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Friday, November 1, 2013
Michael Stephens — An Omnibus Reply to MMT Critics
Randall Wray and Éric Tymoigne just released a new working paper that rounds up and responds to various critiques of Modern Money Theory (MMT)...
"MMT is agnostic regarding the fiscal position of a monetarily sovereign government per se. As Abba Lerner’s “functional finance” approach insists, the fiscal position of the government is not a relevant policy objective for a monetarily-sovereign government. "
Interesting to note the reply by Wray and Tymoigne to the Fiebiger criticism that
in the modern era, the US Treasury sells bonds to acquire the funds it needs to finance deficit-spending and ...without this financing operation would be short of “money”
They answer thus:
MMT does not deny this when one accounts for all of the institutional framework. The point is that, in that extreme case where nobody wants to buy bonds from the Treasury, the central bank will intervene, or the Treasury will finds ways to avoid having no funds in their coffers.
Well said. That is precisely what explains the crisis in periphery Europe: there is no central bank to intervene when markets do not want to lend to governments at reasonable rates.
Found one typo in the document: The central bank is involved in fiscal policy and the Treasury is involved in monetary policy Shouldn't it read: The central bank is involved in monetary policy and the Treasury is involved in fiscal policy.
no, they mean that whilst monetary policy is normally considered to be only the the responsibility the central bank, in reality the Treasury is also involved in monetary policy (and vice versa regarding fiscal policy).
I'd say it's more complicated than that. In the eurozone, a country can literally be drained of money as euros simply flow out of one country and into another. They can flow from euro-denominated Spanish government bonds into euro-denominated German government bonds. This poses a large risk not just to governments but to the entire economy. I don't think the ECB can offset such an outflow by simply lending at a low rate. In contrast, in a country like the US, dollars essentially exist in a closed system within the US. If you want to move your money out of the US you sell your dollars for foreign currency, and the dollars remain within the US economy. James Galbraith has pointed out that this means that dollars eventually all find their way back into US Treasury bonds.
That kind of movement will certainly mean an upward pressure on Spanish bond yields and a downward movement on German ones. That's exactly what we have been observing since at least 2009.
But I don't think Spain will be drained out of euros - and the reason is the existence and automatic intervention of the TARGET2 payments system.
When the Spanish investor dumps his country's bonds and sends a bank deposit of 100 euros to Germany in order to buy a German bond there will be a German commercial bank that gets 100 euros of reserves (an asset) and a new deposit of 100 euros (a liability).
The 100 euros in reserves is also a new liability of the Bundesbank. And TARGET2 will automatically create a corresponding asset for the Bundesbank, thus balancing its books - a 100 euro advance (a loan) to the Banco de Espana.
This loan is a liability of the Banco de Espana - it replaces the previous liability, the bank deposit that fled to Germany.
This means the 100 euros have come back to Spain by the end of the day, when all payments within eurozone central and commercial banks are cleared.
And if the movement out of Spanish bonds and bank deposits persists, draining reserves out of the Spanish commercial banks the Banco de Espana will have to intervene by advancing funds (reserves) to the Spanish banks. That's what indeed took place, to the tune of hundreds of billions of euros, in 2012.
And these movements show up on the TARGET2 accounts. One can read there that Germany's Bundesbank has hundreds of billions of euros in claims on the eurosystem while Spain's (and other European periphery) central bank has Hundreds of billions in "Dues to" the eurosystem.
TARGET2 guarantees that the eurozone is indeed a zone with free flow of payments in the same currency - the euro.
But there remains the problem of Spanish yields increasing to levels that threaten the solvency of the Spanish state. TARGET2 by itself cannot solve that problem. On the contrary, it enables the flight of funds from Spain to Germany.
Thus we are led to the conclusion that the problem of high Spanish yields could only be solved by a central bank intervening on behalf of Spanish public debt.
If the ECB did that - QE on a massive scale on Spanish, Portuguese, Greek, etc, securities - the problem would evaporate. The ECB does not do it, however, because it is not the central bank of the Spanish state. Spain is not monetarily sovereign since 1999 and is now paying the full price for her foolish decision to surrender her money issuing capabilities: it's becoming insolvent.
That is, IMO, the key MMT insight on the eurozone sovereign crisis.
Thanks, netbacker. I emailed Randy and Eric your comments on the typo.
The cb is responsible for conducting monetary policy, both setting it and carrying it out, while the Treasury is responsible for carrying out fiscal policy iaw appropriations. But owing to informal consolidation (working together) the cb is "involved in" fiscal policy and the Treasury is "involved in" monetary policy. The Fed and Treasury coordinate operations.
This is a bit confusing and needs to be spelled out clearly. Most people think that because the Fed is politically independent of the Treasury it acts completely independently. That's not the case.
The cb is the government's bank acting as fiscal agent and the Treasury is the fiscal authority that carries out the wishes of the political authority, which is the US is governed by the appropriations process as established by law. The process is seamless.
no, they mean that whilst monetary policy is normally considered to be only the the responsibility the central bank, in reality the Treasury is also involved in monetary policy (and vice versa regarding fiscal policy).
Yes, but if someone who regularly follows MMT and took the trouble to read the paper didn't get that, it seems that it is not stated clearly enough.
Randy and Eric are presuming they are writing for economists who will understand the background but other who are not economists will be reading this too. Moreover, many economists have misunderstood even very simple MMT points because they are thinking in another paradigm.
The matter of cb independence AND consolidation with Treasury is a particular sticking point and needs to be made crystal clear by reiterating how it works from a number of angles, until people get it.
TARGET2 is arguably the most important, least understood and most underestimated feature of the euro system.
There are some excellent papers dedicated to the subject (starting with Garber, later followed by Whittaker, Whelan, Lavoie, JKH, etc.) mas they're too technical to reach the audience that could make a difference: political leaders and public opinion of the periphery countries of southern Europe.
Just take the case of Portugal. Its banking sector (with one single exception) is under state control or direct intervention. The government could likely easily "convince" the bank managers (that it has appointed or at least not vetoed) to decide to systematically buy newly issued public debt at say 1.5% and then get automatic financing via the central bank at 0.5%.
The debt crisis would be over and no more austerity would be needed. Plus, the banks would make a nice spread on the whole operation.
Yet no one even mentions this possibility.
Furthermore, this solution would be facilitated by the recent U.S. criticism of austerity policies in Europe (because they lead to massive trade surpluses, that may destabilize the international system). The periphery countries now know that they can count on at least tacit support from the U.S. if they dared to defy the "diktat" of core Europe by using the automatic liquidity mechanisms provided by TARGET2.
Let's just hope this will change one day, perhaps after a victory of anti-austerity forces in a fresh election somewhere in southern Europe.
you make it sound like the Portuguese banks' ability to borrow is unlimited, so they could just borrow as much as they want and lend it to the government for a profit. That seems unlikely.
The ability to borrow is only limited by lack of capital, not lack of reserves.
Indeed, this is one of the main teachings of PK economics.
In this specific case, reserves will be provided by the Banco de Portugal, at 0.5% interest. Otherwise bank payments would not clear, there would be a run on banks and Portugal would be out of the eurozone - precisely the result that core Europe wants to prevent at all costs.
The Portuguese banks may be capital constrained, that is true. But let's say the required (Basel) capital ratio is 10% on loans. Then the Portuguese government would just have to inject one million euros of capital for every ten million euro loan it will get from the banks, with an interest of 1.5%.
"Then the Portuguese government would just have to inject one million euros of capital for every ten million euro loan it will get from the banks, with an interest of 1.5%."
can you clarify how they would inject the capital?
The government would inject it through the budget.
The banks have all received billions in public money. Otherwise they would be toast by now.
It would be simply a matter of injecting a few extra billion euros and then receive back 10x that as loans at 1.5%.
The government could do that right after the troika leaves the country (forecast date: July 2014) - to start paying back the 78 billion euros owed to the ECB/EC/IMF.
It could also do it through the pension funds that it controls.
These funds are already buying up government debt; buying shares in banks that will subsequently invest in new debt would just be a roundabout way to keep doing the same thing - only with a much higher "bang for the buck" (10 times more effective).
"MMT is agnostic regarding the fiscal position of a monetarily sovereign government per se. As Abba Lerner’s “functional finance” approach insists, the fiscal position of the government is not a relevant policy objective for a monetarily-sovereign government. "
ReplyDeleteI agree!
rsp,
Interesting to note the reply by Wray and Tymoigne to the Fiebiger criticism that
ReplyDeletein the modern era, the US Treasury sells bonds to acquire the funds it needs to finance deficit-spending and ...without this financing operation would be short of “money”
They answer thus:
MMT does not deny this when one accounts for all of the institutional framework. The point is that, in that extreme case where nobody wants to buy bonds from the Treasury, the central bank will intervene, or the Treasury will finds ways to avoid having no funds in their coffers.
Well said. That is precisely what explains the crisis in periphery Europe: there is no central bank to intervene when markets do not want to lend to governments at reasonable rates.
This comment has been removed by the author.
ReplyDeleteFound one typo in the document:
ReplyDeleteThe central bank is involved in fiscal policy and the Treasury is involved in monetary policy
Shouldn't it read:
The central bank is involved in monetary policy and the Treasury is involved in fiscal policy.
That typo in on page 14 BTW.
ReplyDeleteThis comment has been removed by the author.
ReplyDeleteNetbacker,
ReplyDeleteno, they mean that whilst monetary policy is normally considered to be only the the responsibility the central bank, in reality the Treasury is also involved in monetary policy (and vice versa regarding fiscal policy).
Jose,
ReplyDeleteI'd say it's more complicated than that. In the eurozone, a country can literally be drained of money as euros simply flow out of one country and into another. They can flow from euro-denominated Spanish government bonds into euro-denominated German government bonds. This poses a large risk not just to governments but to the entire economy. I don't think the ECB can offset such an outflow by simply lending at a low rate. In contrast, in a country like the US, dollars essentially exist in a closed system within the US. If you want to move your money out of the US you sell your dollars for foreign currency, and the dollars remain within the US economy. James Galbraith has pointed out that this means that dollars eventually all find their way back into US Treasury bonds.
Thanks for pointing out this article. This is an excellent MMT reference document and should be required reading for all economics students...
ReplyDeleteY,
ReplyDeleteThat kind of movement will certainly mean an upward pressure on Spanish bond yields and a downward movement on German ones. That's exactly what we have been observing since at least 2009.
But I don't think Spain will be drained out of euros - and the reason is the existence and automatic intervention of the TARGET2 payments system.
When the Spanish investor dumps his country's bonds and sends a bank deposit of 100 euros to Germany in order to buy a German bond there will be a German commercial bank that gets 100 euros of reserves (an asset) and a new deposit of 100 euros (a liability).
The 100 euros in reserves is also a new liability of the Bundesbank. And TARGET2 will automatically create a corresponding asset for the Bundesbank, thus balancing its books - a 100 euro advance (a loan) to the Banco de Espana.
This loan is a liability of the Banco de Espana - it replaces the previous liability, the bank deposit that fled to Germany.
This means the 100 euros have come back to Spain by the end of the day, when all payments within eurozone central and commercial banks are cleared.
And if the movement out of Spanish bonds and bank deposits persists, draining reserves out of the Spanish commercial banks the Banco de Espana will have to intervene by advancing funds (reserves) to the Spanish banks. That's what indeed took place, to the tune of hundreds of billions of euros, in 2012.
And these movements show up on the TARGET2 accounts. One can read there that Germany's Bundesbank has hundreds of billions of euros in claims on the eurosystem while Spain's (and other European periphery) central bank has Hundreds of billions in "Dues to" the eurosystem.
TARGET2 guarantees that the eurozone is indeed a zone with free flow of payments in the same currency - the euro.
But there remains the problem of Spanish yields increasing to levels that threaten the solvency of the Spanish state. TARGET2 by itself cannot solve that problem. On the contrary, it enables the flight of funds from Spain to Germany.
Thus we are led to the conclusion that the problem of high Spanish yields could only be solved by a central bank intervening on behalf of Spanish public debt.
If the ECB did that - QE on a massive scale on Spanish, Portuguese, Greek, etc, securities - the problem would evaporate. The ECB does not do it, however, because it is not the central bank of the Spanish state. Spain is not monetarily sovereign since 1999 and is now paying the full price for her foolish decision to surrender her money issuing capabilities: it's becoming insolvent.
That is, IMO, the key MMT insight on the eurozone sovereign crisis.
thanks for the info on Target 2.
ReplyDeleteThanks, netbacker. I emailed Randy and Eric your comments on the typo.
ReplyDeleteThe cb is responsible for conducting monetary policy, both setting it and carrying it out, while the Treasury is responsible for carrying out fiscal policy iaw appropriations. But owing to informal consolidation (working together) the cb is "involved in" fiscal policy and the Treasury is "involved in" monetary policy. The Fed and Treasury coordinate operations.
This is a bit confusing and needs to be spelled out clearly. Most people think that because the Fed is politically independent of the Treasury it acts completely independently. That's not the case.
The cb is the government's bank acting as fiscal agent and the Treasury is the fiscal authority that carries out the wishes of the political authority, which is the US is governed by the appropriations process as established by law. The process is seamless.
no, they mean that whilst monetary policy is normally considered to be only the the responsibility the central bank, in reality the Treasury is also involved in monetary policy (and vice versa regarding fiscal policy).
ReplyDeleteYes, but if someone who regularly follows MMT and took the trouble to read the paper didn't get that, it seems that it is not stated clearly enough.
Randy and Eric are presuming they are writing for economists who will understand the background but other who are not economists will be reading this too. Moreover, many economists have misunderstood even very simple MMT points because they are thinking in another paradigm.
The matter of cb independence AND consolidation with Treasury is a particular sticking point and needs to be made crystal clear by reiterating how it works from a number of angles, until people get it.
Eric just responded to my email "y is right".
ReplyDeletedo I get an award?
ReplyDeletey,
ReplyDeleteTARGET2 is arguably the most important, least understood and most underestimated feature of the euro system.
There are some excellent papers dedicated to the subject (starting with Garber, later followed by Whittaker, Whelan, Lavoie, JKH, etc.) mas they're too technical to reach the audience that could make a difference: political leaders and public opinion of the periphery countries of southern Europe.
Just take the case of Portugal. Its banking sector (with one single exception) is under state control or direct intervention. The government could likely easily "convince" the bank managers (that it has appointed or at least not vetoed) to decide to systematically buy newly issued public debt at say 1.5% and then get automatic financing via the central bank at 0.5%.
The debt crisis would be over and no more austerity would be needed. Plus, the banks would make a nice spread on the whole operation.
Yet no one even mentions this possibility.
Furthermore, this solution would be facilitated by the recent U.S. criticism of austerity policies in Europe (because they lead to massive trade surpluses, that may destabilize the international system). The periphery countries now know that they can count on at least tacit support from the U.S. if they dared to defy the "diktat" of core Europe by using the automatic liquidity mechanisms provided by TARGET2.
Let's just hope this will change one day, perhaps after a victory of anti-austerity forces in a fresh election somewhere in southern Europe.
Jose,
ReplyDeleteyou make it sound like the Portuguese banks' ability to borrow is unlimited, so they could just borrow as much as they want and lend it to the government for a profit. That seems unlikely.
y,
ReplyDeletemaking that 1% nim at 12x is 12% on capital: Not bad for a risk free investment...
rsp,
y,
ReplyDeleteThe ability to borrow is only limited by lack of capital, not lack of reserves.
Indeed, this is one of the main teachings of PK economics.
In this specific case, reserves will be provided by the Banco de Portugal, at 0.5% interest. Otherwise bank payments would not clear, there would be a run on banks and Portugal would be out of the eurozone - precisely the result that core Europe wants to prevent at all costs.
The Portuguese banks may be capital constrained, that is true. But let's say the required (Basel) capital ratio is 10% on loans. Then the Portuguese government would just have to inject one million euros of capital for every ten million euro loan it will get from the banks, with an interest of 1.5%.
Not a bad deal at at all, don't you think?
"Then the Portuguese government would just have to inject one million euros of capital for every ten million euro loan it will get from the banks, with an interest of 1.5%."
ReplyDeletecan you clarify how they would inject the capital?
y,
ReplyDeleteThe government would inject it through the budget.
The banks have all received billions in public money. Otherwise they would be toast by now.
It would be simply a matter of injecting a few extra billion euros and then receive back 10x that as loans at 1.5%.
The government could do that right after the troika leaves the country (forecast date: July 2014) - to start paying back the 78 billion euros owed to the ECB/EC/IMF.
do you mean the govt should buy stock in the banks?
ReplyDeletey,
ReplyDeleteRight.
It could also do it through the pension funds that it controls.
These funds are already buying up government debt; buying shares in banks that will subsequently invest in new debt would just be a roundabout way to keep doing the same thing - only with a much higher "bang for the buck" (10 times more effective).
As someone who reads all sorts of esoteric MMT papers....
ReplyDeleteThis is EXCELLENT!!
I can not wait to see how they respond to this.
7dif and wp_778 will be under my arm from now on!
Just absolutely love it.
This excerpt from the paper (page 31) - concerning the euro system - needs further clarification:
ReplyDeletenational central banks do purchase treasuries in secondary markets
Which NCBs are doing that? Inquiring minds want to know.