Questioning the wisdom of austerity

I have written a series of posts on this blog questioning the wisdom of fiscal austerity in the United States today. Inevitably when I make such an argument, I get comments along the lines of “what about Zimbabwe!”, “it’ll lead to hyperinflation!” and “they’re even worse off than Greece!” But these worries are all based on fundamental misunderstandings on how the monetary system works. To recap:

  • You cannot make an analogy between the finances of a household or a corporation, and those of a country. Individuals have to pay back their debts over their lifetimes, and cannot sustainably spend more than they earn without going bankrupt. Governments, on the other hand, have the power to create money, which makes any analysis of their finances very different. The fact that the US has been able to run deficits almost continually over its 220 year existence makes this point clear.
  • The analogy to Greece is also false. When Greece, Portugal, Spain and Ireland joined the euro zone, they all gave up monetary sovereignty. Greece has to borrow to cover its deficits and is now at the mercy of the bond markets. This is not true of the US.
  • A sovereign nation that is the monopoly issuer of its own currency cannot possibly default (unless it chooses to do so for political reasons). There are no issues in “funding” its deficit. Inflation becomes a concern only if the government continues to run large deficits as the economy approaches full capacity. We are a very long way from this situation today.
  • Any waste associated with government spending during recessions is absolutely dwarfed by the inefficiency of having a large segment of the population unemployed.

This week, Bill Mitchell (of Billy Blog fame) has an excellent article in The Nation that makes many of the same points. He also goes into a long history of how the “unquestioned dominance of neoliberal ideology” has come to be embraced by both major political parties today, and how this ideology is in fact one of the major causes of the recent crisis.

When President Obama announced in December 2009 that “We don’t have enough public dollars to fill the hole of private dollars that was created as a consequence of the crisis,” the leader of the largest economy in the world told us that, despite having caused the worst economic crisis in eighty years, neoliberalism was still firmly in charge. The global economic crisis might suggest that the neoliberal promise—that markets can self-regulate and deliver sustained prosperity for all—was a lie. But that doesn’t seem to have registered with governments, which have, without exception, built their responses to the crisis on a series of myths—the same myths that caused the crisis.

Despite millions remaining jobless and poverty rates rising, governments have claimed that there is no alternative but to impose austerity by cutting budget deficits. In the United States and among most parties in Europe—whether in government or opposition—the unquestioned dominance of neoliberal ideology has reduced economic debate to questions of nuance. So conservatives eschew tax increases and want larger spending cuts, whereas progressives favor a combination of spending cuts and tax increases. This homogenization of the political debate has not only stifled progressive voices; it is also obscuring the only credible route to recovery.

What began as a problem of unsustainable private debt growth, driven by an out-of-control financial sector aided and abetted by government deregulation, has mysteriously morphed into an alleged sovereign debt crisis. As private spending collapsed in 2007–08, budget deficits (public spending minus taxes) rose to bridge the gap. Now conservatives, some of whom were direct beneficiaries of bailout packages in the early days of the crisis, tell us that our governments are bankrupt, that our grandchildren are being enslaved by rising public debt burdens and that hyperinflation is imminent. Governments are being pressured to cut deficits despite strong evidence that public stimulus has been the major source of economic growth during the crisis and that private spending remains subdued…

Austerity is now viewed as inevitable. But is any of this true? The short answer is no, but it needs careful explanation, because the neoliberal arguments against deficits—at least some of them—are seductive.

Neoliberals claim that governments, like households, have to live within their means. They say budget deficits have to be repaid and this requires onerous future tax burdens, which force our children and their children to pay for our profligacy. They argue that government borrowing (to “fund” the deficits) competes with the private sector for scarce available funds and thus drives up interest rates, which reduces private investment—the “crowding out” hypothesis. And because governments are not subject to market discipline, neoliberals claim, public use of scarce resources is wasteful. Finally, they assert that deficits require printing money, which is inflationary…

When British Prime Minister David Cameron said that the government deficit is just like credit-card debt and that Britain was facing bankruptcy, he was invoking the false neoliberal analogy between national budgets and household budgets. This analogy resonates strongly with voters because it attempts to relate the more amorphous finances of a government with our daily household finances. We know that we cannot run up our household debt forever and that we have to tighten our belts when our credit cards are maxed out. We can borrow to enhance current spending, but eventually we have to sacrifice spending to pay the debts back. We intuitively understand that we cannot indefinitely live beyond our means. Neoliberals draw an analogy between the two, because they know we will judge government deficits as reckless. But the government is not a big household. It can consistently spend more than its revenue because it creates the currency. Whereas households have to save (spend less than they earn) to spend more in the future, governments can purchase whatever they like whenever there are goods and services for sale in the currency they issue. Budget surpluses provide no greater capacity to governments to meet future needs, nor do budget deficits erode that capacity. Governments always have the capacity to spend in their own currencies.

Why? Because they are the issuers of their own currencies, governments like Britain, the United States, Japan and Australia can never run out of money. President Obama was wrong to suggest otherwise. Most people are unaware that a major historical event occurred in 1971 when President Nixon abandoned what had been called the gold standard (or US-dollar standard). Under that monetary system, which had endured for eighty-odd years (with breaks for war), currencies were convertible into gold, exchange rates were fixed and governments could expand their spending only by increasing taxes or borrowing from the private sector. After 1971 governments issued their own currencies, which were not convertible into anything of value and were floated and traded freely in foreign currency markets. Most nations have operated “fiat monetary systems” ever since, and as a result national governments no longer have to “fund” their spending. The level of liquidity in the system is not limited by gold stocks, or anything else.

Zimbabwe! Yes, a Bob Marley song. But it has also become the one-word response conservatives use to scare us into believing that deficits cause hyperinflation (the cry used to be Weimar!). The reality is this: if the economy is operating at full capacity—which means it cannot produce any more new products—then attempts by the government to expand spending will cause inflation. But up to that point, governments can run deficits forever without causing inflation. By supporting spending in an economy not at capacity, deficits induce more production rather than higher prices, since companies will be happy to supply the growing demand.

The full article goes into a lot more detail. You may not agree with everything he says, but it’s a fascinating read.

Along similar lines, Paul Krugman (who is a bit hit and miss these days) has a very good column in Friday’s New York Times bemoaning the complete lack of political attention to the plight of the long-term unemployed.

More than three years after we entered the worst economic slump since the 1930s, a strange and disturbing thing has happened to our political discourse: Washington has lost interest in the unemployed.

Jobs do get mentioned now and then… But no jobs bills have been introduced in Congress, no job-creation plans have been advanced by the White House and all the policy focus seems to be on spending cuts.

So one-sixth of America’s workers — all those who can’t find any job or are stuck with part-time work when they want a full-time job — have, in effect, been abandoned.

It might not be so bad if the jobless could expect to find new employment fairly soon. But unemployment has become a trap, one that’s very difficult to escape. There are almost five times as many unemployed workers as there are job openings; the average unemployed worker has been jobless for 37 weeks, a post-World War II record.

In short, we’re well on the way to creating a permanent underclass of the jobless. Why doesn’t Washington care?

That’s a very good question indeed.

Comments

    • Inflation in Zimbabwe was largely the result of the government’s interference in the agriculture sector, Zimbabwe’s (then) main industry. As payback to veterans who had fought against the Smith regime, the government expropriated well-run and highly profitable farms owned by whites, and gave them to the veterans. The veterans had no idea how to run a farm and mostly sat around drinking and going out at night to shoot up a few more white farmers. As a result, the economy collapsed because its main industry (and main export industry) was moribund. Unemployment and inflation both soared (unemployment because the farms were no longer employing workers, inflation partly because production had collapsed, leading to too much money chasing too few goods, and partly because the government reacted by firing up the printing presses to compensate for the collapse in government revenues caused by the decline in employment – the worst possible reaction to a mess of their own creation.)

      • The inflation came from the printing presses, nothing else. There might be reasons for using the printing presses, but hyperinflation came slowly from printing money, not some supply collapse which would move the price level up but not continue to do so.

      • Lorenzo – You are both right and wrong here. The problem is that they continued to print money DESPITE the supply collapse. If they had not fired up the printing presses in response, as you say, you wouldn’t get a continual rise in the price level.

        But the point is that printing money on its own does not necessarily lead to hyperinflation.

      • Agreed, that printing money alone does not NECESSARILY lead to hyperinflation.

        One also needs a loss-of-confidence in the currency being considered, which, may or may not be economically (inflationarily) rooted; in history, it has typically been politcally and militarily related, also.

        (But it goes to say that price inflation (non-uniform) on its own can certainly add to the brew, and highten the likelihood of a loss in confidence).

    • Who knows, if the world’s reserve currency was Zimbabwean $, they may not have suffered hyper inflation.
      .
      But we will never know.

  1. What happens when there is no demand to soak up the products created by the extra capacity built on cheap capital? Deflation?

  2. Memphis Trouser

    Very interesting read about US debt. The thing I’m wondering though is this:

    If the Bernank continues with QE for the next couple of years until the slack in the US economy picks up, the US economy may not experience significant inflation, maybe Mitchell is right here. But isn’t the Federal Reserve exporting inflation to the rest of the world – through a continual monetary expansion of the world’s reserve currency?

    • The Bernank! Yes and No.

      Here is the problem. China and many emerging market economies are indeed importing inflation from the US. But this is their own policy choice, since they are choosing to peg their exchange rates to the dollar (or a currency basket) in order to gain export competitiveness.

      If China let the yuan appreciate, inflation would be much less of a problem.

      • But he’s not really undertaking a “monetary expansion of the world’s reserve currency”, is he? Where are those extra dollars? I can see a boatload of reserves that constitute base maoney doing bugger all but clip a 25bp coupon. That’s what I can see. I don’t see banks falling over themselves to lend them because…well…they don’t need reserves to lend. Anyone who disoutes this needs to explain it the BIS, who clearly agree, as well as explain why the lending and credit binge that brought us the GFC did so on a (gradually declining) pittance of 43bn of reserves…..the US has a trillion now, don’t they. But they’ll lend when they see fit, when they credit-worthy prospects, secured against collateral that isn’t about to lose value (watchin’ that US housing double dip?).

        Though I’m not sure other countries are importing US inflation per se….what inflation? Granted, they are importing innapropriate policy that is causing inflation in its own way, but they are hardly importing US goods and services at higher prices. The prices that are going up are those that are being pumped by speculation, which is related to QE (check the yearly change in say, house prices and wages and CPI vs S&P and commodities in general), without QE being tha absolute culprit…..which is, the committment to keep rates low for a l-o-o-ong time. That is the crux of the commodities boom. It’s just the competition for capital operating in its normal fashion, that’s all. As mentioned, there are no extra dollars flitting about in city bars, cocaine dens, or farmers’ markets, but there is a massive implicit guarantee that cheap funding is around for long enough to make speculators fat and giddy with trading profits, but doing a hell of alot for the unemployed. Clearly there is an explicit element to the “extended period” too (Fed statements etc), but it’s more relevant to watch what they are DOING, not SAYING. It is the current equivalent of the bone-headed policy of keeping rates inapropriately low in the early 2000’s, then doing baby steps 17x in a row over one of those extende dperiods! Anyone miss that signal? Get and buy, you’ve got time! Sheesh. Markets are getting the signal this time too. They don’t need “expansion of the reserve currency” to do it either.

  3. A logical argument but the part that bothers me is the human element in all of this. In a theoretical world this works fine so long as governments do the right thing but invariably they don’t. In the US, the Fed buys near freshly minted Treasuries which is mealy being churned back through the Primary Dealers used to goose the stock and commodities markets. Hardly any of this money is going directly to those who most need it.

    Bill also states that printing money does not cause inflation. First order yes, second and third order no. As in the case of the US, commodities are being pushed high than they’d otherwise should be because you have alot of hot money looking for a better return. The US middle class is tapped out; where next?

    The part that shits me the most is that these austerity measures have come about because governments were forced to rescue the banks and incurred a massive amount of pointless, unproductive debt. The banks should be the ones that pay not the sovereign peoples but there are no governments strong enough (bar Iceland) to make this happen.

    • Johnno – I do agree that governments often don’t do the right thing. As for QE, that is a different issue to the fiscal stimulus, and for what it’s worth, I don’t think it’s effective.

      In my opinion, the banks should have been allowed to fail (in as orderly a fashion as possible) with some of the worst ones temporarily nationalized. Their CEOs and management should all have been forced to resign. And the stimulus should have been targeted directly at job creation schemes and aid for troubled homeowners, etc.

      Unfortunately the US political system is completely captured by special interests, so what we got instead was a very substandard response that concentrated most of the burden of adjustment on the middle class.

  4. “You cannot make an analogy between the finances of a household or a corporation, and those of a country. Individuals have to pay back their debts over their lifetimes, and cannot sustainably spend more than they earn without going bankrupt. Governments, on the other hand, have the power to create money, which makes any analysis of their finances very different. The fact that the US has been able to run deficits almost continually over its 220 year existence makes this point clear.”

    Didn’t Keynes say that printing money was the “miracle…of turning a stone into bread”? But it was Friedman who said “There is no such thing as a free lunch.” And indeed he was right. You cannot print money without there being some nasty consequences.

    “The analogy to Greece is also false. When Greece, Portugal, Spain and Ireland joined the euro zone, they all gave up monetary sovereignty. Greece has to borrow to cover its deficits and is now at the mercy of the bond markets. This is not true of the US.”

    True, but Zimbabwe was not part of the Euro. Neither are Argentina, Iceland or Venezuela.

    “A sovereign nation that is the monopoly issuer of its own currency cannot possibly default (unless it chooses to do so for political reasons). There are no issues in “funding” its deficit. Inflation becomes a concern only if the government continues to run large deficits as the economy approaches full capacity. We are a very long way from this situation today.”

    Inflation can rise despite high unemployment. It happened in Zimbabwe. It happened in the ’70s. It can happen again. It may be happening now:
    http://blogs.wsj.com/economics/2011/03/18/inflation-slowly-showing-signs-of-life/?mod=wsj_share_twitter

    “Any waste associated with government spending during recessions is absolutely dwarfed by the inefficiency of having a large segment of the population unemployed.”

    Based on data I’ve seen, the Federal Reserve has injected (printed) around $US1.5 trillion since September 2008. But where has that money gone? Has it gone to the long-term unemployed that Krugman claims to be concerned about? Nope. Instead it has gone to the politically-connected, i.e. the Wall St banksters and union-friendly corporations.

    But apparently that level of ‘waste’ is perfectly fine.

    • >Inflation can rise despite high unemployment. It happened in Zimbabwe.

      Sidelined ,

      Inflation is caused when there are more financial assets available than real goods. So one of the ways it can appear is when the ability of the economy to produce real goods is destroyed without a corresponding fall in the available financial assets.

      So when the Zimbabwe government decided it was a good idea to destroy its farming sector you suddenly got inflation. That is there was more “money” in the system than goods available for purchase.

      The Zimbabwean tried to compensate by printing larger and larger denominations of their currency. Which was never going to work was it.

      I absolutely agree with your points about how the stimulus was actually implemented in the US. The comment below this one has some info on that one.

    • Sidelined — Let me first say that I am absolutely in agreement about the US stimulus. You could argue that the bailout of the auto sector saved jobs (and it is questionable if this was worth it) but clearly the emphasis (through TARP) was on rescuing the politically well connected banks. In addition, a third of the stimulus went to tax cuts, which were presumably mostly saved, and so do little to help the unemployment problem. All of this is true. But does it discredit the idea of stimulus itself? I don’t think so. The US just screwed it up.

      As for Zimbabwe, Argentina, Iceland and Venezuela, I don’t think these type of comparisons help advance the debate. DE and other commenters have already done a nice job of illustrating the huge differences in the case of Zimbabwe. As for Iceland, budget deficits and printing money had nothing to do with their crisis — it was a banking crisis caused by an out of control private sector and lack of proper regulation.

      I don’t have time to get into the other cases, but I am going to do a post on hyperinflation that will examine some of the S.American countries and hopefully shed a bit of light on this.

      • “The US just screwed it up.”

        Yes we can agree on that. But perhaps where we disagree is that I think govts will always screw up. If I am right, then it follows that Govts should never embark on deficit spending to stimulate the economy.

        I can agree with you that international comparisons are hard to make given lots of local unique factors. My point was simply that if you just look at two variables alone: unemployment and inflation, it is not impossible for the two to rise simultaneously. If I am right, then it follows that Govts CAN cause inflation during a period of high unemployment.

      • No, we don’t disagree on that. Governments do (almost) always stuff it up. This is why I am no fan of big discretionary stimulus plans and bailouts. See my other comment on job creation schemes. I think this is a much better approach. Regardless of this, it doesn’t necessarily follow that governments should not embark on deficit spending.

        Even if there is some waste associated with such schemes, it is nothing compared to the colossal economic and social cost of high unemployment.

        Regarding inflation, more in a future post.

      • Speaking of waste:

        This is part of the transcript from a recent story on SBS Dateline:


        REPORTER: Is China experiencing a property bubble?
        GILLEM TULLOCH, FORENSIC ASIA: Absolutely. A property bubble like which I don’t think we’ve ever seen.
        REPORTER: Bigger than the one in the United States?
        GILLEM TULLOCH: Yes, I think it will make the United States pale in comparison. It is said that there are 64 million empty apartments in China.
        REPORTER: 64 million?
        GILLEM TULLOCH: 64 million.

        You can read the entire transcript here; or watch the video:
        http://www.sbs.com.au/dateline/story/watch/id/601007/n/China-s-Ghost-Cities

        The Chinese are playing by the Keynesian rules:

        GILLEM TULLOCH: It’s essentially the modern equivalent of building pyramids. It doesn’t really add to the betterment of lives, but it adds to the growth of GDP.
        And maintaining economic growth is the government’s number one priority.
        GILLEM TULLOCH: It’s basically happening because China is a command economy and the Chinese Government can dictate where the resources are spent.
        REPORTER: And so, if the order goes out to build, local governments build?
        GILLEM TULLOCH: That’s right. If the central government a GDP target, they have to meet the target and the easiest way to do it is just to build.
        REPORTER: Isn’t all this construction a good thing? It’s creating jobs and getting the economy moving? That’s a good thing?
        GILLEM TULLOCH: People forget that it is not the quantity of GDP that matters but the quality and essentially, they’re building things for where there’s no demand and so they’re creating a large problem for the future.

  5. >A logical argument but the part that bothers me is the human element in all of this. In a theoretical world this works fine so long as governments do the right thing but invariably they don’t. In the US, the Fed buys near freshly minted Treasuries which is mealy being churned back through the Primary Dealers used to goose the stock and commodities markets. Hardly any of this money is going directly to those who most need it.

    I think there are two points to make about that one. Firstly I agree the major problem with any macro policy is that the government are usually an inept bunch of corrupt fools who have absolutely no idea what they are doing.

    I have previously suggested some form of “economic democracy” to attempt to compensate for this which would allow the private sector ( including business ) to have a better say in how the economy is used for the good of ALL.

    The other point is the actual make-up of these “stimulus packages”. The fact is Australia’s stimulus was very successful in achieving a private sector recovery ( I will ignore the failings of the FHBG for a second ) because the spending was directed into the private sector where it was circulated quickly. The US however spent the beginning of the stimulus injecting money into the banking system where it sat and did very little to create private sector demand for goods ( and therefore employment ), it did however bail out the banks.

    I will leave other to contend whether they did that on purpose or whether they just didn’t know what the hell they were doing.

  6. Given the massive expansion in US federal spending, in what sense is a series of comparatively minor cuts “austerity”?

    The Nation article has a common problem of this sort of analysis. It is advancing two propositions:
    (1) Markets perform much worse than politics and so need strong regulation and intervention by politicians.
    (2) Our politicians are persistently stupid and delusional and pursue bad policies.

    The wider notion that the realm of politics can be insulated from the realm of interests so it can “manage” those interests is not one I agree with. On the contrary, interventions will be gamed by said interests. Which is not an argument for no laws, just against complex laws and (particularly) official discretions.

  7. Even if there is not a debt constraint — it can just be extended forever, there is an endless willingness and ability to buy government debt — surely there is an interest burden constraint. People will not buy it if they are not going to get paid. And if they think they are going to get inflated out of being paid, they will charge more to buy it.

    The notion of no sovereign debt constraint is not one that historical experience supports. It sounds, in its sense of no upper limit, very much like arguments about Oz housing prices and how there is no bubble.

    • The point your argument is missing is that there is no actual necessity for the debt in the first place (although there may be a political decision to go that way). In the case of the US, Congress has decided that the US Treasury is not allowed to spend more than it receives in taxes, unless the difference is made up by borrowing. But this again is a political, rather than actual constraint.

      If you look at doing the actual sums, it would be quite reasonable for a sovereign government to spend, on average, around five per cent of GDP more than it receives in taxes. This should not generate (excessive) inflation since nominal GDP would typically grow by this amount each year if the economy is going well. Inflation in this scenario would typically be in the 2.5 – 3.0% range, similar to the actual outcome in Australia in recent decades.

      • Mind you, the “okayness” of inflation in an economy is at least partly founded upon the notion that the inflation will be, basically, uniform.

        Instead, it’s typically not, and tends to “punish” those who get new money last, which is normally the poorer in our society.

        hence, it tends to be, effectively, a wealth-transger mechanism, or even a secret tax.

        I’m not saying it’s a conspiracy, no; but i am asserting that this is a reality that is little appreciated (and is a bit of an inconvenient truth) by proponents of “govts are different” and “a little bit of inflation is OK” arguments.

        my 2c

  8. Appreciate the insights RA( and DE in comments).

    Disclosure: Not a big fan of Billy Blog and MMT!

    Now that is out of the way, external accounts and dynamics of an economy with ROW dictate that one cannot operate in isolation. The following comment from Bill, (I at least think) agrees with it – “governments can purchase whatever they like whenever there are goods and services for sale in the currency they issue”. The point is THE CURRENCY THEY ISSUE

    A factual assertion which should hold is that public debt should not exist to suffice public sector’s contribution to GDP, because it is a sovereign issuer of its currency. What I argue is the point that by default private sector is forced to trade in a currency issued by the govt (even though it takes on whole different shape in form of credit money in era of modern banking). If there was a choice as to not trade in FIAT currencies, maybe some other alternate would emerge. But financialization over the past couple of decades has eventuated in private sector more than willing to conduct business in FIAT, BUT the value of these FIAT is determined by the market and no amount of currency intervention by infinitum printing can force levels on the market (barring a confidence event where abrupt move arresting works in the short term as pointed to another post by DFM). I would go as far to suggest that CB should according to sovereignty assertion, become only a passive participant in FX markets for clearing purposes and not be biased to any particular levels. I am sure you two will agree that the issue of exchange rate levels debate is one of the top contenders in the debate on world stages today (wether it is a fruitful one is open to debate. My modest view is Competitive devaluation cannot buy your way to prosperity in the long run)

    “They argue that government borrowing (to “fund” the deficits) competes with the private sector for scarce available funds and thus drives up interest rates, which reduces private investment—the “crowding out” hypothesis.”

    How would this hypothesis hold if I was to say that private sector competes with govt for the funds? Clearly to private sector they are not available in abundance. That’s why we have interest rate structures for trading credit in private markets.

    Also pondering for a moment, one should comprehend that if Govt takes it sovereignty to the extreme , recessions would become highly improbable events with very short shelf life’s. Great if possible, but who knows, it might be.

    Also if austerity in times of massive decline in private spending is not what is required, then it would not be entirely unreasonable to conclude that PUBLIC SECTOR PENSION LIABILITIES are not LIABILITIES, as a backstop always exists to back them up ( a future outflow of economic/productive resources can be replaced with just more currency backing). Why even the debate about SWF and Future funds! They can loose capital like no tomorrow as a contingency plan always exists. Clearly then the pension debacle in some US states is a non-sensical issue to be pickering over.

    CONFIDENCE in economies and their end of bargain (being their currency, which the govt seeks to maintain the control over) is the critical component that needs to be sustained, if they want to maintain the status quo.

    • Hi vinny,

      >I would go as far to suggest that CB should according to sovereignty assertion, become only a passive participant in FX markets for clearing purposes and not be biased to any particular levels. I am sure you two will agree that the issue of exchange rate levels debate is one of the top contenders in the debate on world stages today (wether it is a fruitful one is open to debate. My modest view is Competitive devaluation cannot buy your way to prosperity in the long run)

      I think your point is a little broader in context than this article is, however I tend to agree with you. In regards to FX I think you should visit this little known site

      http://www.buoyanteconomies.com/

      To get an appreciation of a big issue with running a floating exchange system and why you see constant CB intervention in rates even though the floating system was supposed to remove the need for them.

      >How would this hypothesis hold if I was to say that private sector competes with govt for the funds? Clearly to private sector they are not available in abundance. That’s why we have interest rate structures for trading credit in private markets. Also pondering for a moment, one should comprehend that if Govt takes it sovereignty to the extreme , recessions would become highly improbable events with very short shelf life’s. Great if possible, but who knows, it might be.

      I am not 100% sure what you mean here when you say “competes”. A fiat issue government doesn’t compete with anyone to create financial assets denominated in its own currency. In regards to the private sector they absolutely do compete with the government, but that is how the system works. From an MMT perspective, monetary and fiscal policy are used by the government to restrict and supply money to the private sector in an attempt use the available non-financial resources in a way that will produce the best social and economic outcomes for the country. It is absolutely a competition between the private sectors desire for financial asset wealth and the governments desire for productivity.

      Forgive me if I have misinterpreted your point.

      >Also pondering for a moment, one should comprehend that if Govt takes it sovereignty to the extreme , recessions would become highly improbable events with very short shelf life’s. Great if possible, but who knows, it might be.

      Well I think that is highly dependent on what the government actually does with the private sector resources it utilises. You can search this blog for the term “GPEC” for my rants about this topic.

      >Also if austerity in times of massive decline in private spending is not what is required, then it would not be entirely unreasonable to conclude that PUBLIC SECTOR PENSION LIABILITIES are not LIABILITIES, as a backstop always exists to back them up ( a future outflow of economic/productive resources can be replaced with just more currency backing). Why even the debate about SWF and Future funds! They can loose capital like no tomorrow as a contingency plan always exists. Clearly then the pension debacle in some US states is a non-sensical issue to be pickering over.

      Firstly you need to clearly define what you mean by public sector liabilities. State governments/Local councils are not “the government” in the context of macroeconomics they really can go bankrupt and default on debt by no choice of their own.

      Having said that you bring up a fair point about why should a sovereign issuing government care about any debt because it could merrily print money later on, so basically it can do whatever it wants. We don’t need a sovereign wealth fund,hell we don’t need to do anything we can just print the money when we need it. It is obviously not true, but very difficult to explain why.

      This is actually a question I asked myself many years ago and it took me a great deal of time to answer it. The answer requires you to stop thinking in terms of money and start thinking in other terms because a true sovereign issuing government places no value on its own money. It has no value to it because it can create it whenever it needs it.

      It is an abstract concept, but I talk about this here :

      http://macrobusiness.com.au/2011/01/readers-question-another-visit-to-centralbankopia/

      >CONFIDENCE in economies and their end of bargain (being their currency, which the govt seeks to maintain the control over) is the critical component that needs to be sustained, if they want to maintain the status quo

      True, but the reality is that the currency gets value from the resources you can gain by holding it. Which is why it is not the money that really matters it is the productive capacity, sustainability and stability of the underlying economy that is the important thing.

      • Thanks for the link DE. Will ponder over a couple of papers to refreshen my interpretation of same.

        >A fiat issue government doesn’t compete with anyone to create financial assets denominated in its own currency.

        True. And i know in ideal state of MMT, a govt debt would be of irrelevance (either in monetary or real resources terms upon which the debt holders rest a claim). But in the realm of what we live in currently, govt. score card in broad terms is what is reflected when we do international barter in our own currency (that is how underlying economy has performed on GPEC terms).

        >Well I think that is highly dependent on what the government actually does with the private sector resources it utilises.

        High dependency and extreme efficiency in execution is calling great hopes for very unlikely outcomes, although not impossible!

        I definitely am on page with your GPEC concept and that is what the ultimate aim of any govt. should be. But in reality love for crony-capitalism has given rise to some toxic bureaucratic relationships and circles that will put self interest (as an individual or cohort) way above national agenda. Highly interventionist govt. policies and prescriptive approach to market operations isn’t something I would hold my breadth for.

        And as for them ascribing no value to money, true, they will not need to, if the recent spade of events continues for a couple of years. The world will not end, but it will be a whole damn expensive. Money will still remain just a medium of exchange, but what you could exchange it for is what matters.

        Anyways, enough of my rant.

  9. The Zimbabwe hyperinflation was caused by a shortage of hard currency. Even before the farm invasion, the Zimbabwean government has incurred a huge foreign debt from their disastrous foray into the civil war in Congo. (to protect the diamond mines owned by some Government minister). Faced with a fall in popularity, Mugabe decides to buy it with money and annouced a generous pension for the ‘war veterens’. That caused the Zimbabwean dollar to collapse 50% virtually overnight.

    Faced with economic disaster, Mugabe played the most potent card in Zimbabwe : the ‘race card’. He started the invasions of farms owned by white farmers. This crippled agricultural production which is the main export for Zimbabwe, and the fall in export made the foreign exchange situation even worse. This made the Government ministers unhappy because their wife likes their shopping trips in Paris. That is when the looting of the country begin.

    At the early stages, the Government ministers can exchange their Zimbabwean dollars for US dollar using the ‘official rate’ at the Zimbabwean Central Bank, and then the US dollar will be sold on the street at the ‘black market’ rate. The US dollar is obtained by forcing all banks and businesses to deposit their foreign dollar with the Central Bank, and then it is stolen, never to be seen again.

    When the Zimbabwean businesses ran out of hard currency, it progressed to the next step : the Zimbabwean Government ministers are given as much dollar as can be printed by the press, and they use that to buy US dollar. At that point, the Zimbabwean dollar is more valuable as toilet paper, and the denominaton went to 100 Trillion dollar.

    If the US ever gets to that point, then God help us all..

    I don’t think the US can simply ‘print’ their way out of the crisis. It has to raise taxes on the rich, stop engaging in open-ended wars, and reduce the amount spent on health care. A radical solution to increase short term revenue is for the US to invade Cayman Island!! There is a few trillion dollars to be grabbed there!!

  10. “The fact that the US has been able to run deficits almost continually over its 220 year existence makes this point clear.”

    Firstly, that is not historically correct. Under the gold standard in the 18th and 19th centuries (apart from war time) the US Govt generally ran surpluses. Deficits became more common in the 20th century with the introduction of central banking and fiat money.

    See here:
    http://www.usgovernmentspending.com/downchart_gs.php?year=1792_2010&view=1&expand=&units=p&fy=fy12&chart=G0-fed&bar=0&stack=1&size=l&title=US%20Federal%20Deficit%20As%20Percent%20Of%20GDP&state=US&color=c&local=s

    Secondly, the concern is not about deficits per se, but rather their size. As they get bigger, a larger share of revenues will be diverted in servicing debt rather than providing services. Getting around this by monetizing the debt creates other problems such as inflation and potentially higher interest rates. A further concern is that servicing debt diverts resources away from investment and economic growth.

    • Sidelined – That’s a nice chart. I stand corrected there – the US ran surpluses quite often under the gold standard in the 1800s, although they have run deficits for almost all of the past century, and increasingly so under fiat money.

      This is part of my point though. Under the gold standard, a fixed exchange rate, or a currency union like the euro zone, there are constraints on the ability to run budget deficits. This does not apply to sovereign nations like the US.

      Of course, through sheer economic mismanagement you could still get high inflation, but there is a fundamental difference in the degree of policymaking freedom that the US has today.

      Regarding the size of the deficit and servicing of the debt, in addition to Alex Heyworth’s point above there is a key point that many people are missing.

      What is the biggest reason for the spiraling US deficit over the past couple of years? It is not stimulus spending (which as a % of GDP was much lower than many other countries). It was primarily the collapse in tax revenues caused by the great recession.

      When growth recovers, the deficit will start to fall naturally. If budget cuts reduce spending and slow the economy, they will be counterproductive. The deficit will not fall.

      • “What is the biggest reason for the spiraling US deficit over the past couple of years? It is not stimulus spending (which as a % of GDP was much lower than many other countries). It was primarily the collapse in tax revenues caused by the great recession.”

        According to these websites:
        http://www.usgovernmentspending.com/#usgs302a
        http://www.usgovernmentrevenue.com/#usgs302a

        Federal govt revenue fell by $361bn between 2008 and 2010, but expenditure increased by $473bn over the same period. What is really scary is that while revenue is anticipated to increase by $11bn in 2011, spending will increase by $363bn.

        In other words (if the above sites are to be trusted!?) your claim is wrong. The deficit was caused by out-of-control spending.

      • Yes. I am guessing the numbers on that site are correct.

        What I meant to say was that it was a combination of the collapse in tax revenues and the rise in automatic stabilisers (unemployment benefits, etc). This is not “stimulus” money. It happens automatically and is not discretionary spending.

        So the deficit was NOT caused by out of control stimulus spending. The primary causes lie elsewhere. Incidentally, the Bush tax cuts are estimated to have cost the Treasury close to $2 trillion in lost tax revenue over 2001-2010, which is more than twice the size of Obama’s stimulus program.

  11. Another argument that urks me is when people assert that when inflation occurs due to more money being produced than goods to tie it to, that this is “just inflationary”. And, it is, sure.

    But the implicit assumption here is one of near-instantaneous equilibrium of the money supply, as if “things pretty much just go up together, proportionally”; or at least, that and similar explanations are issued at moderators to contentions raised.

    But the truth is that inflation, at least as I have perceived and experienced it, is rarely, if ever, uniform.

    No, instead, new inflation is grossly non-uniform, with the new money inflating certain parts of the economy more than others, and, typically it is in things that people “need”, as opposed to just what people “want”.

    In my honest opinion, this is one of the real vs theoretical issues of monetary theory that is not often considered, especially when large government deficits and their general “okayness” is being considered, and how they are not constrained to “normal” – dare I say, rational – financial considerations.

    In that sense, governments, are morally negligent when they print new money to “just” pay for their debts, and “just” create some inflation – for whatever “justified” reasons there may be.

    And, in my opinion, it is unwise to use government debt as a coverall for “problems”, as if the expression of said problems was the worst possible outcome. It may well be – and often is the case – that the “problems” are, unfortunately, well-deserved for past mistakes, and that government intervention “to save XXXXX from this and that” does more to ingrain the problems into the systems further, rather than allowing them to express, and allow people and govts alike to actually fully appreciate the consequences of certain beliefs, thoughts and actions.

    Truly, it is a problem with fallen human nature, but we – both individually and collectively – too often seek to escape the consequences of our actions, whilst simultaneously saying the problem(s) is “something else”.

    In my honest opinion, skyrocketing governments debts and the printing (effectively) of new money to pay said debts, are just examples of trying to “fix” (escape) problems, instead of appreciating them more fully, and learning from them.

    Again, in my opinion, theorising that largely justifies such actions fails to appreciate the dynamics and non-equilibrium, non-uniform nature of such systems, and treats them as if they are not much more than push-and-pull mechanical systems – such theorising is found to be wanting in its practical, theoretical and moral application.

  12. In my opinion there is very little truth in this article.

    “When President Obama announced in December 2009 that “We don’t have enough public dollars to fill the hole of private dollars that was created as a consequence of the crisis,” the leader of the largest economy in the world told us that, despite having caused the worst economic crisis in eighty years, neoliberalism was still firmly in charge.”

    He then went on to fill the hole – I refer your readers to this chart: http://market-ticker.org/akcs-www?get_gallerynr=1299 . I don’t think it has done much good. Debt to GDP cannot rise forever, and backfilling the decline with public dollars could ultimately end with only public credit and no private credit – what then? Debt to GDP has the decline.

    “The global economic crisis might suggest that the neoliberal promise—that markets can self-regulate and deliver sustained prosperity for all—was a lie. But that doesn’t seem to have registered with governments, which have, without exception, built their responses to the crisis on a series of myths—the same myths that caused the crisis.”

    Any system of credit with a central bank is by definition not self-regulated. The central bank sets the price of credit for political reasons rather than letting the free market determine the price. It also allows the government to borrow on better terms than the private sector, distorting the price-setting mechanism. This is neoliberal/monetarist I guess but it is certainly not anti-government, and is not a free market.

    “Despite millions remaining jobless and poverty rates rising, governments have claimed that there is no alternative but to impose austerity by cutting budget deficits.”

    Millions remain jobless due to the government interfering and not letting events take their course. The problem was excessive build-up of private debt, aided and abetted by politically motivated central banks and corrupt governments. Replacing this with public debt is morally reprehensible (dumping the problem on to the taxpayer) and is just delaying the inevitable – either debt-deflation a la Japan, or a currency crisis. Real jobs are created by the private sector being left alone to do what it does best – after all that is how the US became so prosperous in the first place.

    “In the United States and among most parties in Europe—whether in government or opposition—the unquestioned dominance of neoliberal ideology has reduced economic debate to questions of nuance.”

    In fact neoliberalism/monetarism and its strange bedfellow Keynesianism have symbiotically allowed runaway government debt to accumulate to the point where it is nearly out of control. Only now that it is obvious this cannot continue indefinitely are people coming to their senses (hopefully).

    • “Millions remain jobless due to the government interfering and not letting events take their course. The problem was excessive build-up of private debt, aided and abetted by politically motivated central banks and corrupt governments. Replacing this with public debt is morally reprehensible … and is just delaying the inevitable – either debt-deflation a la Japan, or a currency crisis. Real jobs are created by the private sector being left alone to do what it does best.”

      Paul – I understand your point of view, but I guess I would argue that what is really “morally reprehensible” is standing by when close to 10% of the population is unemployed.

      If the US government were to balance the budget tomorrow, what is the mechanism by which real jobs would suddenly be created and the 10 million or more unemployed would find jobs?

      My guess is that unemployment would head towards 20%, social instability would rise, and you would get a long period of debt deflation that made Japan’s “lost decades” look like a picnic. Maybe this is the price to be paid for “cleansing the system”, but don’t you think this is an awfully high price to pay?

      • The mechanism by which millions of US jobs were created in the first place – private enterprise. Of course it wouldn’t happen overnight, and there would be pain, but far less pain than the alternative.

        Japan’s “lost decades” have not solved a thing – they have merely been administering anaesthetic rather than curing the disease. The private sector built up huge debt and have gradually foisted it on to the taxpayer in a long but ultimately unsustainable process of deficit spending.

        “I would argue that what is really “morally reprehensible” is standing by when close to 10% of the population is unemployed.”

        If you or I or anyone else really had more power to employ those people than they have to employ themselves, then I would agree. However, you don’t, I don’t, and the government don’t. I agree the government should help those incapable of productive activities. The capable can and will find productive activities of their own – this is the source of all of human wealth. Government propping up big business through bailouts and stimulus doesn’t help this – it hinders by limiting opportunities for new small business.

      • Clearly we are at opposite ends of the ideological pole on this one 😉

        You say that the capable can and will find productive activities on their own – but this is not true when there is a shortfall of aggregate demand.

        By the way, I don’t advocate the government propping up big business or banks through bailouts and stimulus. I think in times like this the government should focus on targeted job creation and retraining schemes.

        Interestingly (and this is a little known fact), Keynes himself did not advocate massive pump priming type stimulus and bailouts.

        He was in favor of a direct job creation scheme that would provide a job to anybody in need throughout the business cycle. This would act as an automatic stabiliser, largely removing the need for discretionary stimulus during recessions. Hyman Minsky and modern day MMTers like Bill Mitchell have advocated similar schemes.

        I have no idea whether or not such a scheme would work in practice, but I find it hard to believe it would be any worse than the current approach. You could then get rid of welfare programs like the dole (which institutionalise poverty) and avoid the need for large discretionary stimulus, which for political reasons usually ends up going to the wrong places.

      • “You say that the capable can and will find productive activities on their own – but this is not true when there is a shortfall of aggregate demand.”

        The concept of aggregate demand is a Keynesian notion that is essentially meaningless when you attempt to analyse his writings. A group of people left to their own devices will spontaneously create goods and services and trade them with one another. There is no magical “aggregate demand” required – demand is always there.

        I don’t see it as an an ideological thing. I think followers of Keynesianism and Monetarism, and for that matter MMT, fall into two camps – a) those misguided and misled by the ambiguous and inconsistent use of terminology and b) those who know the flaws but intentionally seek to perpetuate the confusion, because it suits their ends to do so.

        People in the a) camp can, I think, be persuaded by rational debate to re-evaluate their opinions. I myself was formerly in this camp.

        I think a lot of these people know at the bottom of their hearts that there is no free lunch, they just need the opportunity to think it through, clearly, and examine critically all statements made by Keynesians and Monetarists. These statements are full of trickery.

        People in both camps proliferate because it suits the many vested interests for them to proliferate. These are the people that receive most of the plum academic posts or journalistic posts funded by government and big business.

        Thank heaven for the internet and blogging – rational public debate can now come to the fore.

      • I don’t think anybody claims there is a free lunch or there is an easy way out of this crisis. That is a straw man.

        But I must say I find the Austrian view very dogmatic; ie. that as long as the government, central banks and meddlesome Keynsians get out of the way and we let markets work their magic, everybody will find a job and we will all be living in some kind of utopia without financial crises or recessions.

        In any case, I agree with you that the internet and blogging is a great way for both sides of this debate to gain a better understanding of each others’ positions.

        Can you recommend a good resource that is a fair representation of the Austrian school?

      • RA,

        I don’t think Austrians are saying that, your doing the very thing you accuse others of doing: putting up a strawman.

        The Austrians are saying that, compared to free markets, govt interference makes things worse. Austrians are not utopians.

      • This is a draft of a primer on Austrian Economics:
        adamsmith.org/files/austrian-primer-text.pdf

        The largest collection of Austrian economics literature, articles and other publications is here:

        mises.org

      • Sidelined – Fair point. That was a bit of a caricature (although not far off the kind of arguments that I often hear from the Austrian crowd). I will take a look at the resources you suggested. Cheers.

        RA

      • I am not an “Austrian”. I agree with them on some things however.

        There will never be a “utopia” and markets cannot solve all problems.

        My problem with Keynesianism is its complete lack of clarity and its inconsistent use of terminology. Its success is due to it suiting the ends of vested interests, not due to the correctness of its theories.

        MMT shows the same promise, judging by the ease with which people fall for its blithe definitional machinations.

        Monetarism/neoliberalism ignores the effects of the overall stock of private debt, claiming that “money we owe ourselves” can never be an issue. In my opinion this is a grave error, as “we” are a collection of individuals, and if one group of us owe another group so much that it can never be paid back, then we have a massive problem.

        Mises.org is the best resource for Austrian economics but unfortunately they do themselves a disservice with some of the opinions they espouse.

      • Paul – When it comes to the neoclassical view that the total stock of private debt doesn’t matter, I am completely in agreement that this is a dangerous view. Steve Keen, among others, has written at some length about how mistaken this idea is.

      • Another point of view, RA, is timing: what, really, is the point of saving jobs, etc, for the short term, but only to leave the very same people (and even their descendents) with a less stable, increasing entropic system for the long run, which **will** (opinion) result in a near-total systemic breakdown?

        What, really, then, is the most morally responsible option?

  13. There is a basic confusion here regarding inflation.

    People seem to think that as long as inflation stays low there is no problem.

    Nothing could be further from the truth.

    If the market needs to deflate to flush out poor investments, there needs to be deflation. The natural course of events would be deflation.

    If we think of the headline inflation rate as composed of the natural deflation rate (absent deficit spending) + the effect of the deficit spending and call this “net inflation”:

    “Net inflation” = “Natural deflation” + “Stimulated inflation”.

    The Stimulated inflation is as damaging as the previously existing natural inflation, as it leads to the same kinds of malinvestment.

    For example, if there were no “stimulus”, the US deflation rate at the moment might be of the order of, say 4%, just for the purposes of illustration. However the headline rate is around 1%. This implies 5% of Stimulated inflation to bring the headline rate above zero.

    This 5% is very bad for the economy. And if we follow the same road, the private market will tend to try to deflate even further, meaning Stimulated inflation will grow.

    The market, to heal, needs to be left to deflate and get back to a healthy state where credit is properly priced.

    • Andrew W. Mellon once said “liquidate labor, liquidate stocks, liquidate farmers, liquidate real estate… it will purge the rottenness out of the system. High costs of living and high living will come down. People will work harder, live a more moral life. Values will be adjusted, and enterprising people will pick up from less competent people.”

      That line of thinking created the Great Depression. Deflationary spiral tends to make people hoard cash under their mattresses, and banks without cash is a very bad thing.

      • In actual fact Hoover did not take Mellon’s advice, so to say that line of thinking caused the great depression draws a very long bow. The US government stimulated like never before, aided by the Fed, and the result was ten years of misery.

      • “Liquidate labor” merely means to free up labor to work where work can be most productive, by removing artificial constraints such as minimum wages, compulsory unionism and unproductive propped-up big-business and government employment.

        Minimum wages will obviously cause unemployment in a deflationary environment, and the market if left alone have the best chance of deploying workers to produce the goods and services that consumers most need and want. The artificial constraints listed above are yet more examples of how we were not then, and are not now, anywhere close to a free market.

      • Paul,

        I can’t find a source, but I am fairly certain the Mellon quote is taken from the Memoirs of Herbert Hoover. Hoover then follows this quote by repudiating it.

        As you obviously appreciate, Hoover was an interventionist, and a very bad one at that.

      • DE,

        Which man? I read that article and if you were referring to Hoover I saw nothing to support your comments. What have I missed?

      • I think he/she is referring to this line

        “President Roosevelt finally gave up on the Hooverian austerity”

      • “President Roosevelt finally gave up on the Hooverian austerity”

        Yes, I saw that. But that is just plain wrong, there was no “Hooverian austerity.”

        He was an interventionist.

    • Well I hope so

      In my opinion THIS is the fundamental argument in macroeconomics and I am glad that this site can facilitate an educated and friendly discussion about the topic.

      I doubt anyone here, myself included, believes they have all the answers so it is great to hear other views on this.

      Once again I am stunned and somewhat humbled by the breed of intelligent commentors we have attracted to this blog even though it has only been running for 2 1/2 months.

      • Agreed. This blog is amazing. The quality of the posts and the discussions that follow are fascinating for me.

      • Agreed.

        And, Rotten Apple, another good article – well reasoned and written, even if i don’t necessarily agree with everything you’ve said!

        Thanks.

    • I’m quite happy to have the Austrians come on over and join the debate. Thanks all for keeping it civil — the quality of debate here has been excellent. And now, I will get to some of your individual comments…

  14. “The analogy to Greece is also false. When Greece, Portugal, Spain and Ireland joined the euro zone, they all gave up monetary sovereignty. Greece has to borrow to cover its deficits and is now at the mercy of the bond markets. This is not true of the US.”

    And how does the United States cover its deficits? By borrowing money from China, Japan and countries within Europe. Interest rates on the national debt only have to rise a few percentage points before the United States is paying a trillion dollars a year just to pay the interest on the debt. It wasn’t long ago that the national budget for one year was 1 trillion dollars, with deficits running in the several hundred billions. Now we have 3.5 trillion dollar budgets and 1.5 trillion dollar deficits.

  15. The basic problem is that most people have the intuition that government deficits are storing up trouble for the future – either in the form of higher taxes or inflation – and are therefore irresponsible, immoral, burden on our children, etc. The vast majority of liberals hold this view, not just conservatives. The only difference is that liberals think that the storing up of future trouble can be acceptable if the government’s spending initiatives are sufficiently worthwhile.

    The Modern Monetary Theory paradigm is completely different. The concepts of “sound finance” that apply to currency users (me and you) are inapplicable to currency issuers (the government). Deficits aren’t bad; they aren’t good either. They just are! What matters is the performance of the economy. If deficits help the economy, then run deficits. If surpluses help the economy, then run surpluses. And pay no attention whatsoever to the “soundness” of the government’s finances.

    • Couldn’t have put it better myself! MMT is not easy to get your head around, and as Bill Mitchell says in the article that I linked to, the logic of austerity is quite seductive, however false it may be.

      • I konw you say “false”, but I think it prudent to qualify that something being deemed “false” because of arguments that are only really sound by considering certain timeframes, and certain variables.

        That is, a more holistic perspective could see them undone.

        For example, the way that, IMHO, MMT allows previous ‘problems’ (expressed in whatever the problematic status quo of the economy at the time) to become part of the system, ingrained and systematic, with the accrual of such issues eventually characterising the system.

        I see these modern times as examples of this: certain beliefs, interests and subsequent underlying problems have become so “fixed up” by the powers that be, so many times (eg. by just expanding credit to “solve the problems of X, Y and Z in the short to medium term) that we now have, IMHO, a system that has more and more frequent expressions of said ingrained fundamental problems, and of a larger and larger scale, that the system is essentially unable to cope with intervention, and is essentially dead on its legs.

        It’s not REALLY a market anymore – or, at least, even less than it was before. Truly, it is not being allowed to correct, and it so much more a state-controlled-and-directed-can’t-fight-it-can’t-live-without-it type of sickness riddled Zombie economy that it was before.

        But this is part of the sort of beliefs of MMT (sorry…!) that allow suchs things to accumulate, express, and eventually bring down what we had.

        My 2c

      • Actually MMT is not hard to get your head around.

        It is easy to see that it uses terminology inconsistently to make fallacious points.

        For instance, its use of the term “Private Sector Surplus”.

        When you drill down into MMT you realise that what they mean by “Private Sector Surplus” when they are talking about “Sectoral balances” is actually “The net sum of all private financial claims on others”.

        However when they use the term to make policy prescriptions, they use the term as if it meant the thing that one would normally expect it to mean – i.e. the surplus of goods and services produced but not consumed by the private sector.

        A moment’s thought will tell you that the two things, that MMT uses the same term to refer to, are completely different things.

        Each year, the private sector may produce more goods than it actually consumes. For example, capital goods and inventories. This is the “Private Sector Surplus” that we want to increase in a growing economy. It can and should stay in private hands. It does not need to be lent to the government via the financial system and government bonds. It does not rely on a government deficit. It is totally different to the “The net sum of all private financial claims on others”.

        Keynesian and MMT are riddled with these kinds of terminology switcheroos.

  16. Agreed – this and the recent DE article on housing have brought out many, and in generally good fashion, with great debate.

    Bloggers here – please keep up your good work! It helps to sharpen us all.

    Stewart

  17. To the degree that fiat money acts like real money is the degree to which it works. The US government has much more leeway because their currency is demanded the world over as a reserve and in trade. However, that status can change – at which point the US and their currency are in big trouble.

    If the Australian government starts to use the power it has over our own fiat currency (more than it does already), then we begin down the road to financial ruin. Perhaps we are already too far along that road.

    Sure we have a fiat currency. It seems to be working. It’s only doing so because we treat it with some respect – as if it were real. Once we give that up we’re done.

    We’ve printed up the biggest credit boom in history. The MMTers would have us keep it inflated by massive government intervention (print to pay the national debt + a policy of full employment). The government would eventually run the whole economy (and some of those on the far-left love that idea). The reality is that our lives would change dramatically well before they got away with that.

    • A distinction needs to be drawn between a pure fiat currency and a credit-based fiat currency.

      We have a credit-based fiat currency, which essentially means that any bank notes or central bank reserve deposits must have corresponding assets (usually credit contracts) in possession of the central bank.

      This is designed to prevent the government from being able to print money.

      In cases where the central bank comes under partial or full control of the government (and it is debatable whether this has occurred, and to what degree it has occurred, in various western democracies), there is still a fundamental principle that puts some kind of lid on government money printing, and that is this:

      All money created by the “government+central-bank” through creation of government bonds purchased by the central bank, and including long term bond purchases (QE), must show in the national accounts as government debt.

      This is a fundamentally important point, and it is the key difference between the central banking model and a pure fiat system.

      This vital information informs private purchasers of government bonds, as to the stability of the currency and the government’s ability to repay the debt while at the same time not attempting to inflate it away.

      If any government contravenes this principle they will find it very difficult to find private purchasers for their debt, leading to a radical decay of the system and eventual currency collapse.

      It is a principle that is thought by MMTers to be a mere “political constraint” or “regulation” that can be repealed without consequence in order to allow unconstrained government spending.

    • Steven – I take it you would be much happier under a gold standard, which, of course, has its own issues. There is no perfect monetary system.

      As for the idea that the MMTers would have the government eventually running the whole economy, where on earth did you get that from? MMT can be consistent with any size government that you like, and there are actually a range of opinions on this.

      See this post from Randall Wray (you may not find it as amusing as I do, but it deals with this issue).
      http://neweconomicperspectives.blogspot.com/2010/07/towards-libertarianaustrian-modern.html

      • Thought I’d mention that I don’t find the “gold standard” to be sacred. I’m not sure that I’d advocate jumping onto some kind of gold standard right now. I think it would be very damaging … but would it be better or worse than what’s going on? I am not sure at all.

        However, I would say that if we had remained honest (at least more honest) with money, then we wouldn’t have seen such terrible consequences that are before us now. Also, the closing of the “gold window” of the gold-exchange standard was the last vestige any kind of honest money in the world. If dishonesty is pursued then I am not amazed when injustice results.

        As for MMT. If the MMT’s took over and were honest with other countries about what they were going to do i.e. pay back the national debt with printed money and never borrow again on international markets + fund all government spending by printing, hoping to balance that out with taxation. If they were honest, then our dollar would decline precipitously. Consequences could include damaging international relations (i.e. wars) and high inflation from imports (think oil and everything that comes from China). We could probably feed ourselves and even bring offshore jobs back home. Perhaps it would be a better life … eventually … presuming the government could resist temptation to over-spend and balance the economy. Not sure that everyone would agree that it’s better. Better to let people choose.

      • You might think I haven’t heard of Randell Wray but I’ve been thinking about the monetary system for quite some time. I haven’t done a particularly diligent investigation but I have read, watched and listened to a lot of stuff from folks from many different points of view.

        I hadn’t see this post by Randell before though. It’s a good one. I like to see the “far left” reaching out to the “far right”. It is amusing at that. I wish that I’d been able to do as diligent a research into modern money as Randell has. Think is that I found out enough to be completely horrified. However, Randell see it differently. He _likes_ the modern money. He sees it as a way for him to design a new society is the way he wishes it to be. Listen to him as he talks about was is possible, what is “affordable”, what we’d have enough resources to achieve. This goes to far as to become arrogance and conceit. We can’t be sure of what he says at all and what of the other consequences? This quote comes to mind:

        “The curious task of economics is to demonstrate to men how little they really know about what they imagine they can design.”
        —Friedrich von Hayek

        I’ve studied the Austrians and libertarians too. There ideas make a lot of sense to me. They have a good grasp of what is wrong i.e. what led to the crisis. However, their solutions seem disastrous. Though, I am not able to think of much better ones myself. I certainly don’t imagine my solutions would work. I’d rather see some kind of debt jubilee – somehow made as just as possible, followed by abolishment of the legal tender laws. This would be very politically difficult and I still think there are huge problems and would still appear disastrous.

        There are many points of view amougnst libertarians and even Austrians but I see also many problems amoungst them. I used to think of myself as a libertarian and anarcho-capitalist or voluntaryist. However, I no longer put myself in that camp. Many of the ideas are good. However, like everything, it seems to mix truth with error. Some problems I see are:

        * The government-hate is over the top. Thought I admit that it’s very easy to fall into and much harder to critique each policy for it’s own merits (though I do think that’s a waste of time).
        * The are so many gold and silver bugs. This makes for a *huge* vested interest. There are many good reasons to let bad banks go bankrupt but I feel that the calls from austrians/libertarians are based on how well they think their gold portfolio would do! This is truly evil.
        * While everyone should understand the concept of political anarchy (don’t freak out, I just mean society without rulers – not bombs and riots), it seems to be driven from a juvenile anti-authoritarianism i.e. “you can’t tell _me_ what to do!”. I admit that I found this very appealing.

        Technically I’m agnostic, but I find that the only advice I have left is: pray. We can’t sort this out ourselves. Our conceit leads us to believe that we can.

  18. Wow! some severe caricatures of MMT being expounded here. No MMT proponent I am aware of would say that a fiat government is “unconstrained” in its spending. The true discipline on government spending under MMT is exercised by inflation. If a particular level of government spending does not cause inflation, it is OK. Whether it is matched by tax receipts is pretty much irrelevant. MMTers see the main purposes of taxation as being (1) to control demand and (2) to create demand for the currency, so that the private sector will be willing to provide goods and services to government in return for currency.

    No MMTers AFAIK are proposing “massive government intervention” to keep the credit bubble inflated.

    MMT may have its faults, but please read up on it a bit before criticizing. It might help to avoid raising all these straw men.

  19. If governments can pretty well print whatever money they need without negative consequences, why do they make themselves unpopular by taxing their electorates?

    What would actually happen if we abolished all taxes and funded all state spending via the printing press?

    This was supposed to be a “reductio ad absurdum” argument, but maybe it’s a genuine Eureka! moment?

    • Firstly, governments can’t print whatever money they like without negative consequences (see Alex’s comment above). This is a fundamental misunderstanding of MMT.

      With regard to taxes though, good question!

      I’m no MMT expert, but my understanding is that strictly speaking in a sovereign nation you do not need taxes. Theoretically the government does not need tax revenues in order to spend and it does not need to issue debt to “fund” its spending either (different story in a state like California or a non-sovereign nation like Greece).

      So why do governments impose taxes?

      Firstly, to help manage aggregate demand. Without the ability to withdraw demand through taxation, inflation would almost certainly get out of control when the economy is booming.

      Secondly, governments tax to achieve various public policy priorities. ie alleviating inequality through income redistribution (progressive taxation, etc).

  20. Wow, there are so many logical mistakes and errors in the reasoning presented in this article, I do not know where to begin.

    Inflation and hyperinflation are completely different things. The fact that you don’t have hyperinflation doesn’t mean that your inflation won’t do damage to your economy. Its short-term effects are wonderful but bring with it a long-term hang-over.

    The belief that printing money for financing governments is of great benefit to a struggling economy as a whole is ludicrous. Monetary inflation nothing more than a hidden tax on capital. It combines effectively with capital gains taxes to create a wonderfully large income stram for the government – this is the key point. Savers (traditionally the elderly) are punished while irresponsible borowers (but most and foremost banks) are rewarded.

    You’re dead wrong on taxes too. Taxation has little impact on booms and busts, as they’re cerdit driven. In tax terms, companies and individuals are punished if they don’t go into debt. Income redistribution? – Yes indeed, but a “progressive” tax system is the worst possible implementation of this. There is nothing progressive about it, only additional punishment preventing people from chieveing their full potential.

    In short, the article is entirely misleading and I’m exceptionally disappointed to have found it on macrobusiness.

    • At most we have very mild inflation in the US today. Yes, this is a hidden tax. It obviously upsets you. Are you as upset about the fact that nearly 10% of the population is unemployed? There are bigger things to get worked up about.

      As for progressive taxes, of course there is room for debate about what the most appropriate tax system is. Reasonable people can disagree.

      But there is nothing “dead wrong” about one point of view over the other. How about you try to be a little more open minded?

  21. I think we can all agree that inflation is a hidden tax, but RA isn’t worked up about it. I can think of three reason why he should be.

    Firstly, inflation hurts low income earners the most, which includes the unemployed, precisely those people he is concerned about. The last thing people need when their incomes are falling is higher consumer prices.

    Secondly, inflation can lead to social unrest, as noted by Bloomberg:

    “Rising food costs contributed to riots across North Africa and the Middle East in the last several months that toppled leaders in Egypt and Tunisia. Prices surged as bad weather ruined crops from Canada to Australia and Russia banned grain exports after its worst drought in a half-century.”
    http://www.bloomberg.com/news/2011-03-03/world-food-prices-climb-to-record-as-un-sounds-alarm-on-further-shortages.html

    Thirdly, according to the Austrians, monetary inflation is a cause of the business cycle and so unemployment. Thus to them, trying to cure unemployment through monetary inflation makes no sense since they believe monetary inflation was the initial cause.

    On the issue of ‘open-mindedness’ I note that Paul Krugman wrote this in Nov 2010:

    “There’s really nothing here to shake my view that deflation, not inflation, is the threat.”
    http://krugman.blogs.nytimes.com/2010/11/06/are-rising-commodity-prices-an-inflationary-signal/

    But now he is beginning to realise that maybe, just maybe, he could be wrong. He concedes that inflation may be rising in the US:

    “What would it take for me to decide that I needed another major rethink? A major surge in domestically-driven inflation — in particular, a surge in wages — would do it. And there has been an uptick in core inflation measures that is a bit of a surprise; but at this point it doesn’t remotely count as the kind of discordance with theory that would require a major shift.”
    http://krugman.blogs.nytimes.com/2011/03/19/mind-changing-events/

    We can agree that high unemployment is bad. But the “bigger thing to get worked up about” is high ‘unemployment + inflation’, because that would be worse.

    • You are confusing the issues here. I said that VERY MILD inflation was not a major concern. Higher levels of inflation are problematic for the first two reasons you mention. Regarding the third, obviously I disagree.

      • When you say “inflation” are talking about increases in consumer prices?

        The term inflation has been co-opted (as if often the case throughout history). It once meant an increase in the money supply.

        In Australia, we target increases of consumer prices (CPI) of 2-3%. However, over the last 10-15 years there have been years where our money supply grew by 20% p.a. Even now as the credit boom dies, it is still growing at about 8% p.a. This new money is driven, not into consumer good (to a great extent), but into other assets like property and shares.

        The UK target 1-2% but have currently allowed their CPI to reach 4% (and their more accurate RPI measure to a little over 5% IIRC). Personally, I don’t see how, if you’re going to target something, that 0% plus or minus a bit isn’t the right target.

        It seems that you’re American. What do you target over there? I haven’t been able to find out. Have you heard of the NEED Act. Sounds like what you’re advocating. What do you think of it?

      • Steven – I understand that some people define these things differently, but I was talking about increases in consumer prices. ie. inflation as defined by government agencies, etc. Asset price inflation is a different story. I do think we should pay more attention to that.

        In answer to your question, unlike some other central banks the Federal Reserve does not have a formal inflation target. Having said that, it seems that informally they like to keep core inflation in the range of 1.5-2.0%.