This is a re-posting of a comment by Tom Hickey, that explains the MMT very well I think (Probably not good for dinner conversation but good for a blog ;)
Tom Hickey Reply:
April 3rd, 2010 at 12:38 am
The key here is the MMT concept of vertical and horizontal in relation to money creation. This is sometimes called exogenous (outside) and endogenous (inside).
When the government “spends,” the Treasury disburses the funds by crediting bank accounts. Settlement involves transferring reserves from the Treasury’s account at the Fed to the recipient’s bank. The resulting increase in the recipient’s deposit account has no corresponding liability in the banking system. This creation is called “vertical,” or exogenous to the banking system. Since there is no corresponding liability in the banking system, this results in an increase of nongovernment net financial assets.
When banks create money by extending credit (loans create deposits), this occurs completely within the banking system and results in a liability for the bank (the deposit) and a corresponding asset (the loan). The customer has an asset (the deposit) and a corresponding liability (the loan). This nets to zero.
Thus vertical money created by the government affects net financial assets and horizontal money created by banks does not, although its use in the economy as productive capital can increase real assets.
The mistake that is usually made is comparing what happens in the horizontal system with what happens at the level of government accounting. At the horizontal level, debt is the basis for horizontal money creation. Therefore, it is often assumed that debt must be the basis for the creation of money by government currency issuance. This is not the case.
Reserve accounting uses the standard accounting identities, but the meaning of “liability” is not “debt.” The husband-wife analogy for CB-Treasury accounting relationships is apt. Since a husband and wife are responsible for each others debts, neither can be indebted to the other. That is to say, reserve accounting is a fiction that does not represent real relationships, such as exist between a creditor and debtor in the horizontal system.
Moreover, government debt is not true debt either. At the macro level, the reserves that are transferred to banks through government disbursement are used to buy Tsy’s. That is, when a Tsy is bought, this involves a transfer of reserves from the buyer’s bank’s reserve account at the Fed to the government’s account (consolidating CB and Treasury as “government”).
When the Tsy’s are sold or redeemed, the reserves that were “stored” at interest are simply switched back, creating a deposit again. It’s pretty much the same as buying and redeeming a CD. It’s just a switch from demand to time back to demand in a bank account, and a switch between reserves and securities at the government level. That is to say, the government doesn’t have to draw on revenue, borrow, or sell assets to cover its “debt,” as households and firms do. It’s just a matter of crediting and debiting accounts on the (consolidated) government books, even though it may appear that there is a financial relationship occurring between the CB and Treasury due to the accounting. However, it’s just a fiction.
Therefore, the key to understanding MMT is this vertical-horizontal relationship. When one understands this, then Abba Lerner’s principles of functional finance become obvious. (1) Currency issuance through government disbursement is used to increase nongovernment net financial assets, and taxation withdraws net financial assets from nongovernment. (2) Debt issuance by the Treasury is a monetary operation for draining reserves to permit the CB to hit its target rate.
These principles are then applied to Y+C+I+G+NX to balance nominal aggregate demand with real output capacity in order to achieve full capacity utilization, hence, full employment, along with price stability. This is based not on theory requiring assumptions but on operational reality that can be represented using data, standard accounting identities, and stock-flow consistent macro models.
All of this and much more is explained in considerable detail at Bill Mitchell’s blog.
Definition of money is a claim on human labor, and money is created on the vertical scale or loans created on the horizontal scale is debt. Interest has to be paid on this debt. Who pays the exponentially increasing interest payments since 1913. Answer more money is created out of thin air to pay for more debt which in turn by its creation also requires more interest payments. Money is fiction. Money is debt. and when ever money is created out of thin air by the Fed. this new money is also created as a response to a need to cover the pre-existing interest on the old debt. There are over 3,800 past examples of paper currency that failed. The fiat paper currency system works on the ever increasing growth theorem, but will never work on the decreasing growth theorem as due to the system the 10:1 creation of debt on top of newly invented money (debt) when the system contracts what should happen is many many many loans will default and people get financially wiped out. Problem is the govt is co-opted by the banks in control of the money system and they are self destroying the system they created, but rest assure the money center banks will never get hurt and neither will the politicans or finance police. Every one on the outside will get crushed. The system cannot grow forever due to unlimited surplus. Therefore when the end point of surplus (energy) is reached, a choice must be made on how to divy up the existing surplus between prosperity (nice things for people) and growth- smoke stack industry, commerce etc.
ReplyDeleteSo the fiat system always works well when it is growing but never works when reality sets in of limited surplus or the like musical chairs when the music stops the person who owns 10 house properties with no money down and no income on the properties get taken out of the game. No cop on the block will doom the system to prevent excess. We need a better way to divy up the available surplus to the people in either growth or propserity. Also war is very inflationary. We have just conducted two wars and no one paid for it yet. Wars do create inventions and advancements in technology but in the end the surplus is still a finite quantity and unfortunately the demand due to exponential population growth will cause a collision course with limited surplus and the necessary reduction in prosperity and growth.
Limited surplus will cause an economic contraction and lower standard of living best case scenerio and a nuclear war worst case scenerio.
ReplyDeleteYou want a perfect example of limited surplus. Inability of the govt to clear the highways of snow. Limited surplus causes business to shut down, hence economic contraction. My home city area of Houston today had rolling brown outs, I live in South West Houston suberb and the power went off three times today for about one hour each time. Its 22 deg. fahn here now. This loss of energy could just as easily be due to lack of fuel. You tell me how this thinking is not correct.
Bob,
ReplyDeleteGet your moron utility regulators to allow for nat gas for hot water and electric heat pump assist for these types of rare 22 degree occurances in your Houston area.
the resistive heating coils in the heat pumps use too much KWs for everybody to use them in a week like we're having, an intelligent regional analysis of the elec power demands of a broad cold front would have shown a regional deficiency and should have been addressed.
It has nothing to do with the money supply, it has to do with engineering.
Resp,
We can also direct the Schiff-less and the Deficit scar-d-cats to the YEN
ReplyDeleteWhy does the Yen appreciate when Japan itself is always dogged for being the basket case, 2 decade no hope economy ???
This flies in the face of Schiff, Varney, and Austrians in general.
http://news.yahoo.com/s/csm/20110202/wl_csm/360435
The power grid problem is the result of water damage to some plants who don't plan and don't use money supply for developing contingency response plans.
It's money supply AND engineering.
Oh Bob,
ReplyDeleteThats right, the funds that could have been used for the nat gas infrastructure were probably absconded with by the Enron folks down there.
Blame moron Phil Gramm, his wife, and Slick Willie & Co. for "deregulating" the utilities while you freeze down there.
Googleheim,
ReplyDeleteVarney is not an Austrian. There are tens of millions of people that are concerned about debt and exessive taxation and regulation who have never even heard of Austrian economics.
Tom did a nice job of explaining MMT. I did have one small quibble. He correctly points out that this is "operational," but incorrectly claims that it isn't theoretical. It is both. It is in fact applied theory. What is pertinent is whether this applied theory has good consequences.
WWS,
ReplyDeleteIf you haven't visited Bill Mitchell's blog, the address is http://bilbo.economicoutlook.net/blog/
Laura in Canada
Laura,
ReplyDeleteI'll take a look.
Laura,
ReplyDeleteI read through his "parrot" column and his apologia for Japanese debt.
The parrot could have also have easily said, "Spending is wealth creation"; "Debt-based consumption spending is good."
His article about Japan was non-sensical for the most part. In one paragraph he claims that Japan has been in a depression for the last 20 years because of austerity measures, but in the next paragraph bemoans that their gargantuan budget deficits relative to GDP haven't been nearly large enough. The reason that their budget deficits have been so large is precisely because the Japanese government has been on a spending spree in its efforts to increase aggregate spending under the assupmtion that spending is the fountainhead of wealth creation. Spending is a consequence of wealth creation--not the cause. If there is savings to finance credit for capital investment then the spending will take care of itself.
He complains that the Japanese government engaged in austerity measures in 1997. This is a bit rich. There has been nothing remotely "austere" about Japanese budget deficits for decades. In some years they spent less than others, but they have been trying to increase aggregate spending for decades in the misguided hope that this government spending will result in more production and supply. It has not. Supply creates its own demand--see Say's Law.
They have also employed Keynesian/ MMT prescriptions with monetary policy to equally bad effect.
The Japanese government has resorted to make-work government jobs to bad effect as well. About 10% of Japanese workers are now employed in the construction sector because that is where much of the spending has been directed. Much of the labor and material resources would not be employed in this sector without the government subsidy. Labor and capital are being directed for politcal ends instead of economic ends. This government spending for political end has also created a cottage industry for those with political connections. Corruption is now endemic in Japan because of these policies.
The government has no feedback mechanism like a profit/loss test to determine whether scarce labor and capital that have alternative uses are being used efficiently. If a market actor misuses labor and material resources by the test of consumer preferences then he is punished with losses. This misuse of scarce resources will soon be put to an end for lack of capital. If a businessman uses labor and material inputs efficently by market test then he is rewarded with profits. This efficient use of scarce resources is continued and expanded because the businessman has profits that can be reinvested. These high profit margins also encourage other market actors to enter this market. However, it is the losses that are in fact more important than the profits because harmful use of resources is put to an end quickly.
Compare this to what a government does that lacks a mechanism to sort as with a profit/loss test. There is no feedback mechanism or consumer to tell him that his use of material and labor inputs is inefficient. The harmful activity will not stop because the government has access to taxes and the printing press. In fact, when the government misuses resources it will then claim that it needs even more access to scarce labor and material resources.
Lastly, I have read these arguments before because they aren't that far removed from other schools of thought. Mitchell is in effect saying that Japanese policy measures have failed because they didn't do ENOUGH of what he prescribed. Hehe! He makes fun of those who "parrot" the mainstream macroeconomic orthodoxy, but his policy measures in many respects are in fact very orthodox.
If any of you guys find the time, search for Rudyard Kipling's poem "The Gods of the Copybook Headings." It sums up our current state of affairs nicely even though it was written in 1919.
WWS,
ReplyDeleteI looked at the capital section of that Murphy article,
" it will be physically impossible for the electronics store to fill the shelves with new TVs and laptops unless the manufacturers of those items have already produced them."
Inventory is financed. Take for instance car dealers. The manufacturers unload the cars on the dealers and the dealers go to a bank for "floor planning" loans. the manufacturers are paid immediately.
Supply chain management has been an area of much business innovation over the last few decades owing to the revolutionary advent of CHEAP INFO TECH. "just in time" is now business as usual.
I have to admit I dont see the relevance of Murphy's statement here. Is he trying to say that businesses have to produce inventory out of the cash account? ie the inventories are not real if they are offset with a liability instead of equity on the Balance sheet? Inventories cannot be financed? Does he think this is important?
Resp,
WWS,
ReplyDeleteTo which article are you referring?
If you read his blog you will find that Bill Mitchell is in favor of a Jobs Guarantee and that a government's deficit should be whatever it needs to be to achieve full employment.
ReplyDeleteRe. blog post "Please note: there is no sovereign debt risk in Japan!"
Japan does not have full employment, so according to Mitchell, they could "do more" ie. run larger deficits. Japan does have relatively low unemployment in comparison to what other countries are currently experiencing.
The rest of that blog entry discusses one of Paul Krugman's columns.
I encourage you to read more, Mitchell has posts on Quantitative Easing, if you're interested.
Matt,
ReplyDeleteMurphy is just restating Say's Law. Read through the rest of the article and links and maybe it wil become more clear to you about what he is saying about the coordination of the supply chain. Else, look up Say's Law.
Laura,
ReplyDeleteI did read all of Mr. Mitchell's essay on Japan. I understood exactly what he was saying. When he asserts that the Japanese government can "do more" the implication is that what they have done and are doing is efficacious. What he is unwittingly advocating is a prescription of more poison to cure the patient of the last dose of poison.
IT's amazing to me people are in a rush to judgement to either dismiss, or condemn others point of view, or to defend their point of view with no allowance to even to hear the other side of the arguement, whether legitimate or not. My example of shortage of a surplus in the form of lack of electricity energy, is to point out the fact that resources are becoming scarce, either thru mismanagement due to the present economic system, or just plain not enough of it. Matt points out if the gubbament did this or if the smart company did that, no more problem of shortage of electricity. I disagree. I am a Boone Pickens army member and want to see a US energy policy that will HELP THE AMERICAN PEOPLE.
ReplyDeleteI am a Chief engineer on a merchant vessel and I know too well about limited resources to move the ship safely when the vessel is 2,000 miles off shore. My opinion is we do not need Summers, Geithner,Greespan, Levitt,Rubin Paulsen, Gensler, Phil Gram , and we certaintly do not need the same old same old two political party system co-opted by the elite. My wife had counseled several families destroyed by the Enron collapse. I have another fun filled fact, when CFTC chairwomen Brooksley Born was squashed by Greenspan,Rubin,Summers and Leavitt to "Let the markets work it out", instead of regulating the shadow banking industry, we had the most recent economic collapse. Nothing has changed with the Dodd-Frank act,as the banks are even bigger than before, and the bank lobbyists will fight tooth and nail against regulating the OTC derivitives market. As Brooksly stated "you will see another bubble and collapse worse than the last one, until we finally learn our lesson." I refer anyone who reads this to the PBS website and pull up Frontline "The warning". This is well worth the time to understand what happened. Also a timeline is another good one put out by frontline. The economic system we have today will not and cannot work as it is based on unlimited resources. We need a systme to match up an even distribution for growth and propsperity. No need to attack a person for raising an opinion. My opinion is when people rush to judgement or have destructive criticsm, or personal attacks, that tells me they are usually afraid, that if they truly listen to the opposing side, there is a chance they would have a change of mind on the subject.
Bob,
ReplyDeleteIt sounds like we agree on very much. But I believe we have plenty of resources, they are not managed well, too much "rent seeking" in the resource allocation process. For instance with the ENRON situation, the FIRE sector robbed the assets out of your utility Enron down there and left the shareholders and the local population holding the bag. In those futures markets, there actually is a winner for every loser. FIRE was the winner, the shareholders, creditors and the community were the losers. No wonder they are having utilty problems down there this week. the damage wrought by these policies sometimes take years to manifest.
I apologize if I mmay have seemed abrupt, FD my political compass: i am an authoritarian of the center, I try my best to supress it in these discussions, but sometimes it just has to come out ;)
link_http://politicalcompass.org/
Matt,
ReplyDeleteI enjoy reading your posts, you make sense, however I respectively disagree with the unlimited resource assumption. Refer to US Global investors website at thier webinars on resource consumption.
Over the next 10 years China will build out 10 cities the size of New York City. This consumption does not count the cars, roads, and India as well as Russia and Pakistan. The world will reach critical mass within the next 20 years no doubt, unless Mankind can continue to cheat mother nature. Think of all the drugs that people take in just the US and most of this medicine passes thru the body and ends up in the water table. The biological chains of this medicine will not break down and stays in the system. We are making changes for the sake of growth faster than the consequences can be fully understood. Of course scientists calculated something like 29 million to one chance of setting the atmoshere on fire if the Hydrogen bomb were set off, so they did the tests anyway.
keep the information coming people will read and think about what you post.
thanks.
WWS,
ReplyDeleteBill Mitchell is not "unwittingly" advocating greater deficit spending - one of the implications of MMT is that this option is available to any government that issues its own currency.
In other posts Mitchell has advocated full employment and a JG as the means of achieving this goal. If you wish to learn more, read his posts on these topics. Read first, then follow up by asking questions.
Bob,
ReplyDeleteThere are real resource limits, and consequences to resource consumption that continue to be ignored. If you are advocating a steady state economy, it will require us to reevaluate many aspects of our society, including how we treat the unemployed. I would welcome this!
Laura,
ReplyDeleteI didn't say that Mitchell was "unwittingly" advocating deficit spending. He is in fact purposefully advocating more deficit spending. I said "unwittingly" to point out that he is mistaken in his belief that deficit spending, make-work projects, and money printing are the fountainheads of wealth creation.
Re-read my post about Japanese debt. Explain to me specifically where my reasoning goes wrong.
Good to see a bit of Chartalist-Austrian debate going on. I think modern Chartalists could benefit substantially from engagement with Austrian theory and its approaches to time, production and capital.
ReplyDelete"Murphy is just restating Say's Law"
I'm not sure that he is. I read that as the limiting factor is supply--regardless as to how much current demand you create via fiscal or monetary policy.
vimothy,
ReplyDeleteIn that one paragraph you are correct.
WWS,
ReplyDeleteThey are not "fountainheads of wealth creation". The goal is full employment, which is dependent on public deficit spending.
I cannot comment on the opportunity cost of make work projects that target underutilized resources. Bill would likely deny that there is an OC in that circumstance.
This post might shed some light on Bill Mitchell's motivation in writing his blog:
http://bilbo.economicoutlook.net/blog/?p=10600
Laura,
ReplyDeleteHow has that "full employment" thing working out?
It's a mistaken belief that deficit spending creates productive jobs or wealth creation. It may create political jobs that are dependent on taxation (or borrowing against future taxes) for a time until the state runs up against the ability to keep funding that debt at low interest. These political jobs ,that are actually a burden on those who do create wealth, come at the expnse of jobs that would have otherwise been created by business without government largesse being showered on them. Those tax dollars that support the government's programs have to be taken by definition from market actors that are creating wealth and jobs else there would be nothing to tax. What would those businesses have done with that money if it weren't taken from them by government to support political jobs among other things? Economics is more about what is not seen than what is seen.
You can argue that teh deficit spedning isn't being financed by tax dollars yet, but it will be. The government by borrowing most of the scarce savings is crowding out other borrowers. All government spending is current consumption spending. They aren't taking that money and investing it in new capital equipment or even to maintain the existing capital stock. The government is eating our seed corn.
vimothy,
You are correct in regard to that one paragraph of Murphy. One of the implications of the article is that demand can't create its own supply. I bring up Say's Law because I want some of these guys to consider that the belief that government can increase aggregate spending to good effect is mistaken.
WWS,
ReplyDeleteThe government is not borrowing, it is creating money out of thin air. Taxes do not "fund" anything, their purpose is to limit aggregate demand. A government that issues its own currency is not revenue constrained.
These and other myths, including crowding out theory are addressed, you just have to find those posts and read them. Then by all means, raise questions on the details he provides (or fails to provide).
We cannot debate sound bytes.
p.s. Japan does not have a JG or a full employment policy. Bill might say that this is a political choice, not an economic one.
@WWS
ReplyDeleteIn case you missed it, bubbleRefuge posted a QE reply/explanation in this thread:
http://mikenormaneconomics.blogspot.com/2011/01/social-unrest-in-n-africa-expands.html
WWS,
ReplyDelete"the belief that government can increase aggregate spending to good effect is mistaken."
Right now due to Medicaid shortfalls, patients are being denied bone marrow transplants in several US states.
If the Federal govt credited the Medicaid bank accounts of those states and now the checks to the health care entities involved would not bounce, and then they could perform the life saving procedures, would that be to "good effect"?
Resp,
Laura,
ReplyDelete"The government is not borrowing, it is creating money out of thin air."
I'm afraid that's rather the problem.
"Taxes do not "fund" anything, their purpose is to limit aggregate demand."
Why would you want to limit aggregate demand?
"A government that issues its own currency is not revenue constrained."
Hmm--The only sense in which this is true is trivial. Govt faces a budget constraint in real terms same as every other actor in the economy.
"These and other myths, including crowding out theory"
Crowding out in a literal sense must occur--output consumed by the govt is not available for investment by definition.
WWS:It's a mistaken belief that deficit spending creates productive jobs or wealth creation.
ReplyDeleteDeficit spending is necessary for money to exist. Monetary economies outproduce non-monetary economies. So deficit spending creates productive jobs and wealth. QED
Replying to an old comment of yours, you quite misunderstood Wray's recent paper on Money. He does not concede that "there was a transition from a commodity money to a debt-based paper money" - but says this is a fairy tale. That commodity money - created by "free markets" - never existed and can't exist.
Vimothy: 1) The problem is that the government is not creating enough money out of thin air. Unemployment is high. 2) Demand is limited to support the value of money, control inflation, and for distributional purposes. 3) Government does not face real constraints except at/near full employment.
Financial crowding out of the sort WWS worries about does not and can not occur, ever. Real crowding out - only at full employment.
As Abba Lerner emphasizes, the problem is that critics of MMT (FF) always implicitly assume that economies are always at (or very quickly moving toward) full employment. Baloney.
Calgacus,
ReplyDeleteGovt faces the same constraint at every level of output—real income defines the feasible set. You cannot consume what you have not produced.
Similarly, real crowding out occurs at every level of output. Output that has been consumed cannot be invested. By definition.
Why are you concerned about the value of money? Why would you need to control inflation?
Calgacus,
ReplyDeleteDeficit spending is not necessary for money creation. It is true that money is created out of debt in our perverse paper money system, but that doesn't mean the government has to be the borrower. There is no new wealth creation when more of the medium of exchange exists.
Nor can government replace real saved capital through banking procedures. The credit is phony because the real saved capital doesn't actually exist. Projects will get started and some will even be completed, but when the phony capital pretends to touch actual goods the denoument will come. The economy is being stretched in two different directions at once during a credit bubble.
Matt,
The Fed could certainly credit a hospital's bank account if it were given the power, but there is still a cost there. No new goods and services exist in the economy because an account was credited. You will only have more money chasing the same amount of goods and services. These credit entries will not magically create more production and supply. I know you guys think that there will not be price inflation because you think production and demand will pick up. Nope. This goes back to my point that demand doesn't create its own supply. I really wish that wealth creation were as simple as crediting an account because the Fed could start with mine!
vimothy,
Greetings by the way! I was thinking that perhaps chartalism = charlatanism? :)
WWS,
ReplyDelete"These credit entries will not magically create more production and supply."
If the doctor cant get paid for the procedure, the doctor probably wont do the procedure. If the federal govt signals its intent to reimburse the state Medicaid fund for the procedure, then state Medicaid will authorize the conduct of the procedure. OF COURSE everybody has to wait to get paid... nobody in their right mind would pay in advance???? The govt here would reimburse the health care providers for the bone marrow transplant AFTER IT WAS DONE... this is called 'business'.
Resp,
WWS,
ReplyDeleteWas the Austrian stuff developed before the age of medicine? or the concept of Accounts Receivable?
You had to pay for the leeches in advance? No wealth created until the leech was hatched?
Resp,
WWS,
ReplyDeleteI quite like some aspects of Chartalism, actually. I am always impressed by the moral and social focus of its adherents when I read their stuff on line. As with Austrian economics, I consider myself more of an interested observer. For instance—I disagree with the idea that the govt cannot ever increase aggregate spending to good effect. It’s pretty easy to imagine situations in which it can. On the other hand, Chartalists seem to think it can always increase aggregate spending to good effect, which I also disagree with.
Vimothy: Similarly, real crowding out occurs at every level of output. Output that has been consumed cannot be invested. By definition.
ReplyDeleteThis and the other statements are either tautologies, hold output fixed for no reason, or as I said, presume full employment, which does not happen automatically. The government "intervening" to provide full employment, if it needs to, raises real income, consumption, production & investment and can lower inflation. It's a free lunch, because it amounts to not destroying the lunch you already have.
You cannot consume what you have not produced. So produce more. Use resources that neoclassical/neoliberal/Austrian economics insists on squandering.
Why are you concerned about the value of money? Why would you need to control inflation?
Helps economic calculation to keep it below 50%/year or thereabouts. What are your answers?
WWS: Deficit spending is not necessary for money creation. It is true that money is created out of debt in our perverse paper money system. Our perverse paper money system is the only one that has ever existed, for millennia. The non-perverse system that Austrians imagine never existed anywhere. What Austrians call "money" is a figment of their imaginations. Money as it has been used for 5,000 years is not created out of debt, money is debt. Deficit spending (credit creation/lending) is money creation, by definition. Surpluses (credit destruction/paying off loans) are money destruction, by definition.
Vimothy:
Chartalists think government can always increase aggregate spending (to 100% of all spending) to some effect - good or bad is in the eye of the beholder - and that's a legal point, not an economic one. The economic point is that unemployment exists, and governments can make it not exist, by spending more. That is when the question of efficiency or "good" or "bad" begins to make sense.
vimothy,
ReplyDeleteWhy would you want to limit aggregate demand?
In order to counter inflation or to target behavior deemed socially undesirable, like smoking.
Hmm--The only sense in which this is true is trivial. Govt faces a budget constraint in real terms same as every other actor in the economy.
"These and other myths, including crowding out theory"
Crowding out in a literal sense must occur--output consumed by the govt is not available for investment by definition.
Crowding out in the literal sense is normally referred to as opportunity cost, is it not?
In real terms, there is a consumption constraint, which is defined by the availability of resources, including labour. Unemployed people are an unused resource. Employing them does not involve a financial crowding out, when money is created.
The indicator for real resource availability is inflation.
Calgacus,
ReplyDeleteAs I wrote, by definition output that has been consumed cannot be invested. Since this is an identity (a very common form is given by I = Y – C – G), it is true in all states of the world—whether the economy is at full employment or otherwise. Although economics is a social science, it must nevertheless observe the laws of physics. One cannot get something for nothing. Everything comes from somewhere and goes somewhere.
If the government intervenes to raise employment, this may or may not raise real income, depending on other factors (for instance, the marginal product of unemployed labour might not be above zero). It may not even raise aggregate employment. Again, this depends on other factors (for instance, if govt raises unemployment in those sectors in which its newly employed labour competes).
Furthermore, it is entirely possible that the govt could increase aggregate expenditure to levels that are unsustainable, i.e. succeed in the short-run, but ultimately cause more pain, lost output and increased unemployment in the long-run (think of our recent experience with the housing bubble).
There is no free lunch. Everything has a cost. It may be that you think the food here is worth it, but you are mistaken if you think you don’t have to pay.
Incidentally, deficit spending is not money creation. Deficit spending creates (what Chartalists call, drawing on the work of the late Wynne Godley) “net financial assets” (NFA). The particular form those assets take depends on how that deficit spending was financed. If it was financed by money creation, then the deficit spending created money; if it was financed, as is more typical, by bond issuance, then no (net) new money was created.
Vim,
ReplyDeleteStare at this sentence for a while:
"Although economics is a social science, it must nevertheless observe the laws of physics."
Whaaaaaaaaat?!?!?!?
Good and services do not spring into or out of existence, as if by magic.
ReplyDeleteMatt,
ReplyDeleteI think vimothy was correct to point out that economics is a social science. That is why it must be primarily a deductive science and not primarily an inductive science.
Calgacus,
Our current monetary system has only been around isne Novemeber 1971 when we went off the gold-exchange standard. We had a real gold standard pre-1934. It is paper money that is the anomaly. Gold and silver commodity money are the norm for the last six thousand years. No fiat paper money has lasted even for 50 years. The fiat paper dollar is now 40 years old. It is reaching its life expectancy.
Goods and services "spring into existence" when the provider thinks they are going to get paid for them.
ReplyDeleteVimothy, Chartalists seem to think it can always increase aggregate spending to good effect, which I also disagree with.
ReplyDeleteMMT'ers do not believe that. MMT'ers believe spending beyond capacity will lead to inflation. Warren Mosler perhaps the most active of all MMT'ers has repeatedly said this. You are wrong.
Matt,
ReplyDeleteNo, goods and services don't "spring into existence when the supplier thinks someone needs them."
Before something can be demanded it must first be supplied. No one demanded cell phones before they were created/supplied. The supply chain that is needed to created just one pencil is incredibly complicated. This complexity is taken for granted among many economists who employ mathematical formulas that take the existing capital structure for granted. Those neat macroeconomic formulas that are based on aggregates just assume or take for granted that the capital structure and supply chain already exists. A person's demand is always unlimited, but supply must come first. Search for Say's Law. It is difficult to understand, but it is worth the effort.
As to your question about medicine and disease predating Austrian economics, your question just misses the point. The Austrian school actually can be traced back to the medieval Spanish Scholastics, but that's neither here nor there. Austrians don't want to centrally plan anything. It is a school of thought that seeks to only explain how the market process works. Gravity predated Isaac Newton, but he was able to explain how it worked. He didn't "invent" it anymore then Austiran invented the business cycle, but they have a theory that explains the process. We aren't so arrogant to think that we can build castles in the air you see.
WWS,
ReplyDelete"No, goods and services don't "spring into existence when the supplier thinks someone needs them."
I didnt write "when someone NEEDS them", I wrote "when someone believes they can get PAID for them"
In other words, they have a customer who will buy from them.... no coal company is going to dig out coal from the ground unless they have a standing order from a solvent power co, etc...
There is a big difference there, and also, it does not seem that Austrians give adequate attention to the external sector... having been developed when the west was at war with itself, and the nations running mostly closed economies.
Welfare:
ReplyDeleteSo according to you...
The only reason I eat is because a farmer produced food for me. If the farmer hadn't produced that food, I would not need to eat.
The only reason I live in a house is because a homebuilder built a house for me. If the homebuilder hadn't built the house I'd have been happy living in a cave.
The only reason I wear clothes is because a clothier made some clothes for me. If the clothier hadn't made those clothes I'd have been happy walking around naked.
I desire light, heat and other forms of energy because these things have been organized for my consumption. If these things had not been organized for my consumption I would not need to consume energy.
I desire transportation (cars, trains, buses, boats and planes) because these means of travel have been created for me. If they hadn't been created for me I would have no reason to get from place A to place B quickly.
In addition...
I desire to be healthy because there are doctors. If doctors didn't exist I'd have no desire to be healthy.
I desire to protect my legal rights because there are lawyers. If lawyers did not exist I'd have no desire to protect my legal rights.
I desire to be educated because there are schools. If schools did not exist I'd have no desire to be educated.
I desire to visit beautiful beaches and ski down incredible mountains because there are beach and ski resorts. If there were no beach and ski resorts I'd have no desire to visit beautiful beaches and ski down incredible mountains.
So, according to you, the only reason I eat, live in a house, wear clothes, utilize means of transportation, consume energy, seek medical care, retain lawyers enjoy leisure and basically, exist at all, is because the things that I require to live have been produced for me first. If not, I might as well just climb right back into the birth canal.
In other words, the only reason there is a demand for anything is because someone produced it? So people would be happy being amoebas or some equivalent? (Then again, even amoeba's demand food!)
Mike,
ReplyDeleteDemand is always unlimited. I want a yacht with a heli-pad on it. If demand could truly create supply then no one would be poor.Demand doesn't create supply or purchasing power.
If you find the time to look up Say's Law perhaps it will be more clear to you. It took me a long time to grasp what he was saying because it seems counterintuitive on the surface.
Good luck with Mr. Cantor.
You just refuted your own argument. Indeed, it is demand that is always present and that's what entices producers to produce. Goods and services are "bought" with your labor and it's up to you or your boss or the producer to determine whether or not your labor has enough value to purchase those goods and services.
ReplyDeleteWWS,
ReplyDelete"Say's law, or the law of market, is an economic principle of classical economics named after the French businessman and economist Jean-Baptiste Say (1767–1832), who stated that "products are paid for with products"[1] and "a glut can take place only when there are too many means of production applied to one kind of product and not enough to another"[1]. In Say's view, a rational businessman will never hoard money; he will promptly spend any money he gets "for the value of money is also perishable."
Here is an explanation of Says Law from Wiki. This "Law" is from 200 years ago.
Look at our monetary system as part of a big information system. When say wrote this, there was not even the telegraph, (carrier pigeons?) back then countreis could be at war with each other and no one would even know it yet. How did one develop correspondent business relationships?, comparison shop? communicate customer desires?etc...
Info moved slooooooooowly. I could see how back then, if you were in business, you would HAVE to produce in advance, products that were of demand IN GENERAL (pants with 2 legs, wagons with 4 wheels, bolts of sail cloth, corn, think "consumer staples", feedstocks) Customer demand could not be communicated well if at all. So for business, you would generally have to produce staples in advance and hope there was a customer when you were done.
So maybe Say would look at this and think that yes, producers had to produce in advance, without having any fixed orders: because back then demand could not be efficiently communicated, relationships could not be maintained...how would you know if your customers business burned down until you showed up to deliver your product, etc...
information tech and transportation have rapidly advanced since Say. (pony express, telegraph, wireless, teletype, satellites, internet) its a whole new modern world, your approach to economics has to evolve as well. this Say stuff is Luddite/Malthusian, etc... it is anachronistic.
WWS, its time to move on. The situation is flipped around, now the demand side is driving production. facilitated by the advent of new, revolutionary information technology that allows efficient communication of customer demands/relationships/orders and overall business conditions....
we are not in the year 1800. It is no more "produce your product and cross your fingers"...
Wasn't Say's Law refuted in a debate decades ago?
ReplyDeleteMike,
ReplyDeleteDemand is always present also unlimmited. It must start with supply which is created by savings and capital investment. I am glad you are focused on this though because if supply does in fact create its own demand as I think it does then the starting premise of what the government is engaged in at the moment is flawed from the get-go.
Matt,
ReplyDeleteGlad you took the time to look that up. That little snippet isn't enough to understand what he and others are saying when they posit that supply creates its own demand.I read whole books about it, and it was still difficult to get my head around. I think it is the hardest concept in economics to understand.
As to your speed of information argument, it is neither here nor there. It does not change anything. The objective truth is just that and will be the truth in antiquity as it will be in the future. Truths are timeless. Technologial gains do not refute timeless principles.
Laura,
No, it wasn't refuted though someone claims to have refuted this economic law seemingly every other day.
WWS,
ReplyDeleteTimelessness:
Are you then saying that a bucket full of leeches, that are paid for (ie not financed), represents more "real wealth" than a modern $250M medical center full of facilities, equipment and trained people that has an outstanding note against it?
Resp,
Debate from 1930s onward and ended by the 1960s
ReplyDeletehttp://bilbo.economicoutlook.net/blog/?p=12473
Say's Law is just one part of the mainstream edifice.
Matt,
ReplyDeleteI have no idea what you are trying to say. The laws of physics existed before man discovered them. The value of a "bucket of leeeches" or new technology does not change change these laws and principles.
Laura,
Say's law is a rebuke to some of the things that government wants to do. Of course they ignore it. They just find economists who will give intellectual cover to the things they have already decided to do. Collectivism has been the dominant ideology in government and academia for many decades. That doesn't mean that those ideas won out based on merit. They were simply chosen by the political class because neo-liberal economic ideology expands the power of the state and the political class. Don't confuse truth with politics or the fashions of the moment.
Speaking of the fashions of the moment, did any of you look up the poem by Rudyard Kipling entitled "The Gods of the Copybook Headings" that I mentioned in a previous post? It deals with markets, collectivism, objective reality, and the fashions of the moment. It is very relevant.
WWS,
ReplyDeleteHERE'S THE SUPPLY:
LINK_http://www.businessinsider.com/pictures-chinese-ghost-cities-2010-12?slop=1
Where is the demand?
Resp,
I’m not sure that debating Say’s Law is particularly fruitful. You can think of Say’s Law as a version of the income-expenditure identity that some Neo Chartalists like to highlight. But rather than focusing on the fact that income will be equal to expenditure (a demand story), Say’s Law flips it around and notes that expenditure will be equal to income (a supply story).
ReplyDeleteMatt,
In this world, nothing springs into existence as if by magic, except Tescos, which are everywhere. In order for a good to be bought and sold, it must first be produced. The idea that the economy’s agg supply curve is infinitely elastic is not serious, and directly contradicts statements about real resource constraints common to the Neo Chartalist camp.
Vimothy,
ReplyDeleteI think Say's law is at the crux of the matter. Many in government pursue policies based on the premise that government spending creates additional supply/production. It only misdirects capital and gets us further in debt in the long run.
Matt,
I'll take a look at that link later. I imagine there is a supply of goods that aren't being demanded, right? That is a miunderstanding of Say's law. Just because something is produced doesn't mean that there will ALWAYS be a demand for it. Anything that IS purchased/demanded though must have been produced/supplied first.
There are also a lot of things demanded that aren't supplied to turn that on its head. Abundant food in Egypt for instance.
WWS,
ReplyDeleteNo such thing as contracts and Progress Payments for custom manufacturing/construction...Aircraft carriers? Bridges? Boeing 777s? Software Development?
Resp,
Matt,
ReplyDeleteThat isn't relevant.
Those products are NOT produced first. They are demanded, and THEN they are supplied.
ReplyDeleteVimothy:
ReplyDeleteCavilling at (deficit) spending = money creation may indicate lack of understanding of MMT/Chartalism. Walk before you run. Think of Money = NFA. (Deficit) spending = (net) NFA creation = (net) money creation. Deficits are not "financed". The government just spends (creates money) and then may tax (destroy money, create demand for money) or play around with interest rates buying or selling bonds. The latter is not "financing a deficit" but just comparatively unimportant fun and games with interest rates. Bonds are just another kind of money that the government trades for currency = zero maturity bonds. All money is credit/debt. The important (base) money creation/destruction is with spending/taxing - the only way that private credit/debt with the government is created or destroyed - not with the monetary operations of the Fed or the Treasury.
See e.g. "In a broad sense, a federal (fiat currency issuing) government’s debt is money, and deficit spending is the process of monetising whatever the government purchases. .. It is actually rather obvious but all government spending involves money creation."
http://bilbo.economicoutlook.net/blog/?p=352
There is no free lunch.
There most emphatically is. Rational behavior is a free lunch. This free lunch is the evolutionary advantage of rationality. Here is how you get a free lunch. Mainstream economics tells us that (a) one should work hard and make a nice lunch (support people until they are adult workers, at great social cost) then (b) take a club and smash the lunch to smithereens (have them hanging around doing nothing, inflationarily getting handouts, the more resourceful turning to "crime"). Not destroying a lunch you already have is a free lunch.
Yes, if the government employs people doing insane things, like robbing and killing, aggregate output etc can decline. In the free lunch example, this would be poisoning and eating the lunch you already have. Random killing aside, the most prominent insane thing governments do is follow mainstream economics, sound finance, fiscal responsibility ultimately based on the "wheels oughta be square" "money is a commodity/thing" monetary theory of mainstream econ. On the other hand, not doing insane things works well. Viz: recently Chinese (and some Latin American) economic policies are basically sane; North American so-so, most European, particularly UK polices are pure insanity. No state that has ever tried to have full employment has failed at it.
Empirically, pursuing non-insane "interventional" activities invariably does increase output, real wealth etc. Your error in playing with such equations is as I said, that you illegitimately vary some terms and hold others constant. The trade-offs you posit are an artifact of this abstract, artificial procedure, not of observation and theory.
WWS: "Gold and silver commodity money are the norm for the last six thousand years."
ReplyDeleteNo they were not. Commodity money does not exist. Never existed. Can't exist. This is what MMTers have been saying - for more than a century at least, with varying degrees of clarity. Coinage did not exist for most of that 6000 years. I don't think you appreciate how deep and simple the critique MMT poses is. The size of the error in Austrian/mainstream monetary theory is comparable to an "ornithologist" not understanding that birds are not a kind of rock, and not realizing that ornithology is part of biology rather than geology.
Whatever website you got the 40 year limit from is just making things up. For instance, the Canadian dollar has been fiat since 1933, with short periods of obviously voluntary dollar pegs. Tally sticks were used as a fiat currency for hundreds of years. Matt Franko has been giving sound arguments for the noneistence of commodity money. The gold standard was a recent innovation. Some Austrians even partially understood this - they construed their monetary theories as "the way things oughta be", rather than descriptions of reality. Money = fiat money = credit money, always. It is not only the MMTers who realize this, see. e.g . Guttman's How Credit Money Shapes the Economy, p. 30 "In reality, throughout modern civilization we have never truly had commodity money." quoting Keynes' description of the Indian rupee as a "note printed on silver". Metallism / Commodity standards are imposed constraints, derived from the absurd and ahistorical idea that values of commodities that were used to make tokens of money gave rise to the value of money. Cf Mitchell-Innes' satirical example of the egg standard in his What is Money?.
Calgacus,
ReplyDeleteThat is demonstrably not so. Do a little reading up on history before posting next time.
Also Clagacus,
ReplyDeleteThe whole world was on the gold-exchange standard until 1971. It wasn't just the U.S. Nixon took the WORLD off of the gold-exchange standard. The whole world has been on a fiat paper standard since 1971 including Canada.