Dirk Ehnts — A simple macroeconomic model based on Modern Monetary Theory (and published in 2014 in a peer-reviewed journal

There is a lot of talk about how MMT would lack a “model”. Some commentators on Twitter even claim that MMT would have “no model” and that they just created one themselves. Others believe that stock-flow consistent (SFC) models are basically SFC models. All of that is not quite right!

I think that the only model that can really claim to be a “MMT model” is the one I published in a peer-reviewed journal in 2014. The article in the International Journal of Pluralism and Economics Education (IJPEE) was named “A simple macroeconomic model of a currency union with endogenous money and saving-investment imbalances” (link). With hindsight, it was not a good title, since there is nothing specific about “currency union” or (private!) “saving-investment imbalances” in the model. It is really a replacement of the IS/LM-model and nothing else. The working paper version is accessible freely and was written in 2012 (link). During that year, I was at the Hyman-Minsky summer school at the Levy Institute of Bard College, NY. I showed the model to Randy Wray and Scott Fullwiler and some other people and they all liked it. Given that my model has the sectoral balances at its core that did not surprise me.

Since the model has not gotten a lot of attention so far – I presented it at University of Cassino in Italy after being invited there to spend a week with SFC modeler Gennaro Zezza and in some other place – I would like to use this blog post to explain the model briefly. Of course, the IJPEE paper is the long version. (The working paper contains some minor flaws that had been fixed in the journal version.) For those who can’t wait to see it, you can download a spreadsheet file of the ISMY model here. It has all the equations and is solvable by toying around with it....

econoblog 101

A simple macroeconomic model based on Modern Monetary Theory (and published in 2014 in a peer-reviewed journal
Dirk Ehnts | Lecturer at Bard College Berlin

Alan Longbon — China Sectoral Flow Investment Assessment

China moving toward fiscal austerity?

Seeking Alpha
China Sectoral Flow Investment Assessment

Alan Longbon

Tom Streithorst — The Radical Left-Wing Theory That the Government Has Unlimited Money

Everyone knows governments need to tax before they can spend. What Modern Monetary Theory presupposes is, maybe they don't.

Surprisingly decent article on MMT considering the dismissive headline. Covers most of the bases.

Vice
The Radical Left-Wing Theory That the Government Has Unlimited Money

Tom Streithorst
ht Ralph Musgrave

Peter Cooper — Fiscal Policy, Sectoral Balances and Financial Sustainability

A bit more in-depth look at sectoral balances using some elementary algebra.

heteconomist
Fiscal Policy, Sectoral Balances and Financial Sustainability
Peter Cooper

Dirk Ehnts — In five steps from two identities to the sectoral balances (wonky macro)

I have seen a lot of ways to arrive at the sectoral balances identity, which states that the sum of the change in net financial assets of the private, the public and the external sector sums up to zero. I prefer to show my students six equations – hence five steps – to make them understand the nature of the identity. We start with two definitions (in bold), which are those of GDP (Y) and private saving (Sp). From there, we arrive at the sectoral balances through rearranging the private saving equation, then subtracting the GDP identity from it and rearranging again:…

As I am currently building a textbook around this identity, keep on coming back to my blog to see some more stuff related to this way of theorizing macroeconomics that was pioneered by Wynne Godley and others before him.

econoblog 101
In five steps from two identities to the sectoral balances (wonky macro)
Dirk Ehnts | Lecturer at Bard College Berlin

The forthcoming textbook will be based on the already published (German and English) Modern Monetary Theory and European Macroeconomics (Routledge International Studies in Money and Banking) (2016).

Michael Stephens — Austerity and Growth: Missing the Point

The pseudo-debate about whether Keynesians and other fellow travellers ought to be embarrassed when governments that engage in fiscal austerity nevertheless experience positive economic growth rates has become a distraction.

For countries like the US and the UK, it is possible under current circumstances for governments to implement budget cuts and still see their economies grow. But the truth of that statement is not fatal to the Keynesian-inspired critique of austerity policies; it is not by any means the end of the story. The more meaningful question is this: What would have to happen in these economies for significant growth to occur in the midst of budget tightening?

Finding an answer to that last question is one of the strengths of the approach to thinking about the economy pioneered by Wynne Godley, and fleshed out further in the Levy Institute’s strategic analysis series. This approach also provides a clear understanding of how deeply irresponsible it is to cut government spending under present economic conditions: because the danger, given the state of the US and UK economies, is not just that budget cuts might slow down the economy, but that they might not.….

Countries can grow along with reducing government contribution either by increasing exports or private debt. Not all countries can increase exports simultaneously so some countries either have to increase the government contribution or see private debt rise in order to grow. The US is unlikely to become a net exporter or even significantly reduce its CAD anytime soon, even with shale oil and fracking. So the growth option under continued austerity is increasing private debt, which is not sustainable and would lead to another crisis down the road. Since the level of private debt is already high historically, it might not be very far down the road.

To bring this back to the tired discussions surrounding austerity policies: yes, it is possible for the United States to have both tight budgets and rising GDP over the next few years. Fiscal conservatism doesn’t make economic growth impossible in the near term — it makes it impossible to grow without increasing financial fragility. In the absence of a significant increase in net exports, keeping the government budget on its current track will lead to either stagnation or an acute crisis. 

Austerians in the United States and elsewhere have been allowed to portray themselves as the champions of steely-eyed realism and prudence. In reality, unless their budget proposals come attached with some workable plan to substantially reduce trade deficits, they are courting private-debt-driven financial crises. In any meaningful sense, they are the true practitioners of fiscal irresponsibility.

And a strong dollar is inimical to increasing net exports. Austerity tends to strengthen a currency. not so much by making it harder to get as by increasing confidence in the discipline and responsibility of the monetary authority — the same erroneous rationale that drives austerity.

Multiplier Effect
Austerity and Growth: Missing the Point
Michael Stephens

Winterspeak — Why MMT is still important

Mosler refers to individuals who understand MMT as being "in paradigm", which those who do not as "out of paradigm".....

...this whole notion of exporting countries, such as China, damaging labor markets in the US is completely out-of-paradigm. The MMT argument goes, that if China wants to trade real goods and services for US$, then the US Gov needs to run higher deficits to satisfy the Chinese demand for US$ while maintaining full employment at domestically. Any domestic labor market weakness is due to insufficient spending (as always) and not actions by the exporter. The terms of trade, in this case, are firmly in favor of the importer as deficit spending is easy, while the exporter needs to forgo the real output of their labor.

Winterspeak
Why MMT is still important

Joe Weisenthal — Goldman’s top economist explains his big call for the U.S. economy

Goldman's Jan Hatzius on the three sector model of sectoral balances and a transcript of an interview with Hatzius.

Jan Hatzius may turn out to be the pivot point in the recognition of Godley's contribution and the spread of his ideas beyond the Post Keynesian cohort of economists that have been using this approach for some time but have not been able to crack the mainstream economics profession with it.

Hatzius is not the only well-known Wall Street insider to use the Godley sectoral balances approach to good effect. There is also Paul McCulley, formerly chief economist at Pimco. McCulley also endorsed MMT.

Business Insider
Goldman’s top economist explains his big call for the U.S. economy
Joe Weisenthal

(h/t Peter Martin at Modern Monetary Theory: Real Economics)

Peter Martin — A Simple Four Sector Model of an Economy

Modern Monetary Theory: Real Economics

A Simple Four Sector Model of an Economy

Peter Martin

Bruce Bartlett — National Income: Paying Work, Not Capital

Bruce Bartlett does sectoral balances.

Democracy — A Journal of Ideas
National Income: Paying Work, Not Capital
Bruce Bartlett
(h/t Andy Blatchford on FB)

JP Hochbaum — Sectoral Balances

I know it may seem unbelievable but there was a time when I was a follower and avid fan of the Austrian school of economics. I believed that government spending crowded out private sector spending, that all government expenditures were somehow passed onto my grandchildren, that government spending lead to inflation, and a myriad of other beliefs that stemmed from what I thought was a logical approach to economics. I read Ayn Rand, listened to John Stossel, almost voted for Ron Paul in 2008, and I drank beers with fellow libertarians.

So what happened between then and now? Back in 2008, after the election, I told myself I would suspend any ideology I had when it came to economics and other political issues and refocus on just finding what was really going on with our country. During many years of engaging with people via blogs and forums I collected a myriad of economics experts as friends and so I had plenty of information to digest, to come to where I am at today as an MMT’er. My “conversion” (not to be confused with a religious or ideological conversion that relies on morals and faith) came about in a gradual way, but one particular fact really gave me that “A HA!” moment, and that was seeing a “sectoral balances graph”, like the one below....

Heretical Druthers
Sectoral Balances
JP Hochbaum

Jeff Gundlach: "We Are Drowning In Central Banking"

Zero Hedge
Jeff Gundlach: "We Are Drowning In Central Banking"

The "bubble" that Gundlach sees in central banking is the result of pushing monetary policy to the extreme, which is not working to stimulate domestic economies. The Fed admittedly tried to stimulate the economy by increasing the wealth effect through driving equities higher than they would be otherwise, as well as supporting housing through low mortgage rates. That has not worked to increase nominal aggregate demand or even to keep the inflation rate at the Fed's target of 2% and now deflation threatens.

The sectoral balance approach reveals that if the domestic private sector wishes to net save, including deleveraging, then the government or the external sector must make up the difference due to demand leakage to saving.

However, in a political environment of fiscal austerity, the government's hands are tied by the political process. That leaves the external sector, meaning increasing exports.

Not everyone can increase exports in a global economy that is slowing, as Gundlach observes. Therefore, some countries will attempt to increase exports by lowering prices indirectly through currency devaluation.

Germany was able to devalue some time ago by switching from the DM to the euro, ensuring its position as a net exporter. China supported its export industries through a peg to the dollar that prevented the currency from rising in the market relative to China's growing position.

Now Japan has taken steps to bring down the value of the "too strong" yen, apparently with the blessing of Washington, or at least without objection.

Is the world approaching the point there is going to be push back? Gundlach thinks it's a strong possibility.

It's time to recognize the insufficiency of monetary policy, as Bernanke himself has admitted, and move to a sectoral balances-functional finance approach fiscal policy in order to offset demand leakage to saving and stimulate effective demand instead of pursuing a mercantilist policy that will only lead to further international imbalance, political recrimination, and possible trade war.

Bill Mitchell — Exploring pro-cyclical budget positions

Sometimes one agrees with a conclusion but realises the logic that was used to derive the conclusion was false. Which means that the person will get things wrong when applying the logic to other situations. This is almost always the case when we encounter the reasoning offered by so-called deficit doves. These are economists who do not out-rightly reject the use of deficits but typically below them to be cyclical phenomenon only and should thus be offset at other points in the economic cycle by surpluses – the so-called balanced budget over the cycle rule. While many progressives think that is a sensible strategy – the reality is that it is an unsustainable fiscal rule to try to follow. The same economists talk about the dangers of pro-cyclical fiscal positions but fail to appreciate that such positions are desirable in certain cases and there is a fundamental asymmetry that applies to evaluation the desirability of a “cyclical” position. Fiscal austerity (pursuing surpluses when the economy is contracting) is never appropriate whereas expanding the deficit when the economy is growing might be. It all depends. This blog aims to clear up some of these misconceptions.


One such article (August 7, 2012) was written by Harvard economist – Jeffrey Frankel – The Procyclicalists: Fiscal austerity vs. stimulus.

This article demonstrates some of the classic mistakes that economists make when considering the relationship between the government and the non-government sector.....

Bill Mitchell — billy blog
Exploring pro-cyclical budget positions
Bill Mitchell

Neil Wilson — More support for MMT's external sector analysis

One of the points that comes out of MMT's floating rate analysis is that when export-led nations and import-led nations trade with each other there is a tendency for the export-led central banks to accumulate net-savings in the import-led government sectors. This is due to liquidity action and intervention by the export-led nations in support of their exporters....

3spoken
More support for MMT's external sector analysis
Neil Wilson

Lars Syll — Wynne Godley and the Fiscal Cliff

Looking at balance sheets from a macroeconomic perspective, it is of course important not to look at the different sectors in isolation. Assets and liabilities of households, banks and government have to be analyzed as interdependent parts in a cumulative process where one sector’s surplus is counterbalanced by another sector’s deficit.

To Wynne Godley – and those of us who have absorbed at least a rudiment of MMT – this was self-evident. A sectoral balance approach is a necessary ingredient in understanding financial crises – and that’s also one of the reasons why the Fiscal Cliffers are so wrong.

Lars P. Syll's Blog
Wynne Godley and the Fiscal Cliff
Lars P. Syll | Professor, Malmo University

Joe Weisenthal — Goldman's Top Economist Explains The World's Most Important Chart, And His Big Call For The US Economy

BI: Back to the balance sheet, multi-sectoral framework of looking at the economy. How did you come to this view? On Wall Street this is still very rare. I don’t see many economists talk about the economy this way, recognizing this identity and making projections based on it. How did you come to see this as the framework by which we should be looking at the economy right now?

HATZIUS: I’ve long been fascinated with looking at private sector financial balances in particular. There was an economics professor at Cambridge University called Wynne Godley who passed away a couple of years ago, who basically used this type of framework to look at business cycles in the U.K. and also in the U.S. for many, many years, so we just started reading some of his material in the late 1990s, and I found it to be a pretty useful way of thinking about the world.

It’s usually not something that gives you the secret sauce at getting it all right, because there are a lot of uncertain inputs that go into this analytical framework, but I do think it’s a reasonable organizing framework for thinking about the short to medium term ups and downs of the business cycle.

Basically, in order to have above-trend growth – a cyclically strong economy – you need to have some sector that wants to reduce its financial surplus or run a larger deficit in order to provide that sort of cyclical boost, most of the time.
There are other factors at play in the business cycle – I’m certainly not claiming that ‘this is it!’ – but I have found it to be pretty useful.

BI: Do you have any explanation or thoughts about why this framework hasn’t broken through more on Wall Street? It still seems pretty rare.

HATZIUS: I’m not sure. I think there are actually a lot of people who think about the world in terms of this chart a little more implicitly. I think if you talk about the need to have stronger demand growth somewhere in order to get acceleration, in those charts it becomes kind of a truism. But if you put it in financial balances terms, you’re not really saying anything dramatically different. It’s just perhaps a little more semantics even. I just find it a reasonable discipline to think about.

Business Insider
Goldman's Top Economist Explains The World's Most Important Chart, And His Big Call For The US Economy
Joe Weisenthal

Mike posted on this here earlier, but I am returning to it because it is getting considerable play today.

The publication of this interview is a big deal. It puts the sectoral balances front and center and specifically mentions Wynne Godley. 

Joe Weisenthal has a following. This will get around, and everyone in the markets is looking for a leg up. For example, Bill McBride of Calculated Risk has picked up on it here. CR has a huge following.

This is another step forward on the last mile. If you don't read the whole article, you should at least be aware of the chart and above quote.

Simon Wren-Lewis — Offsetting private sector financial balances with fiscal policy

Simon Wren-Lewis does sectoral analysis. He has been at British treasury and is familiar with Godley's approach.

His approach is clearly neither traditional Keynesian nor MMT, since it is not based on the government's policy objective and moral requirement to maintain optimal use of resources including full employment along with and price stability. But at least we are talking in the same ballpark and asking relevant questions.

mainly macro
Offsetting private sector financial balances with fiscal policy
Simon Wren-Lewis | Professor of Economics, Oxford University

Paul Meli — Sectoral Balances within the Domestic Non-Government

There are many important laws that determine the behavior of various systems within the Universe but as far as economics is concerned, none is more important than the concept of a closed system.


From Wikipedia:

”In non-relativistic classical mechanics, a closed system is a physical system which doesn’t exchange any matter with its surroundings, and isn’t subject to any force whose source is external to the system. A closed system in the classical mechanics sense would be considered an isolated system in thermodynamics.”

What does this mean in the context of a monetary economy? What could properties of a physical system have in common with a system based largely on the relationships between stocks and the flows between them? It turns out that some math systems behave according to the same rules that constrain elemental physical particles, i.e. the concept of the conservation of matter holds mathematically for the “conservation” of currency units within the system.

If we define the closed system as the universe of state-backed US dollar assets and liabilities, including state-issued bonds held by the public, it means that the net dollar assets existing in the economic system cannot change over some period of time t without an add or subtract from a source external to the system.

New Economic Perspectives
Sectoral Balances within the Domestic Non-Government
Paul Meli

Chris Dillow — Fiscal Policy: The Cognitive Biases

The fact that government borrowing has risen so far this year reminds us of a key truth about the public finances - that they are less amenable to government control than generally thought. This is because government borrowing is the counterpart of private sector lending. Borrowing will fall when and only when private sector investment rises and savings fall. And this is not happening yet.

This poses a question. Given this, Why do so many people pretend that governments can easily control borrowing? I suspect it is because of a number of cognitive biases:

Read it at Stumbling and Mumbling
Fiscal Policy: The Cognitive Biases
by Chris Dillow | Investors Chronicle

Chris Dillow — Why austerity's failing

Chris Dillow does sectoral balances

Read it at Investors Chronicle (UK)
Why austerity's failing
by Chris Dillow | Investors Chronicle
(h/t Scott Fullwiler via Twitter)