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.

source