible to talk of ‘financing’ government spending in a meaningful way.

    Bill Mitchell and Marshal Auerback have argued that excess government spending (money printing depending on the monetary system) is a necessary condition, but not a sufficient condition. They argue that when hyperinflation occurs the following is also required, 1. the government’s ability to collect and enforce taxes is diminished 2. the productive capacity of the economy is severely reduced (supply shock), 3. the government may have some debt denominated in a foreign currency.

    For example Bill has a blog post on Zimbabwe explaining that it suffered a supply shock prior to the onset of hyperinflation. Furthermore, if my memory serves me well Zimbabwe operated under a different monetary system to that of Australia and America, their currency was did not operate on a float exchange rate regime.

    3. MMTer’s argue that it is impossible to finance a currency monopolists spending in its own currency. Bonds function to help the central bank maintain its target rate

    4. Government issuing of bonds is actually a benefit for the private sector. It provides them with a risk free financial asset, an income stream, portfolio management, and a way to measure risk. Bill has previously pointed to the outcry when the Howard government was almost eliminating its debt as an example of this.

    The government doesn’t need to be ‘pushed around’ by the bond market because firstly, the bonds don’t finance govenrment spending and secondly, in an economy where the central bank is operating a corridor system, there is a threshold to how high treasury bonds can rise before the difference is arbitraged away.

    Of course, I imagine that MMTers would say that there is some threshold in which public debt to GDP cannot pass without there being consequences for the real economy. I’m imagining a situation of excessive government spending where the economy is operating at or close to full capacity.

    5. The only rule that the government should follow is ensuring that inflationary pressures remain subdued.

  31. I’ve rewritten this comment several times as there is so much ground to cover and I fear I’ll never get what I wish to say correct and concise, so this one will have to do.

    First point. Neo-chartalism / Modern Monetary Theory (MMT) is a Post Keynesian school of thought, so it will be pretty close to other Keynesian views.

    Now I understand the definition of liquidity trap as used by Krugman and Quiggin, from my study of MMT – the build up of bank reserves is because of the lack of credit worthy customers and under the current economic environment everyone is deleveraging and the banks are tightening their criteria

    Now money creation is important to the entire concept of MMT. In recognising money creation is only constrained by inflation (in today’s modern era post-71) and not a gold standard or Bretton Woods system where reserves of Gold or USD are unnecessary, as much dollars can be created as necessary up until the point of inflation.

    This is why MMT talks about a nation sovereign in it’s own currency, as the unit account is always for e.g. AUD which bonds are “financed” in so the Australian Government can never not afford them. It can always afford Aussie Dollars. It creates them (spends) and destroys them (taxes) – the rest is just accounting. A surplus is just greater taxing then spending in a closed economy (no external trade) for example.

    4. Japan. Beyond that if it’s borrowing in its own currency (eg. bonds), it can always afford to. It is what it does with that money that is important.

    5. That’s a balanced budget over the cycle thing that is unnecessary, based on a loanable funds model (set amount of money in economy) when there is no such thing. Otherwise we would have to rely on Gold or USD Reserves and there would be limited flows of currency.

    As I said before, I don’t believe there is any economic school of thought that disagrees with the accounting identity C + S + T = GDP = C + I + G + (X – M) which becomes:

    (I – S) + (G – T) + (X – M) = 0

    After that its just a matter of envisioning a fiat currency being introduced to a sovereign non-monetary economy (that is the State issues the money) complete with the automatic stabilisers that we’re all familiar with. Taxes fall when more people are on welfare and thus the government receives less revenue and rise the more people are employed.

    The ultimately goal being getting as many employed into productive activity as possible and where the private sector fails it is the role of the government to step in and advance public purpose and employment is the best way to do that.

    And for studentee (on the past post), I apologise, it is considered cost-push but a different type of cost-push – meeting a negative supply shock with a negative demand for an essential activity just isn’t going to cut it. Alternatives to that supply must be found and I believe that is what happened.

    From an Australian perspective, I daresay that’s why the Whitlam government struggled (no proof) and Australia didn’t really deal with it until monetarism, neoliberalism and the new consensus paradigm prevailed, if somewhat erroneously in the MMT view.

  32. Dear John,

    I understand macroeconomics very simply: there is the ‘skin of the earth and its resources’ and there are human beings. In between them are human values, made concrete in a monetary system (which is just an accounting record). It’s all about distribution and use of resources: environmental, ecological, societal and individual impacts – and the attempt to resolve ‘value’.

    MMT just recognises that ‘credits’ are infinite, are not tied to anything – and describes absolutely accurately in my view how the monetary system actually operates in accounting for resource use and distribution: it proposes limiting the infinite creation of credits by matching their creation and distruction to the real capacity of the economy. It also proposes a floor to the economy in terms of a Job Guarantee at a minum wage deemed acceptable by the society – (since government can afford to buy anything that is for sale, and the unemployed are unwanted by the private sector).

    If you could create your own credits, would you practice austerity, save, or worry about your budget position?? These should not be a problem, but values and real resources are!

    Would second the notion that you read the core literature, and yes – you “really should get around to looking into this (MMT)” – I think the logical development embedded in the theory would fascinate you. Over twenty years of academic work by your peers should not be just sneezed at – as you regard twenty years of your own.

    Cheers …

  33. It seems to me the more they print the more worthless it becomes in a situation like the liquidity trap in the US… just cant get those without a job or insufficient savings into the banks to borrow the money to spend it.’

    Back to Keynes. Get in the helicopter and rain down jobs not Ben’s worthless money. If there isnt enough willingness to borrow (oh Japan, oh Japan) you have nothing left except a decent government that is prepared to borrow to finance big jobs and hope for a rollout to thr private sector. Just pray you have a government who can see it and isnt beholden to Moodys.

    This is such an old old story but real unemployment / casual unemployment getting higher (not fake NAIRUS and fake one hour unemployment exclusion and people on disability pensions now higher in Australia than those on the too harsh unemployment benefit criteria.

    My god, people without jobs who cant get them are flooding diability pensions.

    Speaks for itself. You can lead a horse to water with low inflation and low interest rates, but you can make them drink, if people arent willing to spend.

    Jobs are what is needed and no amount of that blunt inneffective long lag to be effective, tool called monetary policy works in this situation and its amusing watching the US fed do handstands trying to prove their worth right now.

    Much like fiddling while Rome burns.

  34. @jrbarch

    Apropo talking about the recognition of the work of others:

    “MMT just recognises that ‘credits’ are infinite, are not tied to anything”

    It is not due to the MMT to ‘recognise that credits are infinite’. See Radner 1973 (there is no natural lower bound on securities).

    “If you could create your own credits, would you practice austerity”

    No, if you are a Wall Street banker. You would try to impose austerity on others.

  35. @jrbarch

    “It also proposes a floor to the economy in terms of a Job Guarantee at a minum wage deemed acceptable by the society – (since government can afford to buy anything that is for sale, and the unemployed are unwanted by the private sector).”

    Why should an engineer who works on the construction of a government owned and funded public infrastructure project be paid a minimum wage instead of the wage payed for the same technical knowledge hired by a private firm?

    Are you saying that all research scientists who don’t work for private companies should be paid a minimum wage?

  36. I can understand JQ’s desire not to get bogged down in arguing over what’s “money”, but what I ma seeing here is a lot of skidding around between different implied definitions of “money”, with different consequences attached to each definition.

    MDM captures one view:

    1. Money is financial asset and liability (credit). All entities can create money, but not all entities can get their liabilities accepted. Entities make their liabilities more acceptable (marketable) by declaring that it is convertible into another entity’s liabilities, or a commodity, etc. This convertibility is a financial constraint.

    And this is historically correct. Money started out as a standard unit of account, which could be issued by anyone, and so each source was discounted according to judgements about the creditworthiness of the issuer – more accurately, the probability of being able to turn each particular money into real goods and services. Governments were just another issuer, although more able than most to insist on the recipient taking face value. Nowadays we would call most of this money corporate debt.

    I would guess JQ’s base money (the 10% of GDP) is the fraction held as a medium of exchange. The rest is various debts, public and private, plus the meta-money that races round the world in currency markets (about 3 times US annual GDP daily).

    JQ’s arguments are about the relationship of the medium of exchange to the available supply of real goods and services, and seem sound as far as that goes. The other arguments are about debt money.

    I see what’s missing on both sides is the constant interchange between medium and debt. Bubbles are debt feeding into money. Mostly private, sometimes government. Default is a perfectly (historically) normal way of periodically writing off private and government debt. This need not affect the supply of exchange. As the losers are mostly the rich, there is a strong tendency to try to make government default against the rules (and private default as hard as possible). One tactic is to confuse “government debt” with “money”, so people will think default affects the money in their pockets. This has been effective (this is not to deny there are effects of default).

  37. This discussion is a relief compared to the discussion of MMT at the Austrian blog where I’ve just been.

    I don’t agree with any of points 1-5, but most of the disagreement seems to be with regard to the government’s need to “finance” spending. Even when the government issues bonds, it is still creating money out of thin air. Thus we in the U.S. have a national debt of $14 T. This is money that has been into existence by the government. To that should be added all the currency and reserves in existence.

    For each bond the government issues to pay for the deficit, it spends an equivalent amount of cash. For example, if the government spends $100 billion more than it collects in taxes, it withdraws that $100 billion in exchange for interest bearing bonds. No net cash has been subtracted from the economy. The services have been paid for with bonds added to the existing cash base. From the macro perspective, the government didn’t really finance anything. It just paid for services with IOUs instead of cash. Another way of looking at this is that it credited savings accounts (time deposits) instead of checking accounts (demand deposits).

    I see no reason to believe that the concept of liquidity trap matters. The above is true regardless of what interest rate the government pays. But perhaps I don’t understand what you mean by this.

    The empirical discussion here seems to be of Zimbabwe and the U.S. in the 1970s and 1980s. Obviously, Zimbabwe is the special case of a generally collapsing economy, and I don’t think any MMT advocate would say that Zimbabwe’s problems are solvable by just printing more money. The case of the U.S. in the 1970s and 1980s is infinitely more relevant.

    I don’t have any idea why John thinks that the experience of the 1970s and 1980s supports his point number 2. No one is saying that inflation can’t exist when money is created (large fiscal deficits). So maybe we agree. But what does this have to do with issuing bonds (IOUs) as opposed to paying as you go with cash?

  38. I think its a disservice to the beautiful country of Austria to have such an absurd school of economics named after it.

    I think that school should be called the Hayekians (pronounced Hackians) or the Miserians.

  39. Ernestine Gross :@jrbarch
    “It also proposes a floor to the economy in terms of a Job Guarantee at a minum wage deemed acceptable by the society – (since government can afford to buy anything that is for sale, and the unemployed are unwanted by the private sector).”
    Why should an engineer who works on the construction of a government owned and funded public infrastructure project be paid a minimum wage instead of the wage payed for the same technical knowledge hired by a private firm?
    Are you saying that all research scientists who don’t work for private companies should be paid a minimum wage?

    Ernestine, MMT advocates don’t propose that everyone who works for the government be paid a minimum wage. They propose that the government should make minumum wage jobs available to anyone who wants one.

  40. A little off topic but I’ve been following Prof. Quiggin’s blogging since at least 2003 when I was more interested in the political side than the economic side and had not had my economic enlightenment yet but I have much respect for Prof. Quiggin. It is he via the other political blogs that led me to Club Troppo (amongst other econ blogs) and then Peter Martin and then Bill Mitchell where I finally found an economic school of thought that wasn’t jargon laden and that anyone with a logical mind could understand. Though in recent times it does seem those trained in economics have difficulty unlearning things but many in the finance sectors intuitively grasp the sound logic of MMT. It is also relatively easy for the layman to pick up. I actually wonder if this school of thought is like news media vs. blogs and this is established economics vs MMT.

    I’ve digressed enough, my point is for all the neo-chartalist / MMT advocates here to show a little respect for Professor Quiggin. We don’t need to talk about ignorance, from non-MMT point of view we’re the ignorant ones and we have to show the logic of why in Prof Quiggin’s case the New Keynesian paradigm he uses has erroneous assumptions. This is not a US blog where uncivil discourse is par for the course, it is not Bill Mitchell’s blog where we’re all familiar with his sarcasm, this is John Quiggin’s personal blog and we should respect that. Also please see his comments policy.

  41. Shorter New Keynesians: “We must pay with IOUs. Paying with cash is irresponsible and the road to ruin.” Oops, I mean, “We must finance with IOUs.”

  42. John Q keeps pointing to 1970s / 1980s as evidence of something, but I’m not sure what. Both groups would probably advocate similar policies at that time. Or am I missing something?

    One clear difference is that the Hard Keynesians seem to worry about the deficit, while the MMT folks worry about inflation and employment. Occasionally, these concerns would result in different policies, although I’m not sure I could point to any specific historical instances where the Hard Keynesians would have preferred that the U.S. (or some other government) run a surplus, while the MMTers would have wanted bigger deficits. Until we have more specific situations to discuss, it’s hard to compare…

  43. I have to second Senexx post.

    John Quiggin is a great economist. I would really appreciate his thoughts on MMT.

  44. Point well Senexx. I have also been an admirer of Prof. Quiggin, and continue as such.

  45. Hey my man Senexx-

    How about this for a semi-testable prediction:

    “John Quiggin will be the biggest proponent of MMT once he groks it.”

    What do you think? Biggest is so wonderfully subjective, and “multi-meaninged”. But my prediction stands. I think I might add it to my strategic ideas page.

    I agree on being civil. Prof. Quiggin is one of the good guys. A little – no a huge amount – of respect and civility for the guy who wrote the book on Zombie economics is mandatory.

    I’ve been reading CT for years, and this blog too. We’re lucky to have him kicking around the ideas of MMT.

    Prof Quiggin,

    You can go to Moslers, or Senexx’s blog, or my Blog and get a good start on it. If you go to mine, go to “insolvency vs. debasement”, or since you are talking about budget constraints, go to an embarrassingly arrogant post called “Chapter 2: In Which the Traders Crucible slays the Intertemporal Government Budget Constraint, and Mr. Rowe demonstrates his Worth”

    Also, JKH is the person. He may not be a MMT person, but I think he can explain the core concepts of MMT as fully and in more detail than any other person alive. His comments are everywhere all over the web – he is a big league player, if you don’t know him already.



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