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.
John Quiggin 
[…] Welcome, Prof. John Quiggin! May 10, 2011 TC Leave a comment Go to comments Prof. John Quiggin, author of Zombie Economics, and of Crooked Timber is asking about MMT at his blog. […]
jrbarch, James Haughton, thank you for your clarifying replies.
James, your account of the role of ‘money’ in colonial history corresponds to my reading. But it is time and place dependent (eg the colonialisation of Australia does not fit the picture). But then the complexity of socio-economic-politicl systems makes the subject all the more interesting.
I don’t have a problem with functional finance as a way of looking at things. As I see it, it involves starting with the desirable level of public expenditure on a benefit-cost basis, then determining the mix of tax, debt and monetary financing on macro grounds.
I think the main risk is the temptation to think that you can have a lot of monetary financing and therefore don’t need to worry about deficits or debt. Most of the time, this is wrong. Still, that’s an empirical/judgement question, not a point about the theoretical framework.
As a point of possible disagreement, Hard Keynesians nearly all opposed the Bush tax cuts. I get the impression at least some MMTers welcomed them in macro terms, although they might have preferred a more progressive distribution of the benefits.
All this talk about the gold standard having limited currency/money creation is misguided. Under a gold standard the monetary authority could issue any amount of new currency so long as it did not cause the gold price to exceed the top of the price window. It isn’t radically different to a system in which the monetary authority can issue any amount of new currency so long as it does not cause the consumer price basket to rise above a threshold. The distinction is around the feedback mechanism that constrains the activity. What to use as your price guide for currency creation, be it the consumer price index, the price of gold or an exchange rate is ultimately a political consideration (hopeful informed by economic insight).
John Quiggin,
Thank you for your continued engagement with the topic.
>I think the main risk is the temptation to think that you can have a lot of monetary financing and therefore don’t need to worry about deficits or debt. Most of the time, this is wrong. Still, that’s an empirical/judgement question, not a point about the theoretical framework.
I’m interpreting this to mean ‘the claim that deficits and debt doesn’t matter is wrong’. MMTers would agree with you 100%. Deficits and debts do matter, they have an impact upon the real economy and how real resources are distributed and impacts upon the price level. What doesn’t matter is any concern of government solvency, since the government is the sole issuer of its currency, it’s not like a household and it doesn’t face a financial constraint.
>I get the impression at least some MMTers welcomed them in macro terms, although they might have preferred a more progressive distribution of the benefits.
The way MMTers define their research program is by splitting it up between descriptive and prescriptive components. They all agree on the descriptive side, but there are disagreements on the prescriptive side. So for instance, some of them may have favoured the tax cuts, whilst others may not (implicitly I imagine that they may differ on the impact of tax cuts on the real economy).
@John Quiggin
I think the main risk is the temptation to think that you can have a lot of monetary financing and therefore don’t need to worry about deficits or debt. Most of the time, this is wrong. Still, that’s an empirical/judgement question, not a point about the theoretical framework.
It is a temptation, but in general MMT is well aware that spending is not unlimited. Nobody I am aware of in the MMT world advocates spending something like $100 trillion so we’d all be living in houses made of gold or something like that.
I’d say that MMT makes the link between spending and inflation far more explicit than the standard model. It also recognizes the demand for savings in the medium of exchange as being extremely important to the final inflation rate.
@MDM
“The way MMTers define their research program is by splitting it up between descriptive and prescriptive components. They all agree on the descriptive side, but there are disagreements on the prescriptive side.”
Yep. The plumbing of the monetary system isn’t really up for debate, but what to do after you recognize the operational reality we face, well that is up for debate.
@James Haughton
Bravo James, excellent summary. Scrooge McDuck would surely flip you a doubloon for your efforts.
@TerjeP
While you are theoretically correct, the problem that arises with gold is the fact that it is limited in supply, and therefore subject to price manipulations and a high volatility.
A similar problem does not exist, with fiat money — the money supply is almost completely in control of the issuer — money creation through spending, and money destruction through taxation. There is the issue of international trade and the requirement to balance X and M and that under MMT is done through a floating exchange rate and market. Volatility in the Forex markets can be there, but it should theoretically only impact the movement of goods and services internationally. Theoretically, in a healthy economy, X-M should be close to zero, and the bulk of GDP should be neither X nor M.
@TerjeP
Thanks TerjeP for drawing out a common framework of analysis between austrianism and post-keynesianism; what you take as your feedback mechanism is indeed very important.
I think the point that MMT people are making when they talk about gold-standards is slightly different; it is about the historical/logical order of government spending. If government has to back its spending with gold (either actual gold coins or notes backed with gold) then, logically, it must tax before it can spend; it has to get gold from somewhere. If government spending is unbacked except by the power of taxation (people want the government paper because they can use it to settle their tax liability with the government, on pain of various unpleasant things) then, logically, the government must spend before it can tax; government expenditure is the only source by which people can acquire the money which they then pay back to the government in taxes. Hence the use of money as a mechanism of colonial subjugation. Spending leads taxation also appears to have been the case in the ancient world; the “metallism” theory of the origin of money isn’t supported by the archaeology.
This insight is congruous to the MMT/Post-keynesian point that, in the private banking system, deposits don’t create loans, loans create deposits, and the “money multiplier”, “fractional reserve” story is entirely erroneous. Banks can and will always lend to anyone they think creditworthy, irrespective of their reserves, and if they exceed their reserve requirements (which many countries, including Australia, have now abolished entirely) they borrow from the other banks at the inter-bank rate, or from the central bank if that is unavailable; the central bank effectively cannot refuse this loan, if the central bank were to refuse credit to a private bank, it would cause a crisis of confidence, bank runs, etc. Hence why Obama’s action to boost bank reserves was ineffective; boosting reserves didn’t have any effect on bank’s willingness to lend. (It’s been empirically verified that bank loans lead bank reserves in expansion).
@ Beowulf; thanks.
@ John Quiggin: I also thank you for continuing to discuss the topic.
My understanding of where you are going is that you’re willing to accept the functional finance framework and account of money creation, but hold that issuing debt is preferable to taxation as a way of draining private reserves and “making space in the economy” as Swan/Gillard put it, to ensure that the difference between government expenditure and government takings doesn’t lead to bubbles, inflation, etc in the private and broader economy. Would that be right?
@JH I would state my financing views as follows
1. Nearly all expenditure financed by taxation over the course of the business cycle
2. Some extra (deficit)spending financed by debt in recessions
3. Debt reduction (from surpluses) after recovery from recessions
4. Money creation only important as a finance source in liquidity traps
I agree with the historical/logical point about the order of things, but I don’t think it has critical implications for policy.
@TC
Just a quick reply mate, my blog is mostly (but not completely) Bill Mitchell’s work broken down so any layman or undergraduate can understand it.
TC I think your prediction is possible but as I commented at Mike Norman’s Prof. Quiggin and perhaps Aust. best known economist (in Oz), Saul Eslake gets it then MMT has it made in Australia
@James
An excellent summary of much of the MMT position, in alignment with my own thoughts.
@JQ
“I agree with the historical/logical point about the order of things, but I don’t think it has critical implications for policy.”
I find this statement puzzling, because the logic of the MMT case leads to the conclusion that so-called public debt is not really debt at all, and cannot be compared with private debt. Government doesn’t need to draw on revenue, borrow or sell assets in order to cover its “debt,” as households and firms do.
Another way to view public debt is as the net financial wealth of the private sector, that is, as private sector savings. These financial savings can be held many ways, but Treasury bills/bonds are the most secure form. While it is true that the “nation” owes a debt to the owner of a Treasury instrument, since saving this way should persist as long as the nation endures, the national debt need never be paid off in full (unlike private debt) and can be rolled over generation after generation letting future generations obtain secure savings in Treasury loans and letting government use the savings of the people for only the cost of interest payments, which it “prints” from thin air. The savings function is logically more valid than the debt function of Treasuries because the nation is a perpetuity.
Jack – using this framework then what is the solution for Greece?
TerjeP,
MMT argues that Greece is in a different monetary system to that of Australia, England, Japan, US, etc. Countries in the European Union can be ‘compared’ to the states of Australia. Taxation and bonds do finance Greek government spending and the Greek government does face financial constraints.
Prior to the formal establishment of the EMU there were several Post Keynesians arguing that the EMU was an unworkable system. Their essential point was that the EMU lacked of supranational treasury body equivalent to the ECB, and when if the EMU was to be hit with a crisis, then it would be unable to respond adequately with the risk of several countries defaulting.
Dear Professor Quiggin,
Thanks for engaging with the rogue bunch that MMTers can sometimes be in such a civil way! I remember I sent you an email about a year ago, proposing you should look into MMT. Seems you heeded my advice, so I’ll take full responsibility ;-).
A lot has been said in the comments above, and there is infinitely more to read about in the other blogs and of course the academic literature, so I’m probably best advised to keep it short:
It seems MMTers, as good Post-Keynesians, but taking it a step further than others in the tradition, have, by studying the movements and operations of modern monetary system, found empirical evidence for a degree of devolvement between real economic activity and its counterpart in money that debunks most of the conventional economic models that are around and have subsequently built their own models to suit those findings.
In a nutshell, MMT sees money as an enabling but not a limiting factor for the upside of real development (or only limiting at the very noticeable threshold called full-blown inflation, or a collapse in exchange rate), while it posits that it is very much a limiting factor for the downside, especially with regards to unemployment. In any case, monetary policy is in no way a justifiable punitive tool against, admittedly very real, problems that, in its analysis, are usually caused by imprudent individual or group behaviour. MMT posits that such micro problems should not be treated with a macro tool such as monetary policy, for this is at best counter-productive, and often just plain evil. Instead they should be targeted individually, either via regulation or specific (fiscal) interventions (see Mosler’s proposals for the banking system, re regulation e.g.)
Your point 3 above points to the fact where, from an MMT perspective, New-Keynesianism is moving in the right direction, but has not factored in time, growth and the infinite elasticity of a fiat system properly. I have seen many economists make statements to the extent of: growth in monetary aggregates must be equal to, but may oscillate around, real growth during the course of a business cycle (or whatever time frame they like to focus on), or else….
But, if one accepts that a: money itself is hard to define (as you admit above), b: its aggregates are determined endogenously by the economy (standard Post-Keynesianism), c: its supply is infinitely elastic (a point of logic for fiat money), d: there is a safety valve called the exchange rate (which is preferable to the safety valve called inflation or, even worse, the unemployment rate) and e: any time span to base a fiscal rule on is completely arbitrary, the shape of that oscillating curve becomes rather hard to define. And so, the focus for economic policy in MMT automatically turns away from money and its derivatives and on to the nuts and bolts that make up the real economy. It is this focus on real endeavours where MMT has most in common with the Austrian school of thought, but it is also in its meticulous separation of monetary and real economic measures where the two schools differ most.
Hope that was clear and not too telling of my ignorance.
I don’t understand the claim that 4 entails 5. I’m not saying it’s false, only that I don’t understand it.
For a country that grows consistently over the long run, can’t it run deficits forever without increasing either its debt-to-GDP ratio or debt service-to-GDP ratio? If that’s right, I don’t understand the intuition that the periods of deficit need to be “balanced off” by periods of surplus.
TerjeP, I would say much the same thing as mdm — who beat me to it. The MMT framework that we have been discussing applies to sovereign governments who issue their own independent currency, in addition to collecting income taxes and engaging in market operations with government securities. Regional governments, including the U.S. states and the Australian states, do not fall into this category. Neither do Ireland, Greece, Spain or Portugal. The solution for Greece is obvious.
The idea that governments should run surpluses “after recovery from recessions” strikes me as somewhat unhinged. For example, the U.S. is now in recovery from a recession. At what point would Hard Keynesians say we need to start running a surplus? I apologize in that I am obviously not familiar with the Hard Keynesian literature on this score. Anyway, my impression is that government surpluses are few and far between (and for good reason).
I understand the MMT position — consider employment and inflation (in that order) and loosen or tighten fiscal policy accordingly (while recognizing the need to consider other factors such as financial stability, income distribution, and the overall welfare of the people). Hard Keynesianism seems similar, but deals in absolutes (fiscal surpluses) rather than relative changes to fiscal policy (tightening / loosening).
The fact that Hard Keynesians cling to the (to me) discredited notions of insolvency and bond vigilantes in support of such policy recommendations is important. With regard to rising interest rates and bond vigilantes, most of the problems of this type that I have seen have resulted from attempts to peg a currency. The current problems of the peripheral Euro nations are in this category (e.g. Greece’s currency is the Euro which is tied to many other nations). Black Wednesday refers to the events of 16 September 1992 when the British Conservative government was forced to withdraw the pound sterling from the European Exchange Rate Mechanism (ERM) after they were unable to keep sterling above its agreed lower limit. The Argentine Currency Board pegged the Argentine peso to the U.S. dollar between 1991 and 2002 in an attempt to eliminate hyperinflation and stimulate economic growth. While it initially met with considerable success, the board’s actions ultimately failed. Examples such as these, along with the extraordinary examples of Zimbabwe and Weimar Germany, are used to falsely scare people regarding the dangers of rising interest rates and fiscal deficits. The reality of fiscal deficits in relation to inflation and interest rates is much different, as we have discussed here before.
Also, the notion that bonds always must be issued to finance deficits EXCEPT DURING LIQUIDITY TRAPS seems too convenient.
The empirical evidence (Japan, U.S., U.K.) clearly states that governments can “finance” deficits without issuing bonds. Twenty years ago this sort of monetization would have been thought drastic, no? But we tried it and the world didn’t end. In fact, quite to the contrary, the effects have been minimal, just as MMT would expect. Krugman was one who advocated QE as a solution to Japan’s problems, and I believe he was wrong about that.
Please correct me if I have any of this wrong. Great conversation…
Also, it’s counterintuitive (to me) that paying with IOUs is considered more fiscally responsible than paying with cash. Shouldn’t the New Keynesians at least to least make an attempt to explain what the mechanism would be that would prove IOUs more fiscally responsible?
@Ernestine Gross
Ernestine – FYI. Widens the Job Guarantee discussion to exchange rate policy. The context is interesting in that it’s 1998 and the warning Mosler gives about a ‘mother of all bubbles’ prescient. Cheers ..
Exchange Rate Policy and Full Employment
jrbarch
@Dan Kervick
Point 5 doesn’t say it’s impossible to run consistent deficits. You can do this and still maintain stable debt/GDP ratios. But if you want large (enoug) deficits in recessions, you need to run surpluses at other times.
For example, suppose you want to maintain a 60 per cent debt/GDP ratio and the long-run rate of growth of nominal GDP is 5 per cent. Then you can sustain a consistent deficit equal to 3 per cent of GDP. But if you want to run a 10 per cent deficit in deep recessions and a 5 per cent deficit in the recovery phase, you’ll need surpluses at other times to stay on track.
“The empirical evidence (Japan, U.S., U.K.) clearly states that governments can “finance” deficits without issuing bonds. ”
Not so for the US pre-2008, as I showed in point 1, and I’m pretty sure the same is true for the UK. Japan has been in a sustained liquidity trap position for a long time and is therefore not a counterexample, but I think that in fact they have used debt finance, contrary to the urgings of Krugman and others.
Prof. Quiggin, I believe there is a stable level of government deficit that promotes growth. It’s a deficit level just large enough to create private incomes to make private businesses stable, and willing to hire more people, and thus leading to a positive spending multiplier.
I try to anwer in more detail here:
http://rogueeconomistrants.blogspot.com/2011/05/answering-john-quiggins-propositions.html
Hope it helps.
The purpose of the historical/logical point is to question your statement (1). Since spending must precede taxation, it cannot be said to be “financed” by taxation in any sense except an atemporal one; nor is there any conservation law that limits the amount of money in circulation. Of course, issuing infinite amounts of currency would have terrible practical consequences; but requiring spending to match taxation+debt is not the only way to limit the amount of money in circulation, and, if this approach leads to higher unemployment, it’s probably not the best way to do so.
My understanding of MMT’s perspective on central bank and treasury operations is that taxation acts not to “finance” government spending but to guarantee the value of the currency and to withdraw sufficient money from the economy that there is space for private activity and inflation does not become a problem.
Selling government bonds, if I understand correctly, is just another way of draining the total money in circulation; as it trades money for an interest-bearing asset, it’s one way of turning a one-off spending burst (e.g of infrastructure, or income support in recession) into gradual expansion over time, but again, it may not be the best way to do so, since (as we are seeing now) it leads to deficit hysteria and unreasonable demands to “pay back the debt” at a time when many economies are struggling with deficient demand. In a recession the money supply can be expanded without inflation whether or not bonds are issued to cover the expansion, as QE1&2 in the US have shown, The US would probably have gotten much better bang for their new bucks if they’d used them for public works instead of shuffling the bond market’s bits of paper.
“The BOJ began doing quantitative easing in 2001. It had become clear that pushing interest rates down near zero for an extended period had failed to get the economy moving. After five years of gradually expanding its bond purchases, the bank dropped the effort in 2006.” [http://online.wsj.com/article/SB10001424052748704444304575628403102379326.html]
So my point remains that QE has been tried by the Japan, the U.K., and the U.S. in recent years without much impact one way or the other. You believe that this is only the case in a liquidity trap but I don’t find your arguments convincing.
So I guess we’ll have to agree to disagree on this point. The more significant disagreement perhaps concerns the necessity of high interest rates to attract investors. Anyway, I appreciate the opportunity to discuss these issues on your blog…
PS I’ve often found an alternative version of Paul Krugman’s “baby sitting co-op” analogy useful in understanding MMT. Krugman talks about the co-op that issued insufficient coupons for babysitting (currency backed by a service), so as a result everyone hoarded their coupons, no-one went out, etc, until eventually more coupons were issued and the entire thing was kickstarted back into action.
If, however, those coupons had had to be “borrowed” from the central bank of babysitting, and “repaid” with interest later, it’s pretty obvious that withdrawing the coupons from circulation to “repay the debt” would simply plunge the co-op back into non-baby-sitting recession, whereas having an ongoing “deficit” caused by coupons being printed without debt to fill the inadequate effective demand has no consequences at all, at least, none that I can make out.
To DD and JH, check the numbers in my point 1. Additions to the base money stock pre-GFC were around $50 billion per year or 0.5 per cent of GDP. That’s consistent with a stable ratio of base money to GDP of around 10 per cent.
“You believe that this is only the case in a liquidity trap but I don’t find your arguments convincing. ”
Well then, find cases where it has happened other than in a liquidity trap and without generating high inflation. Given the attractiveness of a policy option that allows spending with no associated increase in tax or debt, such cases should be easy to find.
I don’t think MMT has any problem with the idea of maintaining a stable ratio of base money to GDP in non-recessionary circumstances, but those with more expertise than I may disagree.
I believe that the point that Bill Mitchell in particular is making is that as matters currently stand, the unemployed constitute a permanent recession, a resource that is un- or under-used because there is insufficient effective demand to use them. As you point out, expanding the base money supply in the US during a general recession had no inflationary effects. It seems reasonable, then, that an expansion of the money supply which was well targetted at employing the unemployed (e.g. through a job guarantee or labour-intensive public works) would not be inflationary either, provided that people are employed at the minumum wage and that the government is not therefore bidding against the private sector for their services.
Counterexample: I don’t know how the central bank/treasury relationship worked during Australia’s long boom of 1946-72 so I don’t know if it was done through base money expansion per-se or not, but we managed to have 2% unemployment with low, stable inflation through demand management during that period, while both net and gross public debt consistently declined: “By 1974, gross debt had declined to around 8 per cent of GDP from a peak of around 120 per cent of GDP in 1946” – Treasury Paper, “A history of public debt in Australia”. In fact, public debt appears to have been consistently above that 1974 level since then, when (at least nominally) everyone turned away from Keynesianism. Victor Quirk, one of Bill Mitchell’s students, has recently completed a PhD on this period.
I think that once full employment as MMT defines it (2-3%) was reached, there wouldn’t be much difference in fiscal policy between MMT and “hard keynesians” as both would recognise that further government expansion would be inflationary unless “financed by debt or taxes” (as the HK put it) or “matched by withdrawals of money from the private sector using taxes or bond sales” (as MMT puts it). Possibly MMT would have a more expansionary policy matched by higher taxes on rentiers, to discourage the growth of private sector debt, which doesn’t seem to be addressed much by HK theory. The difference is a bit like that between Newtonian and Einsteinian mechanics; until you get very big numbers or unusual (from a human perspective) circumstances, there really isn’t much difference in the maths, but the conceptual frameworks are very different.
Much like Keynes saw neoclassical economics as a special case applying only when aggregate demand was full, I think MMT views Hard Keynesianism ideas about deficits and “debt” as a special case for financing infrastructure and other things where it is better to amortise the impact of government spending over a longer time period, but rejects the idea that it is necessary to finance recession-busting spending with “debt” – and, as stated above, high unemployment constitutes a permanent recession, probably maintained for political reasons. Of course, when Keynes was working the world was still on a form of gold standard.
This claim that spending precedes taxation seems contrived. There are only a few basic ways to consume. You produce, you trade, you are given, you borrow or you steal. The same is true for government. And for a government to get started from within the midst of an anarchy it seems improbable that it should do anything other than be given or steal. Even before it prints money it must acquire a printing press.
From a normative point of view I’d like money creation, be it via gold coins or otherwise, to be purely a private sector initiative precisely because I don’t want this thing called government free to consume at will. Who would wish for such a dangerous monster. Who but socialists would wish to create a framework that encourages it.
@James Haughton
I think you make many important points on this post but I just want to stress my understanding of Neo-chartalism / MMT definition of Full Employment is zero underemployment and only frictional unemployment – which it supposedly was in the time period you refer to James.
I have found the historical example. The Bailwick of Jersey (the Channel Island) and its parishes issued their own “Jersey pound notes” in the aftermath of the Napoleonic wars, (1831-1890) to pay for reconstruction and infrastructure. As these were received in taxes, the government(s) burned them, thus keeping the currency supply under control. Throughout this period Jersey pounds were exchangable for British pounds and french livres, an indication that this practice was not excessively inflationary.
It’s worth noting that both Jack Lang and Gough Whitlam proposed doing something similar when their supply of government finance was blocked. The removal of both men by constitutional coup d’etat gives an indication of why historical examples aren’t as common as Prof Quiggin suggests.
@TerjeP
Hi Terje, I’ve been following you just as long as I have Quiggin. In today’s post 70s world we have a modern fiat currency and I’m sure you accept that. So imagine Australia had a non-monetary economy before the introduction of this fiat currency, I know it didn’t but bear with me, so when Australia introduced this currency that was backed by neither gold nor USD where did the first dollar come from? Out of nowhere because the government through the RBA & Treasury created it. So logically spending has to come first. You can’t tax something that doesn’t exist.
In reality we had dollars backed by gold and then USDs, probably all the way up until we floated our dollar, so what really happened was the function of our dollars (currency) changed. Or at least that’s how I look at it.
I’ve only read the first three chapters of L. Randall Wray’s Understanding Modern Money and I’m paraphrasing here: Historically bank notes were issued by different banks and circulated as currency but no one trusted the value of each others bank notes, so eventually we established clearing houses which accepted each bank note on par for the others. These clearing houses eventually evolved in what we have as today’s central banks.
@TerjeP
So, let me get this right, “government” is a dangerous frankenstein’s monster, and limited liability joint stock corporations employing private armies” are entirely natural and normal products of the unregulated free market. Is that right?
You can express all the normative viewpoints you like, but money is the historical child of governments. Acephalous societies have never produced anything equivalent; exchange in acephalous societies nearly always consists of limited spheres of exchange which are not inter-exchangable. In historical times, money has usually been introduced to colonised societies by force, and produced violent revolts more often than not. You can call that theft if you want.
I think most socialists see some form of government as inevitable and therefore want the governed to have the maximum control over the governers. Libertarians, by contrast, jump from the observation that “no government works well all the time” to the belief that “No government works well all the time!”
@TerjeP
The logic underpinning the MMT claim that central government spending precedes taxing seems clear to me, and not in the least contrived. Moreover, it appears to me that you are conflating two separate (even if not fully unrelated) issues: (a) whether changes in the money supply are (or should be) endogenously driven, and (b) the causal relationship between government spending and taxation.
Whether or not new money is created by the public sector or the private sector is an important issue, however it is a red herring within the context of this debate. Put simply, modern governments are never free to consume at will, and their spending is constrained in all sorts of ways. This remains true irrespective of the mechanism by which money is created.
The comment ” … I don’t want this thing called government free to consume at will. Who would wish for such a dangerous monster. Who but socialists would wish to create a framework that encourages it” tells me more about your ideological predisposition than anything else (not that I am unsympathetic to your concerns, but making a statement that is not particularly relevant to the context is revealing).
Interesting discussion. My conclusion is that the MMT has a ‘logic’ which dissipates when the problem addressed is viewed in a larger model. By contrast Prof Q’s argument makes sense to me against insights from the general equilibrium literature.
Specifically, a) fiat money is a type of security; b) Radner (1973) discovered (theoretical knowledge) that, in contrast to commodities, weights in a portfolio of securities can be negative quantities. This translates into ‘absence of a lower bound’ (ie the Edgworth-… diagram looks like an empty page. Radner ‘solved’ the problem by choosing an arbitrary lower bound (ie like saying I set the debt/something, say GDP ratio at x%). It is an ‘exogenous’ bound – not derived from preferences or quantity constraints. O. Hart ‘endogenised’ the bound by making very strong assumptions on preferences (each and every individual has to have strictly risk averse preferences and price expectations in a ‘closed cone’). Now, the Radner model doesn’t have a government. But, when it comes to ‘buying’ (spending) and revenue – ie one ignores the coordination role which all macro-models ignore as far as I can tell – then there is nothing I can see which needs to be changed. Oliver Hart’s assumption is clearly not fulfilled in reality (Wall Street bankers as a catchy marker). Prof. Q’s position is that the net borrowing has to be bounded (this is defined in an intertemporal model and therefore needs no further explanation to what Prof Q. has said already). Prof Q’s position is, IMHO, an interpretation of Radner’s arbitrary bound. The MMT people now want the government to act like the proverbial Wall Street Bankers. Not a good idea, I’d say.
Suppose the MMT idea would become popular. My prediction is that it would lead to a ‘beggar-they-neighbour outcome. Not a good idea.
There is something else in favour of taxation. Our current system (call it capitalism, financial capitalism, or whatever) looks like having the characteristic of systematically concentrating wealth (I won’t accept a productivity differential argument because the industrial organisation is such that wealth transfers are possible). In other words, the rich get richer and the poor get poorer. In the absence of unanimous agreement of a total system change (to what?), it seems to me a counter measure is to use taxation and income redistribution. The latter may take the form suggested by the MMT.
The MMT proposition that ‘spending’ (gov) comes before taxation looks to me like someone ‘spending’ on the purchase of a house after having negotiated a mortage. Depending on which paper trail one looks at, there may be an appearance of spending leading payment. But when one looks further, there is one point in time when the purchase contract and the financial contract is exchanged.
An insight from the theory of incomplete markets is that the investment decision is not separable from the financing decision (in contrast to Fisher, around 1900). Source: Maggill and Quinzii, Theory of Incomplete Markets..
@John Quiggin
Ok, I see what you’re saying then John. But, then, here’s where the policy side thought of MMTers like Mitchell and Wray – if they are right – seems to play a role in fiscal sustainability. If the larger deficits during recessions and recoveries are party “financed” by money creation as opposed to taxation or debt, then these larger deficits need not add to the long-term debt level. And if they are balanced off at all, perhaps they can be balanced by deficits smaller than the 3% norm, but not by actual surpluses.
As I understand it, their view is that this additional money need not be inflationary in either the short or long term, so long as it is injected into the economy in the right way. Since the recessionary economy is running way below capacity, the newly created money can be used to purchase goods and services directly from the private sector, goods and services that wouldn’t otherwise be produced at all. In that case, we don’t have more money chasing the same amount of goods, but more goods and the money to purchase them coming into existence at the same time.
@TerjeP
See US Constitution, Article 1, section 8, 10.
@TerjeP
From an economic point of view, and within the context of democratic societies, this thing called “government” is also known as “the public sector”. It is the entire public acting as a single and organized economic agent, in pursuit of the public interest; and its activity stands in contrast with the mere aggregate of all other economic activity carried out by the same people, but acting as separate individual or corporate agents in an uncoordinated manner in pursuit of their separate private interests.
It seems to me we need both kinds of economic activity, and that only the public sector can carry out the large and strategic economic projects that a large and complex society needs to undertake to optimize its long-term prospects.
Pertinent, I believe to the above discussion:
THE CREDIT MONEY, STATE MONEY, AND ENDOGENOUS MONEY APPROACHES: A SURVEY AND ATTEMPTED INTEGRATION
L. Randall Wray
Cheers ….
jrbarch
@John Quiggin
See Stephanie Bell (now Kelton), Can Taxes and Bonds Finance Government Spending? (1998)
@Ernestine Gross
I’m afraid I understood about 1 word in 10 of your comment. In what sense is fiat money a security? This, to me, and your comments about boundedness, suggest your g.e. model has a conservation of money rule, which MMT rejects.
From the more-or-less polemical literature I gather that GE models usually feature ricardian equivalence and don’t actually have money in them, which are both things MMT theorists reject. Is this the case in the model you are using here?
All this talk about the gold standard having limited currency/money creation is misguided. Under a gold standard the monetary authority could issue any amount of new currency so long as it did not cause the gold price to exceed the top of the price window. It isn’t radically different to a system in which the monetary authority can issue any amount of new currency so long as it does not cause the consumer price basket to rise above a threshold. The distinction is around the feedback mechanism that constrains the activity. What to use as your price guide for currency creation, be it the consumer price index, the price of gold or an exchange rate is ultimately a political consideration (hopeful informed by economic insight).
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…
Roughly in line? No, I wouldn’t say that. No. Not at all, sir.
Does this look like spam at all to you Prof or am I being paranoid?. I havent met this stranger before (the Arthurian)?
@The Arthurian
For the 40 years before 2008, the ratio of base money to GDP was virtually constant, as the graph shows, at between 0.05 and 0.065. If the ratio of two variables is constant, their growth rates must be the same.
The graph gives a slightly misleading impression because the zero has been suppressed by the graphing software.
More notably, there was a big decline in the money/GDP ratio from the 1940s to the 1970s, reflecting financial innovations like credit cards, and the desire to reduce money balances in a time of inflation. That’s an illustration of my point 2, that governments can’t use money creation as a significant source of finance.
Thank you, John Q.
Sorry, Alice. You’re right: My first visit.
@The Arthurian
Sorry – It was just all the funny letters in your link that looked a bit spammish.
@James Haughton
“I’m afraid I understood about 1 word in 10 of your comment.”
That should have made interesting reading (smiley). Seriously, I’ve drawn on mainstream post-1950s economics literature. The mainstream seems to be very broad, having a structure akin to that of an olympic swimming pool – several main lanes.
“In what sense is fiat money a security?”
(a type of security) See for Darrell Duffie, “Money in Generel Equilibrium Theory”, in “B.M. Friedman and F.H. Hahn, eds, Handbook of Monetary Economics, Vol 1, chap 3, North Holland, 1990.
“This, to me, and your comments about boundedness, suggest your g.e. model has a conservation of money rule, which MMT rejects.”
Boundedness is the crucial concept to represent the finite life of planet earth – it is ignored by those who preach ‘growth’ of ‘economic activity’. I know nothing about a ‘conservation of money rule’.
“From the more-or-less polemical literature I gather that GE models usually feature ricardian equivalence and don’t actually have money in them, which are both things MMT theorists reject.”
Thank you for writing about the ‘more-or-less polemical literature’ because for years – particularly while working at a management school – I’ve come across outrageous fantasies as to what GE models (or game theory ) are about. The more-or-less polemical literature is the reason for me posting on occasions on GE models (and so far JQ has not reprimanded me but I suspect he is very bored with it). No, there is no (Barro-) Ricardian equivalence (I am not talking about macro-ge-models).
“Is this the case in the model you are using here?” Answered.
@John Quiggin
This short of reasoning forgets that government’s fiscal positions do not happen in vacuum. Government deficits (surplus) equal non-government sectors surplus (deficit) to the penny. In order to save government has to take money out of private economy, that could plunge it to recession and even widen the deficit via automatic stabilizers. So you could try to save at any given time, but could you do it is an another issue.
Only those who are users of an currency has to worry about debt sustainability and financing deficits. Governments who are sovereign in their own currency are currency issuers, and are not financially constrained in their spending. Worrying about some arbitrary rations like debt-to-GDP or deficits-to-GDP makes no sense for them, because all spending is done simply by crediting bank accounts.
Sovereign governments can not run out of money, but the eurozone governments can. Since there are no currency issuer in the EZ, they have created essentially a giant ponzi scheme. Ponzi’s can grow up long time before they finally blow up – it has been decade in eurozones case.