Wednesday, June 29, 2011

Martin Wolf schools BIS on sectoral balances

Martin Wolf has an interesting post from the MMT perspective today in his column at The Financial Times.
Now turn to the yet more debated question of fiscal policy. The question I have is this: does the BIS know that every sector cannot run financial surpluses at the same time?

Few doubt there is excessive private sector debt in a number of high-income countries. But how is it to be reduced? The BIS notes four answers: repayment; default; higher real incomes; and inflation. Let us rule out the last and focus on the first. Repayment means spending less than one’s income. That is what is happening in the US private sector (see chart). Households ran a financial deficit (an excess of spending over income) of 3.5 per cent of gross domestic product in the third quarter of 2005. This had shifted to a surplus of 3.3 per cent in the first quarter of 2011. The business sector is also running a modest surplus. Since the US has a current account deficit, the rest of the world is also, by definition, spending less than its income. Who is taking the opposite side? The answer is: the government. This is what a controlled depression means: every sector, other than the government, is seeking to strengthen its balance sheet at the same time.

The BIS insists this is not good enough: highly leveraged countries are running structural fiscal deficits, which must be eliminated as soon as possible. Fair enough, but where are the offsetting adjustments to occur?
Read the whole post at Why austerity alone risks a disaster.

I posted a comment there commending him. Consider lending your support, too.


Calgacus said...

Martin Wolf & MMT go waaayyyyyy back.

Abba Lerner, in his last book, MAP: Market Anti-Inflation Plan, thanks him for reading & commenting on the manuscript. He clearly got something valuable from the master himself. The only other thankee there I recall that is still kicking is Alice Rivlin, who has become something of a deficit terrorist, or deficit dove at best. How that could happen is a mystery to me. It is like unlearning arithmetic, or how to ride a bike. Oh well, I guess Einstein was right on the infinitude of human stupidity.

Ralph Musgrave said...

Martin Wolf argues that “government structural deficits must be eliminated” and then, asks “where are the offsetting adjustments to occur?” Neither Wolf nor the BIS answer the question satisfactorily.

Strikes me the answer is to reverse the process that brought to the deficit into being (which was borrowing instead of collecting sufficient tax). The reverse is to raise taxes and pay back the debt. That on its own would be too deflationary, but the latter problem can be remedied by obtaining some of the money for the “pay-back” from the printing press. That is, mix some Q.E. into the brew.

Assuming the inflationary effect of the Q.E. equals the deflationary effect of the tax, the net effect is neutral: that is, there would be little effect on GDP, total numbers employed, etc.

For a fuller explanation of this point, see:

HarPe said...

Though it's worth asking whether QE is technically inflationary or just psychologically inflationary, isn't it? The psychological effect wears off pretty quickly and the mechanical one is neither proven, nor theoretically sound under a fiat currency regime and western CB-policy.

Tom Hickey said...

There is a good argument that QE is deflationary because it transfers the interest on the tsys that the cb purchases for its balance sheet to government, effectively depriving nongovernment of an increase of net financial assets through interest payments.

Moreover, unless QE increases either spending or borrowing, it is not inflationary. QE1 and QE2 increased excess reserves by shifting asset composition and term without increasing nongovernment net financial assets.

All the inflationary expectations were based on misunderstanding of how the modern monetary system actually operates. The transmission mechanism from excess reserves to increased borrowing/spending that was supposed to work, e.g., the money multiplier, didn't because the causality runs in the opposite direction.

The money multiplier is actually an ex post accounting residual rather than the ex ante cause that mainstream theory erroneously presumes. This was pointed out by MMT economists weel before MMT was undertaken.