Proponents of MMT generally can’t understand why people don’t “get” MMT as it seems so obvious. They may have forgotten however, that at their critical point of ‘enlightenment’ they had to jump a number of conceptual barriers to get to the other side.
In my experience, these are the six (seemingly) “impossible things” you have to believe (before or after meals, it doesn’t matter) to have any hope of ‘getting’ MMT. Once you believe these “impossible things” however, the getting of wisdom follows quickly and logically.Modern Monetary Theory: Real Economics“
The order of priority is based on my experience of the degree of ‘jaw dropped-ness’ as I’ve sought to explain to friends, family, and household pets.
(1) Taxes don’t fund anything
(2) The government doesn’t borrow from anybody to finance its spending
(3) The government’s fiscal balance (deficit) is the non-government sector’s surplus.
(4) The government creates currency by fiat (‘out of thin air’)
(5) Bond issuance is not borrowing.
(6) Banks lend without reserves constraints imposed by the central bank.
They are of course not “impossible things” but the absolute reality of the sovereign fiat monetary system we actually operate under.
I could’ve added a few more but I needed just six to fit my literary allusion (“Through the Looking Glass”).
Why, sometimes I’ve believed as many as six impossible things before breakfast.” (or what’s so hard about MMT)
Guest Post by John Armour
"They are of course not “impossible things”
ReplyDeleteAhhh, I'm afraid they are impossible for libertarians both right and left....
rsp,
When I was in high school, I wondered, "If someone must spend a dollar in order for me to earn a dollar, how could it even be possible for all of us to make a profit?". The zero-sum nature of income and spending was kinda obvious to me. I wondered for a while, but nobody knew the answer. About a decade later I stumbled across MMT while trying to understand the GFC, and it pretty much instantly made sense.
ReplyDeleteIt's the jump from the micro to the macro that's the conceptual leap that most people haven't made. Why's it so hard for most people? I don't know, but in my opinion, understanding the sectoral balances and the zero-sum of income/spending is by far the most important thing. Once that's understood, all this nonsense about austerity just goes out the window. Every one can't be a net exporter, govt and non-govt can't both be in surplus...
As far as taxes not funding anything, that's a point of logic. Where would you have gotten the dollars with which to pay your taxes, if the govt hadn't issued them first? You just gotta think about where money comes from. Most people have no idea.
"(2) The government doesn’t borrow from anybody to finance its spending"
ReplyDeleteyet money is a government debt...
money is debt, but debt is not borrowing...?
Y-
ReplyDeleteMoney is a liability from the POV of the Govt, just as securities are.
A private sector debt usually comes with collateral, this is not the case for Govt securities.
This is an interesting title choice. It's a play on a video highlighting skeptical arguments toward anthropogenic climate change, specifically w.r.t. to clmate models.
ReplyDeleteBelieving Six Impossible Things before Breakfast, and Climate Models
http://www.youtube.com/watch?v=hvhipLNeda4
I could never understand why acorns are a liability of the acorn tree ...?
ReplyDeleteahhh… Alice in Wonderland is apparently where there "six impossible things" comes from.
ReplyDeleteWorth checking out the Climate models talk.
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ReplyDeleteStatement (3) shouldn´t even be mentioned as a specificity of MMT, because it is stated in every (mainstream) economics textbook in the chapters on macro accounts. It is not - or should not be - controversial at all.
ReplyDeleteStatement (1), however, is the most difficult for people to accept.
If the government uses the proceeds of taxes almost everyday to pay for its expenditures (as it does in practice, the annual deficit being only 4 of 5% of GDP in most cases, while public spending is above 20% of GDP) then taxes do "fund" expenditures in the normal sense of the word "funding".
And nevermind that in the origin, as a "point of logic", there was Fiat. People don´t care about "Prime Causes". They look like cosmological arguments from religious books, and thus a bit out of context in essays or manuals on economics.
As Marc Lavoie once put it: "there is little to be gained from contending...that government expenditures must precede tax collection...or that taxes and issues of securities do not finance government expenditures...ultimately it all leads to confusion and misunderstandings" ("The Monetary and Fiscal Nexus of Neo-Chartalism", p. 23).
This is advice that MMTers would be wise to take, IMO.
Marc Lavoie: (?)
ReplyDelete- Before things can be dried they must first be covered with water
- Evaporation, precipitation and streams do not ‘fund’ the ocean
Don’t tell people, they might misunderstand, find it confusing …. even cosmological?
Or were they fed bs in the first place???
Jose,
ReplyDeleteyou pay your taxes with dollar bills that the government first had to print and issue. Pretty simple to understand really, not a complicated idea.
"If the government uses the proceeds of taxes almost everyday to pay for its expenditures (as it does in practice"
You're thinking that money is an object, like a lump of metal. This is the root cause of the confusion.
You can talk about taxes and spending in either the mainstream way or the MMT way. There is no reason why MMT should abandon its way of describing things and adopt the mainstream way. MMT is a very useful and interesting way of thinking about things.
y,
ReplyDeleteNo need to think of money as an object - at all.
The Treasury spends by drawing on its account at the Central Bank. And that account is replenished whenever taxes are paid.
Suppose a year when the government draws 100 on that account, 95 of which came from (digital) tax proceeds. In the common meaning of the word "funding" 95% of the government's expenditure was "funded" by taxes on that year. And this would apply even if there were zero physical dollar bills in circulation.
Jose,
ReplyDelete"The Treasury spends by drawing on its account at the Central Bank."
MMT version: the Treasury spends by issuing government liabilities.
"And that account is replenished whenever taxes are paid."
MMT version: When taxes are paid government liabilities are extinguished.
MMT version makes sense if you think of money as a government liability.
Your version makes sense if money is an object.
y,
ReplyDeleteThe "MMT version" is just a reference to different lines on the Central Bank´s balance sheet. As the government spends, funds are transferred to commercial banks and thus more bank reserves (a CB liability) are created.
But it does not, indeed cannot, contradict the descriptive statement "Treasury spends by drawing on its account at the Fed".
This statement is simply describing a(n)(accounting) fact of life.
That account balance is a liability of the government.
ReplyDeleteIt is internal government accounting.
Payment of government liabilities to the government extinguishes government liabilities.
But different departments of the government can still show an asset and a liability outstanding on their books.
The Fed books show a liability and the Treasury books show an asset.
This is internal government accounting.
The accounting fact of life is that returning a liability to the issuer extinguishes that liability.
Treasury spends by issuing government liabilities.
These are factual statements.
"the government uses the proceeds of taxes almost everyday to pay for its expenditures"
The government can not "use" the liabilities that are returned to it as these are extinguished.
The number in the Treasury's account shows how much the government is (supposedly) allowed to spend at a given point in time.
The number in the Treasury's account shows how many government liabilities of a certain type the Treasury is allowed to issue at a given point in time.
The MMT argument is that taxes are needed for:
ReplyDelete1) creating demand for the currency
2) diverting resources from the private sector to the public sector
Argument 2) implies that taxes do fund government expenditures.
I see the "taxes don't fund anything" meme is an extremely clever (maybe unconscious) marketing ploy to draw attention to MMT. And it has succeeded brilliantly. MMT, in only a couple of years, has managed (deservedly, btw) to surpass in notoriety all the dozens of decades-old PK schools - combined.
Alas, it is not very realistic. Try to reduce taxes from one day to the other by 90% and one can imagine what will happen: a good dose of inflation. A substantial part of government expenditures will always have to be preceded by collection of taxes (aka "funding") if the economy is to behave in a controlled, not-run-amok, way.
"A substantial part of government expenditures will always have to be preceded by collection of taxes"
ReplyDeleteI find it odd that you persist in making these sorts of statements. You pay your taxes with money issued by the government. In order for people to own money which they can then pay in taxes, the government has to have spent first. Or possibly the non-government could borrow the money from the government first to then pay the taxes, but then the non-govt wouldn't be able to become un-indebted to the government unless the government spent money, so it comes down to the same thing.
As things stand the Treasury gets numbers in its account and then it spends. But where did those numbers originally come from? The government, obviously.
You could easily imagine a slightly different accounting method whereby the Treasury kept a tally of outstanding government monetary liabilities and then marked those liabilities down, or deleted them, when taxes were paid. The current accounting method is different but the underlying logic is the same.
"Argument 2) implies that taxes do fund government expenditures."
ReplyDeleteThe government doesn't get real resources when it collects taxes though. It gets real resources when it spends (or in other words when it issues money).
You pay your taxes with money issued by the government
ReplyDeleteTechnically, most citizens and firms pay taxes with bank deposits, not money issued by the government.
But it´s true that banks have to simultaneously transfer reserves to the Central Bank - and reserves are issued exclusively by the Central Bank.
However, the Central Bank may issue reserves in a way that is totally disconnected to GDP or deficit spending.
For instance, by doing QE.
In that case, reserves sent back to the CB - when taxes are being paid - may have originated in private sector assets previously sold off to the CB under a QE program.
"Technically, most citizens and firms pay taxes with bank deposits"
ReplyDeleteTechnically, most citizens and firms pay taxes by instructing their banks to make payments to the Treasury on their behalf.
That's what 'paying with a bank deposit' means. You instruct your bank to make a payment (of reserves) on your behalf.
"the Central Bank may issue reserves in a way that is totally disconnected to GDP or deficit spending. For instance, by doing QE".
QE involves buying government bonds or mortgage-backed securities.
When the CB buys mortgage backed securities it is lending money to the private sector.
Government bonds represent prior government spending.
(When the CB holds government bonds it is 'lending money to the Treasury').
This is what I said in my comment above: government money (such as bank reserves) gets into the private sector via government spending or lending.
If the CB lends money to the private sector, the only way the private sector can pay off the debt is if the government spends.
I cannot instruct a bank to pay in reserves because I don´t own reserves. I own a deposit in the bank. The bank owns the reserves.
ReplyDeleteDeposits are second in the hierarchy relative to the top of the pyramid - government money (dollar bills and reserves). Deposits are promises to pay in that higher-order money, nothing more.
As for the Fed, it could - if it wanted - buy up all of the assets of the economy. Not only credit products such as MBS, but also shares, houses, anything.
And that operation would be disconnected from government spending or GDP. It would be an exchange of assets, nothing more than that.
"I cannot instruct a bank to pay in reserves because I don´t own reserves. I own a deposit in the bank.
ReplyDeleteDeposits are promises to pay in [reserves], nothing more."
Do you not even see a contradiction there, Jose?
If you own a bank deposit your bank owes you reserve money.
Because you have that claim on reserve money you can instruct your bank to pay that money to the government.
If you owed me $10 cash and promised to pay it to me on demand, I could instruct you to pay it to someone else instead.
Get it?
If your bank deposit was NOT a promise to pay reserves, you could NOT use your bank deposit to 'pay your taxes'. If for example your bank deposit was a promise to pay bitcoin, you could NOT use it to pay taxes.
This really isn't complicated.
"As for the Fed, it could - if it wanted - buy up all of the assets of the economy. Not only credit products such as MBS, but also shares, houses, anything."
ReplyDeleteThe Fed isn't legally allowed to do that. It's funny that people who are so concerned about the rules governing what the Treasury can and can't do never bother to extend that concern to the Fed.
But anyway, if the Fed could buy any assets it wanted - boats, houses whatever, that would be spending. Otherwise known as fiscal policy.
Yes the Fed is part of the government.
You seem to think that details and hypothetical scenarios can be used to refute basic logic. Not so.
If the bank lacks reserves and decides to break its promise than I have a problem.
ReplyDeleteBy depositing currency in my bank I ceased to own first order money and accepted to own instead a risky asset - a bank deposit, second order money, a mere promise to be paid on demand in the "top of the pyramid" money.
I did once own money - now I own a mere claim on (highest order) money.
And whereas I as an individual have the ability to own currency - dollar bills - I cannot own deposits at the Central Bank. Only commercial banks can - in that sense they are the mediators of the whole payments system.
As for the ability of the Fed to buy assets - there is nothing to prevent it from doing so. At least that's what Perry Mehrling is teaching at its course on money and banking. And it seems quite logical - where is the drawing line between MBS, shares and houses? Going from T binds to MBS was much more daring jump and no one complained about it from a legal POV.
And no - having the Fed buy houses or shares is NOT spending in the GDP sense. GDP refers to newly produced goods and services. Already existing assets do no count as part of GDP. The Fed would be merely swapping them for bank reserves (and their mirror image, bank deposits, would become assets of the non bank sector replacing the previously held houses, boats, shares, etc).
"now I own a mere claim on (highest order) money."
ReplyDeleteThe bank owes you that money. As I said, if someone owes me $10 and promises to pay it to me on demand, I can instruct them to pay it to someone else instead.
That is what you do when you pay taxes via a bank.
"As for the ability of the Fed to buy assets - there is nothing to prevent it from doing so."
Yes there is - the Federal Reserve Act.
"where is the drawing line between MBS, shares and houses?"
Buying MBS is lending money. Buying houses is spending money.
"having the Fed buy houses or shares is NOT spending in the GDP sense"
Buying a house IS spending.
If I buy a house, I am not lending money to the house seller. I am spending money.
According to you, if the Treasury were to buy a piece of land, it would not be spending money. Obviously that is not correct.
"As for the ability of the Fed to buy assets - there is nothing to prevent it from doing so. At least that's what Perry Mehrling is teaching at its course on money and banking. And it seems quite logical - where is the drawing line between MBS, shares and houses? Going from T binds to MBS was much more daring jump and no one complained about it from a legal POV."
ReplyDeleteWhat the Fed can and cannot do is established by the Federal Reserve Act of 1913 as amended — which is open to some interpretation.
The basic principle is that the Fed an only do monetary policy and not fiscal, which is reserved under the Constitution to the legislature, and Congress did not delegate that power to the Fed, although they could if they desired and as some advocate. However, the fiscal power is perhaps the most jealously guarded of all Congress's powers.
However, under ordinary conditions, the Fed's normal operations are limited to buying and selling US government securities. Congress left an opening to use discretionary powers in extremis, left up to the discretion of the Fed BoG. However, the Fed realizes that if it oversteps its powers, then Congress will react negatively, so it is reluctant to do so.
When the financial crisis hit and the system froze, basically with the big banks insolvent as well as illiquid, Secretary Paulson begged Chairman Bernanke to bail out the banks and Bernanke refused, saying it was fiscal and exceeded his powers and that Paulson would have to do to Congress, which is what happened.
Bernanke did oblige with massive liquidity, using his emergency powers to relieve the banks of MBS and inject payment balances aka "reserves."
When the Treasury buys existing assets that is NOT spending in the GDP sense.
ReplyDeleteIf Treasury (or the Fed) bought one trillion in houses built during the past decade or two GDP would not change - and neither would the G component of GDP.
But banks would have one trillion in extra reserves available - among many other purposes - to pay taxes.
"that is NOT spending in the GDP sense"
ReplyDeleteIt is still spending. It is not counted as spending on 'goods and services', but it is still spending.
I'd love to see what the reaction in the US would be if the Fed decided to start buying up housing inventory to support the market and offered to buy up all underwater properties to prevent default.
ReplyDeleteOh, and to support the equity market by taking all offers that are without a bid at the market price that Fed wants to set, since everyone knows that the equity markets are the foundation of the US economy along with defense spending. That brings up the point, could the Fed order up a fleet of ships and planes? :)
Could the Fed do it operationally? Of course.
The questions are then, could the Fed do it legally, and would the Fed be likely do something like this using emergency powers in extremis. I think both are doubtful, unless the Fed went to Congress for permission, as it did in the case of payment of IOR, which is a quasi-fiscal add.
As I understand it, the Bank of England has more authority to do something like this than the Fed does.
In fact, a shrewd left-wing government aiming at control of the economy would not need to resort to nationalization, therefore eschewing the dreaded and dangerous N-word.
ReplyDeleteIt´d rather merely use existing rules, mechanisms and institutions, especially the most powerful one: the Central Bank.
The CB could start buying up shares in the country´s main corporations and hey, presto, the public sector would assume the commanding heights of the economy - not via "revolution", but by following well-established and consensual procedures instead.
Which possibility shows that neoliberals may not be so bright, after all.
By allowing enormous powers to concentrate in technocratic, opaque, almost secretive institutions, they may be providing an opening for an easy and "legal" way towards capitalism´s ultimate demise.
except that the rules as they stand don't allow the Fed to buy up corporations.
ReplyDeleteThis is fiscal authority which has to wielded by the elected Congress.
"the most powerful one: the Central Bank"
ReplyDeleteIt's not really the most powerful though, it just looks that way superficially.
You should read this paper by John Cochrane. It might make you rethink that assumption:
http://media.hoover.org/sites/default/files/documents/2014CochraneMonetaryPolicywithInterestonReserves.pdf
What is to prevent the Fed from buying shares in the stock exchange?
ReplyDeleteAfter all, the company would have to pay back to the Fed in the form of dividends. Just like MBS owers will pay the Fed back, but in the form of interest and principal.
It´s clear that perhaps the cleverest of tricks performed by neoliberals has been to convince the populace to just not look at the Central Bank - and entertain itself instead with pointless soap operas performed among allowable, "mature", "serious" candidates at elections.
Just look at the eurozone. It´s being ruled from Frankfurt, yet people direct their complaints towards Brussels or national capitals. Towards powerless, indeed impotent fora - while clever bankers under the sway of the financial sector run the continental roost, not even having to bother with those boring processes called, you know, "elections".
"What is to prevent the Fed from buying shares in the stock exchange?"
ReplyDeleteFederal Reserve Act.
"the company would have to pay back to the Fed in the form of dividends.
There's no obligation to pay dividends. As a shareholder you are simply the part owner of a company.
Operationally, the Fed or the ECB could do it.
ReplyDeleteThe ECB is now toying with the idea of buying up debt of small and medium companies - without so much as a hint of public discussion of the issue.
As for legal "constraints", we´ve learned how hard and unbending these turned out to be in the last 5 years.
:)
"If the Fed could buy any asset...that would be spending"
ReplyDeleteIt certainly can buy gold, euros, you name it - marketable assets with no obligation of "repayment" or borrower on the other side and thus meeting a definition of "spending" as opposed to "lending".
"It certainly can buy gold"
ReplyDeleteThe Fed can only buy gold on behalf of the Treasury.
Buying gold and currencies is considered normal operations wrt monetary policy even though it is quasi-fiscal like paying IOR.
ReplyDeleteAgain, operationally, the Fed has the means to purchase anything at any price. However, central banking is a legally constituted institution nationally and internationally, and the law prevails, regardless of what is possible operationally.
Countries can manipulate their currencies but they agree not to. In the end, disputes that cannot be settle though negotiation and compromise lead to conflict. Everything that is possible operationally is not possible in context without consequences.
We all know that government has enormous power and the only limitation on this state power is the consent of the governed, at least enough to prevent revolt, or in the case of revolt the force to suppress it.
The government creates and destroys currency, and spends and transfers it, using various agencies, among which are the central bank, the treasury, and the agencies that contract purchases.
Who spends in buying an F-16? The Air Force purchasing department, the Air Force, the DOD, the Treasury that pays the bills, the Fed that issues the settlement balances, the Congress that appropriates the funds, or the government acting for the state?
In a liberal democracy like the US the government is created by and operates under the Constitution, laws, and judicial precedent. Al this transpires in terms of that legal institution in the coordinated way that the institutional arrangements specify.
Theoretically, the state can confiscate all property, or it could buy up everything and tax back the proceeds as it chooses. There is no problem with that operationally, and laws could be passed to accomplish it if lawmakers agreed.
There would be no social, political or economic problems standing in the way of it either if the society wished to switch to a socialistic state. Everything would just change.
These are all interesting theoretical issues that reveal both the power of a state, and popular sovereignty if exercised, and how it can operate.
In different parts of the world, all kinds of options are put forward and debated that might seem strange in other places. And to conclude that neoliberalism is already a done deal would be premature.
In fact, it was recently through to be improbable that modern central banks as presently constituted would drastically depart from normal practice. Recent events have shown that to be wrong.
The world is in flux. What was normal in the Agriculture Era changed drastically in the transition to the Industrial Age. We can hypothesize that the transition from the Industrial Age to the Information Age will also bring drastic changes, most of which we cannot foresee even the outline of.
Central bankers are already talking about the termination of physical money things and a switch to exclusively digital transactions conducted directly through central banks in an international payments system.
At the same time, we have an existing system and need to plan in terms of it rather than what might come to be in the future. They doesn't mean that we shouldn't also be thinking out of the box, both within the existing framework and also in anticipating the next iteration.
BTW, I don't like "taxes don't fund anything." It's simpler and clearer for most people to say that taxes don't pay for spending. "Fund" is an ambiguous terms that creates more issues than it solves as far as I can see. One one hand there is the meaning of "fund" associated with sources and uses, while the ordinary language meaning is equivalent to "pay for." In talking to a broad audience, using "pay for" avoids the ambiguity of "fund."
ReplyDeleteFrom the flow of funds - sources and uses POV, revenue (source) funds expenditure (use).
Spending and taxation are separate operations and they are undertaken separately in the legislature, where they originate — although the right in the US has been trying for some time to legislate that all "unnecessary" spending (social) be offset with taxes, but not "necessary" spending (defense and law & order).
FDR admitted at the time that tying a tax to Social Security "pay for" it was just a political ploy rather than a fiscal necessity.