Thursday, December 18, 2014

Basic MMT distinctions between monetary and fiscal policy.

Bill Mitchell – billy blog
Central banks can sometimes generate higher inflation
Bill Mitchell | Professor in Economics and Director of the Centre of Full Employment and Equity (CofFEE), at the Charles Darwin University, Northern Territory, Australia

See also

WCEG — The Equitablog
I Hate Those Blurred Lines! Monetary Policy and Fiscal Policy: Daily Focus
Brad DeLong

And here is another basic MMT post from Bill today, elaborating on the above link.

The following is a response to John Quiggin, MMT and Russia, requested by Cameron Murray in a comment there.

Friday lay day – public spending is not necessarily matched by tax revenue in the long-run
MMT provides an organising framework for understanding the possibilities available to a currency-issuing government and the limitations that a currency-using government (such as a Member State of the Eurozone) faces. It allows us to understand in a deeply-grained way, the relationships between the treasury and the central bank and the relationship between the government sector in aggregate and the non-government sector. 
No ‘Keynesian’ literature up until the 1990s (or beyond for that matter) provides the level of granularity that the MMT literature that we have developed over the last 20 years provides.…
A common misconception seen in the derivative literature on MMT (which is dominated these days by blogs, social media pages and tweets) seems to think that MMT says that currency-issuing governments are omnipotent and can solve any crisis just by spending. None of the main proponents of MMT over the last 2 decades has ever made statements to justify such a view.…
A nation with limited real resources has limited prospects for material welfare. That is the fact. The constraint is real and the infinite financial capacity the government might have in its own currency cannot alter that.
Modern Monetary Theory (MMT) provides no further understanding than that in these sorts of cases.…


Jose Guilherme said...

There is another very interesting comment on Quiggin's post (by "Ikonoclast" ), that says:

"... it’s kind of interesting that Russia has an economic downturn and 9% inflation. One expects a downturn to be deflationary or at least less inflationary. I mean simplistically and naively one might expect that. So what is Russia’s story?
Egypt appears to have about 3.7% GDP growth, an unemployment rate of 13.1%, inflation rate of 9.1 %, a budget deficit of 9.1 % of GDP and government debt to GDP ratio of 87.1%. Their balance of trade is -3,898 USD Million. Food inflation is 11.52%. What would MMT prescribe for Egypt? I asked this question on an MMT website a while ago and got no answer. Is the answer too hard?".

Interestingly, Brazil has a similar, paradoxical situation: zero growth, witn 6.5% inflation and policy rate at 11.75%.

So: what would be MMT's prescription for such economies?

Tom Hickey said...

As Bill points out, it depends in country specifics. For example, is the inflation demand-led with money in circulation expanding demand faster than the economy can respond at full potential, or it is supply-led, for example, can enough food not be produced domestically so that imports are required with the ability pay limited by foreign reserves? These necessitate different approaches, with the first requiring limiting money in circulation to demand consistent with productive capacity, or substitution or even rationing.

I don't know much abut the Brazilian economy but zero growth suggests that available resources not not being used effectively and efficiently. Why is the private sector not addressing this is the first question to ask. It seems also that an inflation rate of 6.5% doesn't justify a policy rate of 11.75%. Looks like the policy rate may be cramping investment. Is price level relatively stable or accelerating? What are the factors leading to inflation. If it's mostly food, for instance, how best to increase domestic supply. Brazil certainly doesn't lack land. Answering such questions should lead to a information needed to formulate a government policy based on utilizing available real resources to advantage. Brazil is a resource-rich country. Probably, the biggest opportunity long-term would be to ramp up education and infrastructure, and short-term to increase domestic productive capacity and productivity using public investment to supplement and stimulate private investment. The MMT point is that for a currency sovereign, affordability is not the issue, as is usually the excuse.

NeilW said...

The prescription of MMT is

*stop talking about the money*

It's not a money situation. It's a real resource situation and you have to analyse that.

What is there available, what is it currently being used for and by whom.

From that you can come up with some prescriptions.

Jose Guilherme said...

But how could a MMT proponent join the present ecomomic debate in Brazil in a useful way?

The economy is stagnating (though zero productivity growth has helped maintain a nearly full employment situation), inflation is slowly accelerating, the current account deficit is increasing - and the orthodoxy as an answer to all this. An answer that will be applied from January 1, 2015 by the new economic team chosen by President Dilma Roussef: austerity.

In a sense, it´s a stagflation situation similar to that of the U.S. in the 1970s, but without the oil price shock.

So there´s an urgent need for countervailing ideas as a short term alternative to austerity. How can MMT help and be relevant (apart from common sense proposals for the long run, such as increasing investments in infrastructure, education etc.)?

Dan Lynch said...

A nation with limited real resources has limited prospects for material welfare. That is the fact.

Yet Japan has a high standard of living and low inflation despite a dire shortage of "real" resources. Unless of course, you count knowledge and organization as real resources?

Ian Welsh had a recent post about exchange rates -- nothing really new -- but it makes more sense to me than other explanations.

@Jose, the questions you ask about Brazil and Egypt are valid questions, and I have been wondering the same thing. MMT (along with most mainstream economics) does not address the "stagflation" problem of developing countries, much of which is related to Dutch Disease, if you ask me.

Developing countries make many economic mistakes, like borrowing in a foreign currency and attempting to peg their exchange rate. But one problem I see over and over is Dutch Disease.

To fix Dutch Disease, you need to abandon free trade and impose tariffs to encourage domestic production of basic necessities. This clashes with mainstream economic thought, including MMT, so they prefer to pretend Dutch Disease does not exist.

If Venezuela had a JG where people picked up litter, that would not solve their shortage of toilet paper. Obviously Venezuela needs to ramp up domestic toilet paper production, and they have plenty of unemployed resources to do that, but it would require capital investment and protection from imports. Ditto for Venezuela's food shortages. (though their food shortages may be partly due to climate change induced drought?)

Also, part of the standard neoliberal prescription for developing countries is to replace food crop farming for local consumption with commodity crop farming for export. This can drive up the local cost of food while the commodity exports contribute to Dutch Disease.

Tom Hickey said...

I doubt there is a bank of the envelope solution. An MMT economist would have to sift through the facts first to come up with a plan, and probably no one is going to do this for nothing.

I would suggest Dilma attempting to engage an MMT economist to advise her. She is not getting good advice now if they are arguing for expansionary fiscal austerity. That will just alienate her core consistency and undermine her presidency by benefitting only the few at the top on the assumption of trickle down.

Calgacus said...

The MMT prescription is not "stop talking about money." It is "stop talking nonsense about money." "Stop talking about money" very easily leads and has led to serious errors, identifying money/credit - a relationship, with commodities/things, taking only the latter as "real". And usually turns very rapidly into the commodity theory & (neo)classical, mainstream.

Part of an MMT prescription in both of Jose's cases would be to cut interest rates, as almost always, and restrain bank lending if necessary. Deciding to have an unemployment rate of 0% by a job guarantee. These are basics for every society. High interest rates and unemployment only "benefit" a tiny slice of society, at far greater cost to everyone else. A society which made these two simple, easy decisions would rarely get into the problems of Brazil or Egypt. Self-sufficiency, affordability in food, not having it under the control of private monopolies should always be a top priority. I agree with the rest of what Tom and Neil say.

Dan Lynch said...

Ian Welsh on Dutch Disease:

Dan Lynch said...

Ian: Nations built entirely on resources are and will always be subject to economic collapse when the resource price collapses.

He just explained Russia and many of the Latin American countries that are highly dependent on commodity exports.

Tom Hickey said...

Now we are getting into development economics, which I confess to knowing little about. But I have several impressions.

The problem is very much complicated by two factors.

The first one is speed of globalization is forcing the process beyond its limits in many cases. The pace of change is outrunning the ability to change in a balanced way, with the result that societies are becoming increasing dysfunctional as they "grow" materially. This is the result of conflating development with economic growth. This leads into the second factor.

Secondly, the overarching paradigm is neoliberalism, which is a social and political theory based on the theory of economic liberalism developed in the West, especially America and the UK. It is based on privatizing the commons and capitalizing the gains, while enclosing the commons and socializing the losses. What could go wrong?

These two factors are stringing the global system to the breaking point and look to be heading toward a major conflict after a string of "minor" conflicts.

So I don't think that the problems can be fixed within the current paradigm, which is unfolding toward its inexorable culmination in catastrophe. The only question now is what will catalyze the collapse.

Will emerge out of the ashes (perhaps quite literally) is anyone's guess.

Tom Hickey said...

In summary, the basic problem arises from attempting to monetize everything amenable to exchange. This means monetizing the informal economy, which has been the basis for life in many areas since the advent of humanity.

Tom Hickey said...

In economics, the Dutch disease is the apparent relationship between the increase in the economic development of natural resources and a decline in the manufacturing sector (or agriculture). The mechanism is that an increase in revenues from natural resources (or inflows of foreign aid) will make a given nation's currency stronger compared to that of other nations (manifest in an exchange rate), resulting in the nation's other exports becoming more expensive for other countries to buy, and imports becoming cheaper, making the manufacturing sector less competitive. While it most often refers to natural resource discovery, it can also refer to "any development that results in a large inflow of foreign currency, including a sharp surge in natural resource prices, foreign assistance, and foreign direct investment".[1]
The term was coined in 1977 by The Economist to describe the decline of the manufacturing sector in the Netherlands after the discovery of a large natural gas field in 1959.[2]


It's actually better termed colonialism. The Dutch case is an exception in the developed world. The emerging world is beset by this condition owing to asymmetrical development with the developed countries having colonized the undeveloped in order to loot their natural resources, not to mention slaves. Slaves were the major source of capital in the US until emancipation.

Globalization is now in the stage of neo-colonialism. This is what the American Empire is all about and it explains what is going on with Russia today and also how Russia plans to escape the trap.

The American Empire is constructed of a core led by the US composed of the developed countries as American satellites. The periphery is composed of the emerging world as vassal states that supply needed resources in exchange for development on the terms of the core.

Obviously, the emerging states are trying to become developed as quickly as they can so they can join the core. Of late, they have realized that the present core is resisting this happening, so they are joining together to form a bipolar world with two separate cores.

Anyone with a brain and a smattering knowledge of history can see where that is headed.

circuit said...

Jose and Tom: Nice discussion!

A quick anecdote. A few years ago I was talking about MMT to a group of mainstream-minded economists. Our conversation quickly turned to the stagflation of the 1970s.

In the end we all came out of the discussion more or less in agreement.

The fact is that Warren Mosler's claim about how the 1970s inflation came to end as a result of the deregulation of natural gas in 1978, which allowed natural gas prices to rise (resulting in the uncapping of natural gas wells and enabling U.S. electric utility companies to switch from fuels from high-priced oil to still lower-priced natural gas) fits nicely with the mainstream view.

Once you've taken into account the positive supply effect of the uncapping of natural gas, Mosler's view is entirely consistent with the mainstream AS-AD model interpretation, which holds that (1) the rise in oil (and food) prices in the 1970s reduced purchasing power and caused a recession in output and a sharp rise in unemployment, and that (2) cost-push inflation subsides when the economy is faced with a positive supply shock.

Tom Hickey said...

Another fundamental issue is associated with enclosure of the commons, which happened in earnest in the transition from the Agricultural Age to the Industrial Age.

Much of the commons was enclosed in Europe during the feudal period, but the people were not displaced from the land. Instead of using it common, they worked it as peasants in the role of tenant farmers on the English manors or land-bound Russian serfs, for example.

But with industrialization came centralization. Formerly rural agricultural people were forced to make a transition to becoming urban industrial workers.

The role of urbanization in development cannot be overestimated. It's huge and it is going on in leaps and bounds.

Looking historically to what happened in the now developed countries, the period of development was fraught with huge challenges socially, politically and economically. Politically, there were revolutions and civil wars that changed conditions quickly and drastically.

The transition from feudalism to capitalism in the West, with the resettlement of rural folk in cities was not pretty. The transition from tribalism to "modern civilization" in the rest of the world is similarly fraught with dysfunction.

The challenge is generating a developed nation with sufficient infrastructure and technology, education, health care, R&D, and, regrettably, modern defense often almost from scratch. This would be a great challenge even if all the resources were available domestically, but they seldom are, so countries have to either make do with what they have or else face the difficulty of borrowing to pay for what they need and cannot trade manufactured goods for, or else sell assets they may have, which usually natural resources.

So development is a balancing act that must deal with juggling social, political and economic factors in a cultural and institutional environment that is path dependent and affected by hysteresis.

Even the most developed countries, the US for example, are not fully developed and have huge area that are underdeveloped. For example, America never faced up to the issues created by the emancipation of the slaves at the time of the Civil War. That was a century and half ago.

Dan Lynch said...

@circuit, Mosler's theory about how deregulation natural gas ended 70's inflation is mistaken, IMHO.

In fact, inflation had already subsided prior to the passage of the deregulation bill.

What actually happened was that in 1976 Kissinger made a secret agreement with the Sauds (sometimes called the Doha agreement) -- that the Sauds would set the price of oil at a moderate, stable level, and priced in U.S. dollars. Hence inflation was already subdued by the time natural gas was deregulated, and the US dollar has effectively been pegged to price of oil.

The Saud's low oil prices destabilized Iran (that was a feature, not a bug) and there was another brief episode of high inflation when the Shah's regime collapsed. Once again the Sauds stabilized oil prices and the CPI returned to normal.

IMHO, rising oil prices did not, by themselves, cause the 70's recession. Instead, aggregate demand fell due to increased demand leakage due to a growing trade deficit, combined with Jimmy Carter's austerity policies.

Likewise, the recent fracking boom stimulated our economy in two ways 1) an increase in private debt associated with the fracking bubble and 2) a reduction in demand leakages as the trade deficit shrank. The Saud price war will reverse both those trends and likely trigger a recession.

@Tom, agree about the importance of shifting people away from self-sufficient economies and into wage labor economies.

circuit said...


Thanks for the comment. Did not know about that aspect.

However, concerning your comment:

"In fact, inflation had already subsided prior to the passage of the deregulation bill."

Recall there were two peaks, one in 73-75 and another in 79-81, so inflation had not subsided when they deregulated the natural gas industry.

But regardless, I think we can agree that this was a clear supply-led event, whether we are talking about COLA clauses, energy prices, etc.

The bottom line is that, on the one hand you had Keynesians saying this, while on the other, you had New Classicals who were writing papers that did not contain the word "oil" in them.

NeilW said...

"Yet Japan has a high standard of living and low inflation despite a dire shortage of "real" resources. Unless of course, you count knowledge and organization as real resources? "

Real resources are anything that is not money.

Knowledge, organisation, robots are all real.

Tom Hickey said...

The three classical factors of production are land, capital and labor.

Land includes all natural resources in addition to territory.

Capital includes all real goods that are not produced for consumption but rather production.

Labor includes all human resources including management (organization) and knowledge/skill.

Some economists recommend adding factors to the initial three, for example, making energy, management, and high-end human abilities separate categories. Maybe celebrity should be its own category. :)

Neoclassical economics folded land into capital and now the trend is to distinguish human resources as knowledge work and high-end skills from labor and fold that into capital as well. As a result, "capital" today is a much different concept than it was for the classical economists.

Note that they did distinguish land separately chiefly because of their acute awareness of land rent. Some see neoclassical economics as being developed to avoid including land rents in economic consideration in reaction to Henry George, who was quite influential at that time.

Tom Hickey said...

Recurring to the points I was making about about the complexity of development and development economics, China seems to be the only country today that is taking a holistic and systematic approach to development that take into consideration the range of social, political, and economic factors. Most of the rest of the world is following the neoliberal paradigm of letting markets decide direction and speed based on the assumption of the invisible hand of market forces as the modern version of Divine Providence. So there's a test case on the table and right now it looks like the Chinese model is doing pretty well in comparison.

Detroit Dan said...

Likewise, the recent fracking boom stimulated our economy in two ways 1) an increase in private debt associated with the fracking bubble and 2) a reduction in demand leakages as the trade deficit shrank. The Saud price war will reverse both those trends and likely trigger a recession. [Dan Lynch]

Well said. The markets seem balanced on a knife's edge now, but the concentrated damage will probably have more of an impact than the broad benefits.

Schofield said...

"So there's a test case on the table and right now it looks like the Chinese model is doing pretty well in comparison."

I don't believe, however, that attempting to "corner the market" in volume manufacturing "does well" by the rest of the world.

Tom Hickey said...

Countries are competitive in the global marketplace, and still communist China has to face being in the crosshairs of America as one the list for regime change and positioned as the #1 military threat. Added to that, China has set the objective of making the transition from a humiliated failed empire of former glory become a backward and poor nation to the indisputable world leader, recovering its former premier position in the world by displacing the US as the dominant economic and military power.

Tom Hickey said...

I should add that they have to do this fairly quickly and deftly or they will get taken down. The leadership has know this for some time. The great game is on with China after the US dispensed with the USSR and has been merely swatting flies since.

Matt Franko said...

"land, labor, capital"

1. Land: that is where the metals are;

2. Labor: that is what we need to get the metals dug up;

3. Capital: That is what we term the metals when they are then in human possession...

Jose Guilherme said...

Must we then conclude from this discussion that MMT has not much new to propose in situations of stagflation?

As circuit has put it, if the MMT "view (of stagflation) is entirely consistent with the mainstream AS-AD model interpretation" then we'll be hard pressed to find answers to the widespread opinion held in, say, 2014 Brazil - according to which the economy is overheated with "excessive" employment and zero productivity growth with only one possible policy answer: austerity

A very depressing conclusion indeed.

Tom Hickey said...

Ass I understand it, stagflation usually involves supply-led inflationary pressure resulting from disruption of real resources. This is difficult to address using either monetary or fiscal policy unless it addresses the supply issue. Bill Mitchell has a post on MMT and supply-led inflation.

Modern monetary theory and inflation – Part 2

MMT doesn't have a magic wand that creates real resources or removes resource blockages.

Stagflation "comes from cost pressures from an outside source, such as opec hiking oil prices. The wrong thing to do is implement policies that put people out of work. It's not a monetary problem, it's a relative value/supply issue." — Warren Mosler on FaceBook.

Dan Lynch said...

@Jose, here are my recommendations for Brazil, and Latin America in general:

-- government should stop borrowing in foreign currency (as per MMT)

-- allow the currency exchange rate to float (as per MMT)

-- forget free trade (contrary to MMT) except perhaps with other Latin American countries that have similar economies.

-- 25% tariff on imports of manufactured goods and foods. (contrary to MMT) No tariff on import of raw materials (consistent with MMT).

-- mineral extraction, energy, transportation, communications, education, and health care should either be nationalized or else regulated as a public utility.

-- job programs targeting infrastructure, affordable housing, and production of basic necessities (similar to MMT).

-- a national policy on family planning. Current population growth is unsustainable.

Just my 2 cents.