Friday, September 6, 2013

Guest Post: Ralph Musgrave

Monetary policy is nonsense.

As far as I can see, MMTers tend to favour simply creating new money and spending it into the economy when stimulus is needed, rather than fund such expenditure from borrowing. Certainly Warren Mosler advocated that in a Huffington article (2nd last paragraph). He said that government should issue no liabilities at all, apart from monetary base. (Milton Friedman also advocated a “zero government borrowing” regime.)

As Warren rightly points out, the main effect of government borrowing is to artificially raise interest rates.

The numerous flaws in monetary policy.

Apart from Warren’s interest rate point, there are several other basic flaws in monetary policy, and as follows.

1. As to QE, its effect is to enrich the rich by boosting asset prices, plus it destabilises developing economies.

2. Interest rate cuts channel stimulus into the economy just via increased investment spending. That makes as much sense as channelling stimulus into the economy just via restaurants, massage parlours and car production.

3. The BASIC PURPOSE of the economy is to produce what people want. And “what people want” comes in two basic forms. First there is public sector stuff: law enforcement, education, roads,  etc. Second, there’s the stuff produced to meet demand from household spending: cars, food, etc.

If there is excess unemployment, then there is scope for producing more stuff (public and private sector). So the reaction to excess unemployment should be to expand both public spending and household spending.
As to investment, employers can work out for themselves whether or not to expand investment in reaction to the latter increase demand. And in fact increased public spending and household spending will tend to increase investment spending AUTOMATICALLY, given that extra demand.

4. Central bank base rates do not seem to have any effect on rates charged by credit card operators.

5. There might be a case for monetary policy if it worked more quickly than fiscal policy. However, the lags seem to be roughly similar in each case: about a year.

6. As soon as a country issues debt that pays interest, other countries and their citizens buy some of the debt, and the issuing country becomes indebted to foreigners and has to pay interest to those foreigners.  Of course if the US issued no interest yielding debt, foreigners could still build up a stock of US dollars. But there’s no need for US taxpayers to ACTUALLY REWARD foreigners for doing that.

Reversing stimulus.

Unfortunately, abandoning monetary policy and implementing the “create new money and spend it” policy would not be plain sailing. But it wouldn’t be TOO DIFFICULT.

One apparent problem is that monetary policy is easier to reverse than fiscal: for example raising interest rates isn't difficult. And reversing or “tapering” QE is not difficult in principle: the central bank just sells government debt back into the market.

However, the very fact that monetary policy is likely to be reversed means that recipients of any cash they get as a result of monetary easing tend not to commit their money on any long term basis: e.g. they might just buy stock exchange investments – which can be easily sold. And that’s not of much use to Main Street.

Secondly, if reversing fiscal policy took the form of increased income tax, that might cause political difficulties. But against that, the UK reduced it’s sales tax (VAT) down and then up again in the last five years. That caused no problems. And adjusting payroll taxes doesn’t seem to cause problems.


Another obstacle to the “create money and spend it” policy is a bunch of economic illiterates known as politicians.

The electorate and politicians have every right to determine what proportion of GDP is taken by public spending, and how that public spending is split between education, law enforcement, etc. They also have every right to determine how taxes are collected.

In contrast, politicians are just not qualified to measure inflation or work out how much stimulus will produce how much extra inflation. That sort of decision is to a significant extent already in the hands of committees of economists (e.g. central bank interest rate committees). And ideally, decisions on the amount of stimulus should be ENTIRELY in the hands of that sort of committee.

Thus the reality at the moment is that we have to deal with a herd of bulls in a china shop: politicians. Getting them to implement the right amount of fiscal stimulus at the right time is near impossible. And a recent and disgraceful example that is the fact that it’s primarily US politicians who have stood in the way of allowing a decent stimulus package in recent years, which had it been implemented, would have resulted in millions more being in work since the recent crisis.

So we’ll probably need monetary policy for several decades yet so as to counter the effects of that herd of bulls.

Politicians will always have the final say of course. But when it’s TRADITIONAL for politicians to influence stimulus, a country is in trouble. An extreme example is Argentina where if the central bank governor doesn’t do what politicians want, the governor gets the sack. Look at the result.

So ideally (and hopefully in the long term), it will be traditional just for just economists to take decisions on stimulus. In that scenario, we’ll be able to dispense with monetary policy and concentrate on “create new money and spend it” policy: i.e. expand the production of what people want when the economy has spare capacity

Ralph Musgrave


Unknown said...

"As far as I can see, MMTers tend to favour simply creating new money and spending it into the economy when stimulus is needed, rather than fund such expenditure from borrowing"

'MMTers' don't think that selling bonds funds govt spending, so there seems to be a bit of a miscommunication going on there.

Unknown said...

"Warren Mosler advocated that government should issue no liabilities at all, apart from monetary base"

That's not the same thing as saying that selling bonds funds government spending. Warren wouldn't say such a thing because he doesn't believe that to be the case.

More confusion.

Unknown said...

"So ideally (and hopefully in the long term), it will be traditional for just economists to take decisions on stimulus"

A lot of economists seem to be demented brainwashed ideologue asswipes.

I'm not sure how you would ensure that those types - apparently the dominant breed within the economics profession - don't just take control and impose their asswipe ideology on everyone else.

Clint Ballinger said...

Nice post Ralph. I've been traveling but try to follow here when I can.

Ralph Musgrave said...


I'm baffled as to why you think I'm under the impression that MMTers think "selling bonds funds govt spending". If anything I'm saying the opposite.

In fact in the first quote above I said "rather than fund such expenditure from borrowing". I.e. I'm saying the conventional wisdom is that selling bonds is a way of funding government spending, whereas many MMTers think otherwise.

David said...

I don't see the problem so much as politicians being dunderheads (which they are), but the fact that we now live in a uni-polar world in terms of power. In the past, as now, the dunderhead politicians knew which side their bread was buttered on. The difference was that they had to work harder to balance their servility to money occasionally with something more than lip-service to populist desires. The modern politician is insulated, to a degree that has yet to be sufficiently appreciated, from the voter. They don't fear the voter. They don't fear communism like they did in the Depression and the post- WWII era. They don't fear "riots" like they did in the sixties. As long as there is no counterbalance the neo-liberal banker's regime will continue. Most people don't even know there is such a thing.

Critical Tinkerer said...

'Create money and spend' has a question about operation of doing it, actual operation.Create and spend without record, with the record of it or doing it trough government owned banks.
There is a question of what the system that have government print money and spend is called (it does it through coins but very small ammounts).
Is it still capitalism, or is it socialism?
Hitler doing creation of money and spending it was called socialism, on the other hand, FDR did it trough government ovned developement banks, funding base capital with Treasuries and then proceeding to create money and spend it. Requierd Reserves were Tsy's without selling them and when credits were extinguished and even failed such bank accounting was just disolved leaving money in the system.

Since money is digital now there is absolutely easier to do it with new developement banks where base capital and reserves were TSY's.
I have no prefference on the questions, but having a new law that institutionalizes such process will have to have operational description.

Since FDR way of creating money and spending kept the knowledge about it from the public, public never even knew what happened and now are ignorant of possibilities that it has in the sleeve. Public is unaware of realities of who can print the money in capitalism and socialism.

Tom Hickey said...

Of course government "funds" itself with tsys issuance in the technical sense of the accounting entries. The Treasury creates a security and the cb auctions the securities into the private market in exchange for banks' rb which then gets credited to a Treasury account to "fund" its expenditure.

"Fund" simply means that an asset must have a corresponding entry on the liability side. For example, coins are a government (Treasury) liability that shows up on both the sides of the book. The Treasury delivers the coins to the cb in exchange for a corresponding mark up to its reserve account, which is booked as an asset and is used for expenditure. The liability remains on the Treasury's book as the "funding" for the expenditure.

Treasury can only spend when it has settlement balances (reserves) to clear in the settlement system. Those settlement balances (reserves) are also government liabilities that reside on the book of the cb.

In the US the Fed cannot just credit the Treasury with reserves to clear (overnight). The Treasury has to issue either coins or tsys for funding on its book. The asset spent when the Treasury spends by directing its bank (cb) to credit non-government accounts is in the currency, which is how settlement balances are denominated.

International settlement was in gold prior to 1971. When Nixon shut the gold window, the US no longer funded trade deficits with gold. Now governments either accumulated foreign exchange using reserve currencies or use SDR's.

The point is that iaw accounting rules, all expenditure is "funded" in the sense that accounts always balance.

Does the US government "fund? itself by borrowing from non-government savers in tsy auctions. Of course, it does. Does Treasury spend the funds that it borrowed through tsy issuance. Of course, based on the accounting.

However, this is deceptive in that people then erroneously conclude that government is taking funds from the private sector to pay for its expenditure. This is patently not the case, since the level of rb remains the same and non-government also holds the tsys.

Most people don't notice is that in the process, government replaces the rb used to purchase tsys, so no change in $NFA wrt to consolidated non-government in aggregate. But consolidated non-government in aggregate increases by the amount of the tsys issued, in effect doubling the previous amount of $NFA held.

Since reserves and tsys are effectively interchangeable — as Warren says, tsys are actually base money — the tsys held as consolidated non-government saving of $NFA function to drain rb from the settlement system and are really only needed operationally when the Fed doesn't desire to set the overnight rate to zero or pay IOR.

Moreover, a currency sovereign in a non-convertible flex rate system does not have to get anything it doesn't create itself to fund itself, e.g., gold or foreign exchange. So in this sense government funds itself and cannot become insolvent in its currency, as Alan Greenspan testified to Paul Ryan's committee. As Greenspan noted then, the only issue is availability of real resources when they are demanded, which can have implications for price level.

What government is actually doing is competing with the private sector for use of private sector real resources, which is irrelevant when the government is bidding for idle resources. However it can be an issue when the government needs real resources that are scarce, as it wartime. Then scarce goods can be bid up.

This can result in inflation unless government also withdraws $NFA through taxation, as President Lincoln explained in creating greenbacks and as Abba Lerner expressed in functional finance. During WWII, the scarcity was so great that imposition of rationing and price controls was deemed necessary.

Tom Hickey said...

Marriner Eccles:

There was a feeling that this [Fed overdrafts to the Treasury's General Account] left the door wide open to the Government to borrow directly from the Federal Reserve bank all that was necessary to finance the Government deficit, and that took off any restraint toward getting a balanced budget. Of course, in my opinion, that really had no relationship to budgetary deficits, for the reason that it is the Congress which decides on the deficits or the surpluses, and not the Treasury. If Congress appropriates more money than Congress levies taxes to pay, then, there is naturally a deficit, and the Treasury is obligated to borrow. The fact that they cannot go directly to the Federal Reserve bank to borrow does not mean that they cannot go indirectly to the Federal Reserve bank, for the very reason that there is no limit to the amount that the Federal Reserve System can buy in the market. That is the way the war was financed.

Therefore, if the Treasury has to finance a heavy deficit, the Reserve System creates the condition in the money market to enable the borrowing to be done, so that, in effect, the Reserve System indirectly finances the Treasury through the money market, and that is how the interest rates were stabilized as they were during the war, and as they will have to continue to be in the future. So it is an illusion to think that to eliminate or to restrict the direct borrowing privilege reduces the amount of deficit financing. Or that the market controls the interest rate. Neither is true.

FRB St. Louis