Monday, August 15, 2011

Warren Mosler critiques Paul Krugman's "MMT, again"

Paul Krugman's post is italicized in block quotes. Warren Mosler responds point by point in caps.

Let’s have a more or less concrete example. Suppose that at some future date — a date at which private demand for funds has revived, so that there are lending opportunities — the US government has committed itself to spending equal to 27 percent of GDP, while the tax laws only lead to 17 percent of GDP in revenues.

And consider what happens in that case under two scenarios. In the first, investors believe that the government will eventually raise revenue and/or cut spending, and are willing to lend enough to cover the deficit. In the second, for whatever reason, investors refuse to buy US bonds.

The second case poses no problem, say the MMTers, or at least no worse problem than the first: the US government can simply issue money, crediting it to banks, to pay its bills.

WHICH, WHEN LOOKING AT GOVT. ON A CONSOLIDATED BASIS- FUNCTIONALLY COMBINING THE TSY AND FED, IS WHAT HAPPENS IN ANY CASE.

GOVT. SPENDING ADDS TO MEMBER BANK RESERVE BALANCES, AND TAXING REDUCES THOSE SAME BALANCES. BORROWING SHIFTS THOSE BALANCES FROM RESERVE ACCOUNTS TO SECURITIES ACCOUNTS, BOTH AT THE FED. AND REPAYING BORROWING IS THE SHIFTING OF DOLLARS FROM SECURITIES ACCOUNTS BACK TO RESERVE ACCOUNTS.

POINT HERE IS, THE GOVT. (FROM INCEPTION) CAN’T DO WHAT’S CALLED A RESERVE DRAIN (DEBITING RESERVE ACCOUNTS) WITHOUT FIRST DOING A RESERVE ADD (SPENDING OR LENDING).
SO UNLESS THE GOVT. ALLOWS BANK OVERDRAFTS- AND AN OVERDRAFT, IS, FUNCTIONALLY, A LOANS TO THAT BANK, AND BOOKED AS SUCH WHEN IT HAPPENS- IT CAN’T TAKE DOLLARS OUT OF MEMBER BANK RESERVE ACCOUNTS WITHOUT FIRST PUTTING THEM IN. AND IN THE CASE OF OVERDRAFTS IN RESERVE ACCOUNTS, THE OVERDRAFT LOAN IS THE GOVT DOING A RESERVE ADD FIRST, AND THEN A RESERVE DRAIN.

IT’S LIKE A BUS COMPANY CAN’T COLLECT IT’S TOKENS FOR ANY REASON UNTIL AFTER IT ISSUES THEM. THAT’S THE DIFFERENCE BETWEEN ISSUER AND USER- ISSUERS MUST ISSUE FIRST, AND THEN COLLECT, USERS MUST FIRST COLLECT AND THEN MAKE PAYMENTS.

But what happens next?

We’re assuming that there are lending opportunities out there, so the banks won’t leave their newly acquired reserves sitting idle; they’ll convert them into currency, which they lend to individuals.

IN THE BANKING SYSTEM, THE CAUSATION IS FROM LOANS TO DEPOSITS. LOANS DON’T DIMINISH THE TOTAL RESERVES IN THE BANKING SYSTEM.

So the government indeed ends up financing itself by printing money, getting the private sector to accept pieces of green paper in return for goods and services.

NOT EXACTLY. IF GOVT SPENDS AND DOESN’T ISSUE SECURITIES, WHICH ARE TIME DEPOSITS IN FED SECURITIES ACCOUNTS, THE DOLLARS INSTEAD SIT IN RESERVE ACCOUNTS. IN ORDER TO SUPPORT THE FED’S TARGET RATE OF INTEREST, THE FED THEN PAYS INTEREST ON THOSE RESERVE BALANCES, OFTEN CALLED THE ‘SUPPORT RATE’, OR THE MARGINAL COST OF FUNDS- THE FED FUNDS RATE- FALLS TO 0%.

THE WAY THE GOVT SUPPORTS A NON ZERO RATE TARGET IS TO PAY INTEREST ON THE RESERVE BALANCES CREATED BY DEFICIT SPENDING. IT CAN USE EITHER TSY SECS, WHICH ARE FUNCTIONALLY TIME DEPOSITS AT THE FED, OR INTEREST BEARING RESERVE BALANCES HELD BY MEMBER BANKS AT THE FED.

And I think the MMTers agree that this would lead to inflation; I’m not clear on whether they realize that a deficit financed by money issue is more inflationary than a deficit financed by bond issue.

WITH TODAY’S FLOATING EXCHANGE RATE POLICY, IT’S PRIMARILY THE ACTUAL SPENDING THAT’S INFLATIONARY, AND NOT SO MUCH THE WAY THE SUPPORT RATE IS PAID- EITHER ON OVERNIGHT BALANCES OR ON TERM DEPOSITS (TREASURY SECURITIES).

For it is. And in my hypothetical example, it would be quite likely that the money-financed deficit would lead to hyperinflation.

AS ABOVE. YOUR CONCERN IS FOR FIXED EXCHANGE RATE REGIMES, SUCH AS A GOLD STANDARD, WHERE TREASURY SECURITIES MUST COMPETE WITH THE OPTION TO CONVERT AT THE GOVT. OF ISSUE. AND BY NOT OFFERING TREASURY SECURITIES OR OTHERWISE COMPETING WITH A COMPETITIVE INTEREST RATE, THE HOLDERS OF THE DOLLARS WOULD BE PRONE TO CONVERT THEM AND DRAIN THAT NATION’S RESERVES, WHICH CAN QUICKLY LEAD TO DEVALUATION AND AT LEAST A ONE TIME JUMP IN THE PRICE LEVEL.

The point is that there are limits to the amount of real resources that you can extract through seigniorage. When people expect inflation, they become reluctant to hold cash, which drive prices up and means that the government has to print more money to extract a given amount of real resources, which means higher inflation, etc..

I CALL THAT A DROP IN SAVINGS DESIRES. WITH FLOATING EXCHANGE RATES, INFLATION FROM THAT SOURCE IS TAKEN OUT IN THE LEVEL OF THE CURRENCY. AND YES, WITH INFLATION GOVT SPENDING TENDS TO GO UP, HOWEVER SO DO TAX RECEIPTS, AS PER THE SMALL CARTER SURPLUS IN 1979?


Do the math, and it becomes clear that any attempt to extract too much from seigniorage — more than a few percent of GDP, probably — leads to an infinite upward spiral in inflation.

ALSO, INFLATION IS ALREADY DEFINED AS A CONTINUOUS INCREASE IN THE PRICE LEVEL. MORE OFTEN THAN NOT, I’VE SEEN RATES OF INFLATION STABILIZE AT ELEVATED LEVELS, RATHER THAN ACCELERATE, THOUGH IT’S CERTAINLY POSSIBLE IF PUSHED ENOUGH.

I SAY IT THIS WAY- THE RISK OF OVERSPENDING IS INFLATION, NOT SOLVENCY.

AND EVEN IN RUSSIA IN 1998, A CLASSIC FIXED EXCHANGE RATE BLOW UP, THE RUBLE WENT FROM 6.45 TO THE DOLLAR TO ABOUT 28 TO THE DOLLAR, WHERE IT’S PRETTY MUCH BEEN EVER SINCE. SAME WITH THE MEXICAN PESO A FEW YEARS BEFORE THAT. IT WENT FROM 3.5 TO ABOUT 10 TO THE DOLLAR AND PRETTY MUCH STABILIZED THERE. BUT ALL I’M SAYING HERE IS THAT CONTINUOUSLY ACCELERATING INFLATION ISN’T NECESSARILY AUTOMATIC, EVEN IN SITUATIONS FAR WORSE THEN ANYONE’S IMAGINING FOR THE US.

In effect, the currency is destroyed. This would not happen, even with the same deficit, if the government can still sell bonds.

AS ABOVE, IT’S NOT ABOUT BOND SALES PER SE WITH OUR CURRENT INSTITUTIONAL ARRANGEMENTS.

The point is that under normal, non-liquidity-trap conditions, the direct effects of the deficit on aggregate demand are by no means the whole story; it matters whether the government can issue bonds or has to rely on the printing press. And while it may literally be true that a government with its own currency can’t go bankrupt, it can destroy that currency if it loses fiscal credibility.

RESPECTFULLY DON’T AGREE, AS ABOVE. WITH TODAY’S INSTITUTIONAL STRUCTURE IT’S ENTIRELY A MATTER OF AGGREGATE DEMAND.

Now, I am not predicting hyperinflation for the US — I am not Peter Schiff! Most of our current deficit is cyclical, and even in the long run a modest return of political rationality would make the budget issue eminently solvable. But the MMT people are just wrong in believing that the only question you need to ask about the budget deficit is whether it supplies the right amount of aggregate demand; financeability matters too, even with fiat money.

AGAIN, NOT THE CASE WITH TODAY’S INSTITUTIONAL STRUCTURE. I’VE BEEN AN ‘INSIDER’ IN MONETARY OPERATIONS FOR ALMOST 40 YEARS. I KNOW HOW THE DEBITS AND CREDITS WORK. AND EVERYONE IN FED OPERATIONS WOULD AGREE WITH ME.

19 comments:

wh10 said...

Per the last sentence- let's fund a video of top fixed income traders on Wall Street telling Krugman and mainstream economics 'you're wrong!' Then have them proceed with lessons on banking and macroecon.

SchittReport said...

"Now, I am not predicting hyperinflation for the US — I am not Peter Schiff!"

that made my day. obviously the good professor has been bombarded with (hate) mail telling him about the unholy trinity of the US$ being worthless, combined with sky-high interest rates and hyperinflation.

googleheim said...

George Will is a liar. He says that we owe China $2 trillion but does understand that the Chinese have already been paid.

It's done deal, the money is in their treasury accounts.

How can such a "conservative" journalist be taken for real ?

For every dollar spent on Chinese imports by American consumers, most of it goes into the Chinese account at the US Treasury.

wh10 said...

Andy Harless coming to MMT's defense in the Twitter world?

Good stuff. Someone catch that big fish...

Anti said...

Tom, I found your comments on the Krugman post to be the clearest for the unfamiliar.

GLH said...

Have you noticed how Mr. Krugman always denigrates MMT.

We all know that Mr. Krugman isn't stupid and he must really understand MMT.

The only answer I can come up with is after watching a Ben Still vidio yesterday. Mr. Still told an anchor man about some news people who were basically fired because they agreed with his idea that the government didn't need to raise debt to spend. It seems JP Morgan put pressure on the station to terminate the reporters.

I wonder if Mr. Krugman were to begin to agree with Warren Mosler how long Mr. Krugman would continue to write for the Times.

Shaun Hingston said...

@GLH

Interesting thoughts.

Perhaps he is wording his articles such that readers will quickly identify his erroneous assertions. Hence 'shining' more light upon MMT.

Tom Hickey said...

Thanks, Anti. I try to keep it simple. Krugman seems to be having a hard time getting this. I posted essentially the same comment on his previous posts on MMT. He just doesn't get the sectoral balance approach coupled with functional finance due to his monetarist tendencies and his lack of familiarity with the operations of the Treasury, central bank, and commercial banking system and how the actually interact. He is in over his depth, which often happens when one exceeds one's field of expertise without studying up.

Tom Hickey said...

GLH: "We all know that Mr. Krugman isn't stupid and he must really understand MMT."

Looks to me like PK doesn't understand MMT and only has a vague impression of it.

Hugo Heden said...

@Tom, @Anti --

where can I find Tom's comments?

Perhaps worth reposting somewhere, Tom?

Tom Hickey said...

@ Hugo

comment on the first post here.

comment on the second post here.

Hugo Heden said...

My answers to Krugman would have been as follows. I'm an MMT-newbie however, not a proper "MMT:er". Any thoughts, corrections or other notes would be much appreciated!?

PK: Let’s have a more or less concrete example. Suppose that at some future date — a date at which private demand for funds has revived, so that there are lending opportunities — the US government has committed itself to spending equal to 27 percent of GDP, while the tax laws only lead to 17 percent of GDP in revenues.

This could potentially be inflationary. MMT says it's all about aggregate demand. If aggregate demand increases to levels above the capacity for the real economy to absorb it, then inflation results.

In this example, yes, if non-government demand increases (while "government demand" remains the same), then inflation could result. In reality however, an increased non-government demand would be likely to invoke automatic stabilizers -- tax revenues would increase and transfer payments would decrease -- which could largely offset the increase in inflationary pressure.

But if there would still be inflationary tendencies, then the government should take measures to decrease its deficits; the normative part of MMT is all about achieving full employment along with price stability.

PK: And consider what happens in that case under two scenarios. In the first, investors believe that the government will eventually raise revenue and/or cut spending, and are willing to lend enough to cover the deficit. In the second, for whatever reason, investors refuse to buy US bonds.

In an economy with an MMT-aware government and MMT-aware investors, a third scenario would be more likely: investors believe that the government will achieve long term full employment, growth and price stability. Therefore, they will be interested to hold bonds denominated in the currency in question (or even proper currency -- "zero-interest bonds"). Wheter the government eventually will raise revenue and/or cut spending is not of any primary concern, as long as the government runs by these "functional finance" principles. Investors would not be thinking of themselves as "lending" to "cover government deficits", but just "holding interest bearing assets".

PK: The second case poses no problem, say the MMTers, or at least no worse problem than the first: the US government can simply issue money, crediting it to banks, to pay its bills.

Well, operationally it can, yes. But MMT says it's a bad idea to deficit spend beyond the point of full employment, because that would cause inflation. When there is inflation, government needs to decrease its deficits.

Hugo Heden said...

PK: But what happens next?

PK: We’re assuming that there are lending opportunities out there, so the banks won’t leave their newly acquired reserves sitting idle; they’ll convert them into currency, which they lend to individuals.

According to MMT this is a rookie error -- and yet it is at the heart of mainstream neoclassical monetary economics.

Remember that the central bank targets some over-night interest rate (often above zero).

Lending will not be affected by the composition of reserves versus bonds that banks and other financial institutions hold.

If there are lending opportunities out there then banks will lend -- irrespective of their reserve positions.

Inadequate reserve positions are resolved after the fact, when the central bank invokes its Open Market Operations to maintain the target interest rate.

On the contrary however, banks' solidity by law will limit their capacity to lend. It's about solidity, not liquidity. For solidity, it does not matter if the bank holds bonds or reserves.

So, given a specific over-night interest rate target, increasing reserves is not necessasily more inflationary than increasing bonds. It could be, but it may not be. In fact, the opposite may be true for various reasons (leverage, interest payments...).

PK: So the government indeed ends up financing itself by printing money, getting the private sector to accept pieces of green paper in return for goods and services.

Look at it this way: The government must by necessity "finance" any deficits by issuing "government money paper" -- either interest bearing (bonds) or non-interest bearing (currency). It is highly unclear if one is more inflationary than the other (given a specific over-night interest rate target).

PK: And I think the MMTers agree that this would lead to inflation; I’m not clear on whether they realize that a deficit financed by money issue is more inflationary than a deficit financed by bond issue.

Nope, MMT:ers do not "realize" that (at least not the newbies?), but rather rejects this as a gross oversimplification stemming from an incorrect understanding of monetary operations, as indicated above.

Hugo Heden said...

@Tom -- thanks Tom, yes, excellent comments.

Chewitup said...

Tom,
I've read your comments on more than a few occasions there you succinctly describe the difference between floating exchange and fixed exchange in two sentences, ie income spread, debt etc. Please restate it. I was tongue tied today trying to come up with it. Thanks

Clonal said...

Randy Wray on "MMT - again"
Paul Krugman Still Gets it Wrong: Modern Money Theory

Quote:
On Monday, Paul Krugman tried yet again to spell-out where he disagrees with “modern money theory” (MMT)—the approach that I adopt. (http://krugman.blogs.nytimes.com/2011/08/15/mmt-again/) And, again, he gets it wrong. He continues to make two kinds of errors: errors of attribution, and errors in his understanding of money and finance. I don’t normally like to include long quotes followed by critiques, but I think in this case it will be useful. Sorry, this is going to be a bit long and wonkish.

Before proceeding, let me say that I appreciate the role that Krugman plays
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Anonymous said...

Personally I think Krugman wants an excuse to keep "tax the rich" rhetoric in play. If he goes to the dark side (MMT) he'll have to admit that the government doesn't need more tax dollars from the rich at this stage (or any time there is inadequate demand).

I believe his lefty bias can't handle that realization and he will never admit it in public even if he eventually grasps MMT.

Y said...

But Anonymous, there are other implications from MMT that he would like:

1) Not being revenue constrained, the main purpose of taxes is to constrict aggregate demand. Since your marginal propensity to consume declines as you become wealthier, there's a much less compelling reason to lower taxes on the wealthy in a downturn. Likewise, if the world is still working in the orthodox paradigm and demands the raising of "revenue", raising taxes on the wealthy is much less contractionary than raising them on other income groups.

2) Loanable funds is out the window, banks aren't reserve constrained and the Fed can fix interest rates at any point on the yield curve - this suggests that letting rich people save more of their money doesn't help the level of investment in the economy.

Of course, he supports unions and higher taxes on the wealthy primarily as a means of income redistribution, so I mostly agree with you.

Clonal said...

A good article from up North - from Fictional Reserve Barking - Modern Monetary Theory and its Critics

Quote:
Paul Krugman published today another of his critiques of Modern Monetary Theory (MMT) (aka neochartalism, for those who've known about this macroeconomic paradigm since the 90s and beyond). For an excellent introduction to MMT, I recommend the following article by economist Pavlina Tcherneva. Prof. Tcherneva's take on MMT is by far the most comprehensive (and relatively brief) description of neochartalism available.

In his post, Prof. Krugman argues that adherents to MMT are wrong in (1) believing that modern, economically sovereign governments (i.e. governments that have the ability to issue fiat money) do not face financial constraints and in (2) thinking that deficits financed by money issue are no more inflationary than deficits financed by bond issue.

In regard to the first objection, I could keep it short and simply quote the great economist Michal Kalecki,
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