Thursday, June 21, 2012
General theory and special cases in Modern Monetary Theory
In the general - special case theoretical approach of Modern Monetary Theory (MMT). The general theory sets forth the parameters of a fiat currency, showing what falls in bounds and out of bounds operationally. The major alternatives regarding monetary systems are convertible or non-convertible currency, or fixed or floating exchange rates. MMT focuses on the non-convertible floating rate regime since it is operative globally at present, since FDR ended convertibility during the Great Depression in order to increase policy space, and Nixon shut the gold window internationally for the same reason.
Within those basic parameters, various options are available for constructing special cases. One of the sets of alternatives that MMT describes for constructing a special case as an option within those parameters of a non-convertible floating rate regime involves issuing bonds as a reserve drain for rate setting, or not issuing bonds and paying IOR instead, or setting the rate to zero permanently, or setting the rate to zero as a general rule and only using rate setting as need by unusable conditions.
While it is possible to run more than one of these at the same time, only one is dominant in setting monetary policy. For example, the US has chosen politically to issues bonds but the law allows the Fed to override bond issuance as a reserve drain operation by paying interest on reserves (IOR) to manage the interest rate as an alternative.
This shows that bond issuance is a political choice within the bounds of the general theory, rather than an operational requirement of the present monetary regime. The operational requirement of the system is that if the central bank opts to set the rate, then in must manage reserves to do so, or else pay IOR if it chooses to let the amount of reserves float free.
Thus, the general theory accounts for why and how choice among these alternatives is optional in constructing institutional arrangements that result in special cases within a monetary regime. There are many alternative such as this on involving interest rates. Every country selects from a variety of alternatives in establishing a special case as an option for running a non-convertible floating rate regime.
Note that some alternatives that can be selected are out of bounds. If the politicians that choose among alternatives in constructing a special case do not realize this, then the special case will run into problems due to deficiencies in the institutional arrangements. MMT economists and others cognizant of the general theory points this out at the time the Eurozone treaties were being entered into.
Secondly, there are economic consequences of these choices — monetary, financial, and non-financial — that MMT economists also articulate. Different choices of alternative policies used in constructing special cases as options define in law and regulation the institutional arrangements that result in the special cases we observe in the different countries. MMT analyzes these special cases by inspecting laws and regulations, as well as a county's behavior, since work-arounds are used when deemed necessary in extraordinary conditions.
These special cases, exhibited by the different countries in the global economy, which is now on a non-convertible floating rate regime generally all have different implications for the nation's policy space, for example, as well as the interests that are winners and losers. Thus, the institutional arrangements that define a national monetary system also affect its application of monetary economics, with macro implications as well.
Not all countries in the global economy choose to run a floating rate system, however. Emerging countries may choose to peg their currency to another currency like the $dollar (USD). China does this, instance. Switzerland has also set a floor for its currency against the euro. These are special cases within the special cases of non-convertible floating rate currency.
But such extraordinary measures are ordinarily presumed to be temporary, erected under special conditions that are not expected to be permanent. They are extraordinary means for increasing policy space internationally due to the effects of exchange rate fluctuation on the domestic economy. When those conditions cease to exist, the nation again conforms to the norm of floating rates.
As far as recommending policy, MMT uses the MMT macro approach to show how choosing wider policy space and using certain tools — such as the MMT JG (job guarantee), which includes a buffer stock of employed and a wage floor as price anchor — lead toward a potential balancing production, employment and price stability.
These macro conclusions derived from the general theory must be applied differently in different countries, owing to the special case differences set forth in law and regulation,and adapted to political exigencies prevailing at the time. These are strategic and tactical considerations that are subservient to the general theory, which only deals with general operational parameters.
Macroeconomists in general take these three factors to be macro goals, which are used as criteria for evaluating the effectiveness and efficiency of a set of assumptions on policy and policy on anticipated outcomes. All approaches to macro seek to optimize efficiency and effectiveness with respect to these three persistent challenges that a modern economy faces and the overall challenge is to do this in integrated way that enhances them all. The objective is policy formulation based on theoretical insight that yields overall beneficial effects for the country socially, politically, and economically.
Here's a comment I put up at The Center of the Universe in explication:
Basically, what this says is that countries can decide on an international monetary standard and the choice is essentially between convertible or non-convertible currency, and fixed or floating rates. There are other choices, too, such as a system that generally relies on central banking or on that does not. These and other options have historical precedents.
This post focus on having made the choice in favor of non-convertible currencies and floating rates, which is now enshrined in international treaty post-1973 when Nixon’s unilateral decision to shut the gold window two years before was formally ratified.
That established a framework within which countries agreed to operate but it let considerable choice to individual countries regarding specifics. The general theory articulates the framework in terms of the boundary conditions that the agreement imposes. The specific ways to implement this in each county constitutes the actual special cases, although other cases are also possible since all the options are likely not exhausted. Countries are also free to alter the specifics within the general framework that has been agreed to.
What is so difficult to understand about this? It’s all legally formalized in international agreements and laws and regulations of the different countries.