deficit doves

WaPo Covers MMT, But Does Its Usual Bad Job: Part Four, The Victory

Joseph M. Firestone — Thu, 23 Feb 2012 01:41:34 -0500

This post concludes my critical evaluation of Dylan Matthews's, post published on Ezra Klein's blog called “You know the deficit hawks. Now meet the deficit owls.”

Dylan's post is in some ways typical of what one finds in WaPo these days. What was once a proud example of journalism has descended into a “he said/she said” format with only two sides to every question and a kind of parroting back of talking points the journalist or columnist constructs which she/he believes are associated with the two sides. Dylan's article addresses the question of what we ought to do about the deficit by viewing it from the perspective of the deficit hawks vs. the deficit owls. However, there aren't just deficit hawks and deficit owls in the economic aviary. There are also deficit doves as well.

Matthews ignores that position as a distinct one, even though he cites a deficit dove like Paul Krugman when it suits his purpose. So what is the deficit dove position? How does it differ from the other two? We don't know based on his post. But there are MMT posts on this subject that Dylan might have and I think should have, researched.

In addition, the ping-pong talking point format of the post leaves one with a very superficial analysis of what hawks and owls and different people believe. The excuse for this, of course, will be lack of space in a short blog form. But that doesn't change the fact that even though the journalist or writer involved makes an attempt to be neutral toward the contending parties, no real objectivity involving a deep understanding of the contending positions is presented. Only caricatures on the incomplete fair critical comparison set of positions survive the journalistic malpractice of faux objectivity.

Reading the post, you get the impression that MMT questions the mainstream with very distinct and opposed policy positions, and that the mainstream has counter-arguments to MMT. But you really can't get any sense of the underlying deficit hawk, deficit dove, deficit owl reasoning behind their policy positions.

You don't learn that the hawks are viewing the Government from the viewpoint that it is like a giant household, and that some of the doves share that perspective.

You don't learn that the hawks often claim that the Government can run out of money.

You don't learn that the hawks accept the Quantity Theory of Money, or that both hawks and doves, but not the owls believe in the existence of an inter-temporal Governmental budgetary constraint (IGBC) on spending.

And most important of all you don't learn about the Sectoral Financial Balances (SFB) Model, and how it works from the hawk, dove, and owl points of view.

In other words, from reading the Matthews piece you don't learn anything about the depth of the owl position, relative to the others, and you also don't get an impression that Dylan really understands the deficit owl position, and that he is capable of assessing with reasonable fairness how well it stands up to the criticism from the hawk or mainstream approaches.

So, in the end, even though people who like MMT were very happy to have the coverage from WaPo, and very happy that the post was relatively friendly as these things go, I think we have to conclude that Dylan's wasn't a good post, but another indication of WaPo's decline as a paper of record. Nor am I alone in having a negative view of this post. Michael Hudson has recorded a strong reaction to it, as well, in a note to Stephanie Kelton which was blogged at Mike Norman Economics by Tom Hickey.

So, I call for WaPo to try again. People need an MMT post from WaPo written by one of the MMT leaders, alongside parallel posts from leading deficit hawks like David Walker and deficit doves like Paul Krugman, Jared Bernstein, or Dean Baker, with a concluding post recording extensive debates among the representatives of the major approaches. If we had that then all of the readers of The Post would be better able to judge for themselves which approach has the most to offer in the way of policies for setting our economy on a course that doesn't waste people and that is culturally, socially, politically, economically, and environmentally sustainable in the foreseeable future. I'm sure that's what we all want, but I'm afraid that this opening bid on MMT by WaPo didn't get us very far down the road toward that result.

Having said all this about what was wrong with Dylan's post, however, I will now end on a positive note, which perhaps explains why so many MMT supporters have a positive view of the post. There's one very important and very beneficial thing that Dylan Matthews did that deserves a real shout-out!

For many years now, MMT economists and others who write in support of them have been trying to make a very important point to the mainstream. And that is that the claim:

The Government is running out of money,

is a myth, a fairy tale, or a deadly innocent fraud.

Dylan doesn't say that in so many words. But he and the economists he cites, even Greg Mankiw grant this very important MMT/deficit owl point in passing.

If this post is any indication, mainstream economics, and certainly deficit doves, and hawks like Mankiw, now acknowledge that a nation like the US which is sovereign in its own fiat currency can never run out of money, or be prevented by the pure fiscal aspects of any situation from paying its debts or buying whatever goods and/or services it needs that are available for sale in its own sovereign currency.

So, that part of the great debate is now over. It will be very hard from here on, for the deficit hawks to maintain their deficit/insolvency terrorism in the face of the general recognition in economics that the Federal Government is not like a household, because it can never run out of the currency that it has the sole legitimate power to issue.

If they try, they will now be the ones facing ridicule and marginalization. And, increasingly, those politicians who try to claim we are running out of money, will also face ridicule and be viewed as ignoramuses by others.

That may not bother many of the Republicans coming from districts resistant to the realities of modern life. But, increasingly, “serious people” in Washington will stop repeating the myth about coming insolvency and move on.

Dylan's post already does that by assuming that the real issue about MMT vs. the mainstream isn't about solvency, but about excessive deficit spending causing either inflation or hyperinflation. Every critic of MMT cited in the post raises the objection either implicitly or explicitly that MMT policy proposals will lead to worrisome inflation, or hyperinflation. Now, that's progress, because unlike the level of one's national debt, or the size of one's deficit in the abstract, or the nonsense debt-to-GDP ratio, which means nothing in itself, inflation is a real issue, not an artifact of some economist's fevered theories.

More generally, the real issue is the generalized consequences of Federal fiscal policies and the programs associated with them. They have employment consequences, inflation/deflation consequences, environmental consequences, safety net consequences, medical consequences, educational consequences, inequality consequences, climatological consequences and all the rest. The position of MMT is that alternative fiscal policies need to be evaluated in terms of our best estimation of their impacts on our societies, cultures, polities, environments, and futures, and not in terms of their narrow, purely fiscal impacts on present and future Federal budgets.

Changes in unemployment and in inflation are two such real impacts, but we need to go beyond them to other real impacts. We need to evaluate the whole thing. Let the hawks put forward their budgets, and the doves theirs, and we owls will put forward ours, and then let everyone evaluate what consequences are likely for all of the alternatives, and which alternative is best overall in terms of real consequences and in terms of public purpose and not in terms of arbitrary debt, deficit, and debt-to-GDP ratio targets, that, in themselves have no meaning for people.

In other words, let's get real. Let's talk about real problems of real people that can be alleviated through fiscal policy and Government programs. Let's stop taking about fairy tales, myths, and bogeymen. And let's get on with the job of rebuilding the United States for our children and grandchildren and using every tool we have, including our fiat currency system, to realize the blessings of liberty and equality of opportunity for everyone.

(Cross-posted from Correntewire.com

WaPo Covers MMT, But Does Usual Bad Job: Pt 3, Banking, & “Hyperinflation"

Joseph M. Firestone — Thu, 23 Feb 2012 01:31:34 -0500

This post continues my critical evaluation of Dylan Matthews's, post published on Ezra Klein's blog called “You know the deficit hawks. Now meet the deficit owls.”

Other Issues

Here's the next exchange envisioned by Dylan:

“According to Galbraith and the others, monetary policy as currently conducted by the Fed does not work. The Fed generally uses one of two levers to increase growth and employment. It can lower short-term interest rates by buying up short-term government bonds on the open market. If short-term rates are near-zero, as they are now, the Fed can try “quantitative easing,” or large-scale purchases of assets (such as bonds) from the private sector including longer-term Treasuries using money the Fed creates. This is what the Fed did in 2008 and 2010, in an emergency effort to boost the economy.

“According to Modern Monetary Theory, the Fed buying up Treasuries is just, in Galbraith’s words, a “bookkeeping operation” that does not add income to American households and thus cannot be inflationary.

“It seemed clear to me that . . . flooding the economy with money by buying up government bonds . . . is not going to change anybody’s behavior,” Galbraith says. “They would just end up with cash reserves which would sit idle in the banking system, and that is exactly what in fact happened.

“The theorists just “have no idea how quantitative easing works,” says Joe Gagnon, an economist at the Peterson Institute who managed the Fed’s first round of quantitative easing in 2008. Even if the money the Fed uses to buy bonds stays in bank reserves — or money that’s held in reserve — increasing those reserves should still lead to increased borrowing and ripple throughout the system.”

Evidently, Gagnon has no idea that increasing the amount of reserves does not lead to increased borrowing, because banks don't need more reserves to make loans. All they need are credit worthy borrowers and access to the Fed discount window to make whatever quantity of loans they want to. This is one of the main points about the banking system MMT makes. Put simply: lending is not reserve constrained! It's constrained by bank willingness to lend to credit worthy borrowers.

Dylan's next point is:

“Mainstreamers are equally baffled by another claim of the theory: that budget surpluses in and of themselves are bad for the economy. According to Modern Monetary Theory, when the government runs a surplus, it is a net saver, which means that the private sector is a net debtor. The government is, in effect, “taking money from private pockets and forcing them to make that up by going deeper into debt,” Galbraith says, reiterating his White House comments.

“The mainstream crowd finds this argument as funny now as they did when Galbraith presented it to Clinton. “I have two words to answer that: Australia and Canada,” Gagnon says. “If Jamie Galbraith would look them up, he would see immediate proof he’s wrong. Australia has had a long-running budget surplus now, they actually have no national debt whatsoever, they’re the fastest-growing, healthiest economy in the world.” Canada, similarly, has run consistent surpluses while achieving high growth.”

Gagnon must be kidding, or at least totally ignorant about Jamie's background, and the major contributors to the MMT synthesis, Of course, Jamie is quite familiar with Canada having close ties to the land of his father's birth, and MMT economists know all they need to know about Australia, since MMT leader Bill Mitchell is constantly writing about the Australian economy and its various tragedies. However, the point here is that Gagnon doesn't see that these two nations show that MMT's Sectoral Financial Balances (SFB) model is exactly right in its explanations, since they are able to run surpluses without disaster, only because, unlike the United States, the foreign sectors of their economies run deficits (that is Canada and Australia run trade surpluses) large enough to accommodate the private sector savings desires of Australians and also the Government's desire to run a budget surplus. The US however, currently has a need to run Government deficits of 10% to support both our private sector savings desires of 6% of GDP, and our foreign sector's desires to export 4% of US GDP to US consumers so they can accumulate US dollars in the form of electronic credits.

Default vs. Hyperinflation?

“But MMT’s own relationship to real-world cases can be a little hit-or-miss. Mosler, the hedge fund manager, credits his role in the movement to an epiphany in the early 1990s, when markets grew concerned that Italy was about to default. Mosler figured that Italy, which at that time still issued its own currency, the lira, could not default as long as it had the ability to print more liras. He bet accordingly, and when Italy did not default, he made a tidy sum. “There was an enormous amount of money to be made if you could bring yourself around to the idea that they couldn’t default,” he says.

“Later that decade, he learned there was also a lot of money to be lost. When similar fears surfaced about Russia, he again bet against default. Despite having its own currency, Russia defaulted, forcing Mosler to liquidate one of his funds and wiping out much of his $850 million in investments in the country. Mosler credits this to Russia’s fixed exchange rate policy of the time and insists that if it had only acted like a country with its own currency, default could have been avoided.

“But the case could also prove what critics insist: Default, while technically always avoidable, is sometimes the best available option.”

Well, this last is a mouthful. Yes, Warren Mosler made a lot of money on his “bets” on Italy, and lost a lot on Russia. But what this shows is that Governments can voluntarily default if they choose to. MMT economists have always said this and still say it. So why is political stupidity or perfidy counted against the truth of the MMT proposition that Governments sovereign in their currency have no fiscal solvency problems, only voluntary constraints and political problems?

On the contrary, I think the Russian case is one of the primary illustrations of a point that deficit owls have been trying to spread far and wide. Namely, that sometimes default is due to stupidity and perfidy and not to economic forces and that citizens in a democracy need to be aware of that, and of the full capabilities of currency sovereign Governments to always pay debts incurred in their fiat currency and to spend whatever is necessary to enable full employment in their nations. They are never, never, out of money except by choice. So, the real questions are:

-- why are they choosing to default?
-- Who will benefit from this political choice?
-- And who will be asked to pay the price?

And how does the Russian case “prove” that: “Default, while technically always avoidable, is sometimes the best available option”? Is Dylan, through this quote from Gregory Mankiw suggesting that “public purpose” in Russia was better served by its voluntary default than it would have been if the Russians repaid their ruble debts in the rubles they might have created had they wished to? I'm afraid that both Dylan and Mankiw will have to prove that statement to me, since Russian citizens seem to have suffered quite a lot by taking the default choice and accepting austerity when they didn't have to do so.

WaPo Covers MMT, Does Its Usual Bad Job: Pt Two, Inflation/Hyperinflation

Joseph M. Firestone — Wed, 22 Feb 2012 01:51:30 -0500

This post continues the critical evaluation of Dylan Matthews's, post published on Ezra Klein's blog called “You know the deficit hawks. Now meet the deficit owls.”

The Inflation/Hyperinflation Bogeyman

“And while Modern Monetary Theory’s proponents take Keynes as their starting point and advocate aggressive deficit spending during recessions, they’re not that type of Keynesians. Even mainstream economists who argue for more deficit spending are reluctant to accept the central tenets of Modern Monetary Theory. Take Krugman, who regularly engages economists across the spectrum in spirited debate. He has argued that pursuing large budget deficits during boom times can lead to hyperinflation. Mankiw concedes the theory’s point that the government can never run out of money but doesn’t think this means what its proponents think it does.

“Technically it’s true, he says, that the government could print streams of money and never default. The risk is that it could trigger a very high rate of inflation. This would “bankrupt much of the banking system,” he says. “Default, painful as it would be, might be a better option.”

Well, Krugman has argued there is a danger of hyperinflation where deficit spending lasts for many years, but in a really balanced piece, the counter-arguments of MMT economists to his conjecture would at least be mentioned. Dylan doesn't say what these counter-arguments are.

And as for Dylan's reference to Mankiw, it's easy to wave off MMT by saying there is a risk of inflation in using deficit spending to create full employment, but it is entirely another matter to say what the level of risk is, and to provide compelling arguments about why that risk is appreciable, and more costly than the effects of chronic unemployment in a stagnating economy. This Mankiw doesn't begin to do. I think Dylan should have pointed this out, rather than just mentioning Mankiw's opinion. Who cares about his opinion? It's his arguments, his theories, for expecting inflation that we care about. So, why doesn't Dylan outline what these are and critically evaluate them?

When Mankiw tells us that default might be a better option than risking inflation by printing money, he is going way beyond his claimed area of expertise in economics. The 14th Amendment to the US constitution prohibits even questioning Government debt, much less defaulting on it. Mankiw in his capacity as an economist is unqualified to say whether a violation of the US constitution is a better option than taking the risk of triggering hyperinflation by “printing money.”

“Mankiw’s critique goes to the heart of the debate about Modern Monetary Theory — and about how, when and even whether to eliminate our current deficits.

“When the government deficit spends, it issues bonds to be bought on the open market. If its debt load grows too large, mainstream economists say, bond purchasers will demand higher interest rates, and the government will have to pay more in interest payments, which in turn adds to the debt load.”

Well, this is what the mainstream says. But what do MMT economists say in return? Why doesn't Dylan mention that?

What MMT replies is that bond issuance isn't an inevitability, but a result of choices made by the US Congress and the Executive Branch of Government. The Congress could place the Fed under the authority of the Treasury Secretary in the Executive Branch, and then no debt would have to be issued to deficit spend, since the Fed could just mark up the Treasury General Account (TGA) under orders from the Secretary.

MMT also points out that the Fed controls the Federal Funds Rate which, in turn, heavily influences all bond rates. If the Fed targets a near zero FFR, and the Treasury issues no bonds longer than say, three months in duration, then bond interest rates can be kept near zero no matter how much debt is issued. Japan has proved this is the case since its debt-to-GDP ratio is now in excess of 200% while its interest rates are very near zero on short-term debt instruments.

Finally, Mankiw seems not to know that even if neither of these alternatives is pursued, the Executive Branch still has options to avoid further borrowing and paying higher interest rates and ro repay debt without either cutting spending or raising taxes. Here, I refer to Proof Platinum Coin Seigniorage (PPCS).

As I've outlined in numerous posts including this one, the President at his option could require the Treasury and the US Mint to create a coin of arbitrary face value and deposit it at the Fed. The coin's value is limited only by the President's specification. For example, a $60 T coin might be minted. The Fed must provide $60 T in electronic credits in return for the US Mint deposit of the coin in its Public Enterprise Fund (PEF) account. The Treasury can then “sweep” the PEF for the difference between the Mint's cost in producing the coin and its face value, and place that difference in the Treasury General Account (TGA). Treasury could then use this “seigniorage” to repay all US debts as they fall due, and to implement all spending in excess of tax revenues appropriated by Congress. Using the PPCS option would require no new legislation. The President can use it at will to fill the public purse awaiting Congress's appropriations providing authority to spend the electronic credits already in it to secure goods and services from the non-Government sector. Of course, there's no possible inflationary effect of purse filling as long as Congress's appropriations and the ensuing deficit spending aren't inflationary.

Next, Dylan says:

“To get out of this cycle, the Fed — which manages the nation’s money supply and credit and sits at the center of its financial system — could buy the bonds at lower rates, bypassing the private market. The Fed is prohibited from buying bonds directly from the Treasury — a legal rather than economic constraint. But the Fed would buy the bonds with money it prints, which means the money supply would increase. With it, inflation would rise, and so would the prospects of hyperinflation.”

Again, Dylan only tells the mainstream side of the story and not the MMT reply to it. If the Fed buys bonds with money it prints, this will increase reserves in the private sector, but it won't increase Net Financial Assets (NFA), because buying the bonds is just an asset swap. So with no new NFA being added to the private sector by the Government, this sort of Fed operation won't be inflationary, as its massive QE programs have just demonstrated empirically. In fact, by removing the payment of interest on bonds from the private sector, and given that most of the Fed profits are returned to the Treasury, some MMT economists say that the end result of such operations may well be deflationary.

Dylan continues:

“Economists in the Modern Monetary camp concede that deficits can sometimes lead to inflation. But they argue that this can only happen when the economy is at full employment — when all who are able and willing to work are employed and no resources (labor, capital, etc.) are idle. No modern example of this problem comes to mind, Galbraith says.

“The last time we had what could be plausibly called a demand-driven, serious inflation problem was probably World War I,” Galbraith says. “It’s been a long time since this hypothetical possibility has actually been observed, and it was observed only under conditions that will never be repeated.”

Note, that Jamie refers to demand-driven inflation above. He doesn't say that cost-push inflation can't happen as the economy approaches full employment. MMT economists recognize this possibility, and consider that the 1970s inflation was of this type, but point out that cost-push inflation has little to do with Government deficit spending per se, and must be combated with anti-speculation law enforcement, price controls, targeted taxation, and sometimes even de-regulation (See: [01:03:29] and [01:03:47]) in the effected or related sectors, rather than by raising taxes or cutting spending.

(Cross-posted from Correntewire.com

WaPo Covers MMT, But Does Its Usual Bad Job: Pt One, Basics and Solvency

Joseph M. Firestone — Tue, 21 Feb 2012 19:53:31 -0500

It was very welcome to see The Washington Post cover MMT with a reasonably favorable post by Dylan Matthews, published on Ezra Klein's blog called “You know the deficit hawks. Now meet the deficit owls.” I'm pretty familiar with the deficit owls, having blogged about them soon after they were first named by Stephanie Kelton, in July of 2010, intermittently since, and most recently here. So, I thought I'd review Dylan's post in the spirit of correcting any mistakes in the record made by The Post and Ezra's blog in its first real effort to cover MMT. Hopefully Ezra, Dylan Matthews and others associated with WonkBlog learn from these mistakes and not simply double-down on them.

Some Background and Recognizing That “There Is No Solvency Constraint”

Dylan says:

“In contrast to “deficit hawks” who want spending cuts and revenue increases now in order to temper the deficit, and “deficit doves” who want to hold off on austerity measures until the economy has recovered, Galbraith is a deficit owl. Owls certainly don’t think we need to balance the budget soon. Indeed, they don’t concede we need to balance it at all. Owls see government spending that leads to deficits as integral to economic growth, even in good times.”

This is OK for a start but it leaves the impression that Deficit Owls think we ought to run deficits all the time if we want the economy to grow, and that's a distortion of their position. So, let's try this.

Deficit owls, believe that there is no structural deficit, and that most of the present US deficit will go away when full employment is reached, but probably not all of it, unless the private savings levels in the economy are balanced by an equal or greater foreign sector deficit (trade surplus). They also believe that in times of unused productive capacity like these, Government deficits are caused by the state of the economic system, and that explicitly managing them by taxing more or spending less will not improve its condition, but only result in a downward economic spiral making conditions still worse.

On the other hand, if real economic problems like unemployment, alternative energy capacity and production, infrastructure renewal, education, and industrial innovations are addressed through Government deficit spending, then aggregate demand spurring private sector business activity and ending U6 unemployment will result. In addition, deficit owls believe that in a fiat money system, where there is no debt in foreign currencies, and no “peg” to such currencies, solvency is never a problem for the Government, and that while inflation partly caused by Government deficit spending can become a problem in such a system, this can only happen when full employment is achieved.

Dylan goes on:

“Modern Monetary Theory” was coined by Bill Mitchell, an Australian economist and prominent proponent, but its roots are much older. . . . “

I think this is just an error. It's a small thing, but it's important to stop the propagation of myths. Stephanie Kelton, an important thinker in the core MMT group, who is thoroughly familiar with Bill's work, says that the MMT name was given to the approach by others and then was adopted by MMT economists, including Bill.

“This claim, that money is a “creature of the state,” is central to the theory. In a “fiat money” system like the one in place in the United States, all money is ultimately created by the government, which prints it and puts it into circulation. Consequently, the thinking goes, the government can never run out of money. It can always make more.”

Not quite what MMT says. Yes, a fiat currency is necessary, but also necessary for currency sovereignty is to have a non-convertible currency, a floating exchange rate, and no debt in a currency not your own. These qualifications are very important because examples (e.g. Weimar, Zimbabwe) that are often given contradicting the claim that there's no solvency problem for Governments like the US don't fulfill these conditions.

“This doesn’t mean that taxes are unnecessary. Taxes, in fact, are key to making the whole system work. The need to pay taxes compels people to use the currency printed by the government. Taxes are also sometimes necessary to prevent the economy from overheating. If consumer demand outpaces the supply of available goods, prices will jump, resulting in inflation (where prices rise even as buying power falls). In this case, taxes can tamp down spending and keep prices low.

But if the theory is correct, there is no reason the amount of money the government takes in needs to match up with the amount it spends. Indeed, its followers call for massive tax cuts and deficit spending during recessions.”

This is pretty good. But it doesn't include one more thing that taxes may be good for, and that's economic leveling. Inequality in the United States is greater than in most other modern OECD nations. Specific types of taxes are one instrument that can be used to create greater equality.

MMT writers don't normally advocate taxation for this purpose. But the truth is that we have an inequality problem and it is contributing to undermining our democracy. So a Government fiscal policy incorporating much heavier taxes on very wealthy people may well contribute to the public purpose which is, after all the overall goal of MMT fiscal policy.

Why Do “They” Want To Limit Our Sovereignty In Our Own Currency?

Joseph M. Firestone — Tue, 12 Apr 2011 15:20:27 -0400

One of the most emotional issues in American politics is the sovereignty of the United States itself, and its independence from foreign powers, interests, other nations and their ruling elites, and emerging globalizing elites who place their own interests against the nation interest of America and its people. The issues of fiscal sustainability and fiscal responsibility should be discussed from the viewpoint of our national interest, not from the viewpoint of abstract financial ratios, or supposedly critical indicators that generate a lot of sound and fury signifying nothing.

When we look at fiscal policy in the United States from the viewpoint of our national interest, among the first things we must consider is maintaining the national sovereignty of the United States. Most Americans want the United States to remain autonomous and independent, and to not be subject to the economic control of any foreign power, whether another nation, an international organization, or an international political grouping of a more informal character.

This desire is a constant throughout our history and it is the basis for the relative unpopularity of the United Nations here. A very important dimension of our national sovereignty is sovereignty in our own currency. The Constitution gives Congress authority: “To coin Money, regulate the Value thereof, and of foreign Coin, and fix the Standard of Weights and Measures.” That authority, through interpretation by the Supreme Court over the years, has come to mean that it is constitutional for Congress to cause the issuance of fiat money, whose value may be regulated by the government, at will in order to serve the public purpose.

Today the Federal Reserve Bank interprets the power to “print money,” as the power to “mark up” accounts in the banking system by computer, in the process of augmenting the money supply or in implementing spending by the Treasury. There is no limit on the power of the Government to create money this way, provided that Congress doesn't set such limits itself.

In addition, to its unlimited power to create fiat money, the United States also has a constitutional obligation that is worth mentioning when talking about economic sovereignty, since the classical notion of sovereignty is also related to obligation. Section 4 of the 14th Amendment states:

". . . .the validity of the public debt of the United States, authorized by law... shall not be questioned."

Of course, constitutionally, the Government can only spend what Congress has appropriated; but, beyond that, there are other constraints that Congress has set for the Government which are not mandated by the Constitution, and which limit the degree of economic sovereignty of the Government. Here are three:

-- the Treasury is not allowed to run a negative balance at the Federal Reserve,
-- the Treasury must issue debt when it expects to deficit spend, and
-- the Treasury cannot issue debt beyond the statutory debt limit,

The first two constrain the Government by forcing it to remove money from the non-Government sector before it can deficit spend; even when Congress has already appropriated the deficit spending. The last constraint is intended to impose an arbitrary limit on deficit spending by bringing it to a halt, even after it has been appropriated. Its purpose right now seems to be to provide periodic and very public opportunities for political kabuki theater during which the two parties can express their core political values as they apply to fiscal policy, while they dismantle the heritage of the New Deal.

The kabuki opportunities carry a very high cost, however, since the constraints making them possible:

-- cause Government shutdown crises,

-- sometimes create doubt that the Government will voluntarily become insolvent and fail to meet its obligations, and most important of all,

-- are responsible for the existence of the National Debt of $14 Trillion, and for the “welfare” for the rich and foreign nations paid to them every year in the form of interest on Treasury securities, which, except for the Congressional requirement to issue debt, the Government would never have to pay.

Why does the Congress limit the fiscal flexibility of the Government, including its own flexibility, with constraints like the three above?

Why are some in Congress trying to get a balanced budget amendment passed to further limit flexibility in Government spending and fiscal policy?

Why do many in all three branches want to limit the monetary power of the Federal Government and its potential for helping America achieve in public purposes?

Why, in short, are so many politicians so much in favor of limiting the currency and fiscal sovereignty of the United States?

Why are we letting them do it?

Why aren't we as protective about our currency/fiscal sovereignty, as we are about other aspects of sovereignty, such as our territorial integrity, and our political independence?

Before I try to answer these questions, I'll review what fiscal/monetary sovereignty is.

What It means To be Sovereign In Your Own Currency

Deficit hawks in the United States envision a day when the United States Government will go broke, unless we curb government spending on entitlements. Well, governments can go broke in the sense that they can run out of money they need to pay their debts. But not all governments. Only Governments:

-- whose monetary systems are commodity-based, such as those on the gold standard; or

-- those using fiat money,

whose official fiat currency is issued by supra-ordinate authorities, or

-- those who owe debts in a fiat currency issued by another governmental authority,

can all “go broke,” involuntarily.

Governments issuing their own fiat currency, subordinate to no higher authority, and owing no debt to anyone else in a currency other than their own, can never “go broke,” or put another way, become insolvent, due to events in financial markets, or decisions made by other nations. This is true, because all they need to do to spend money is to issue credits to non-government sector accounts in banks, and all they need to do to pay back other Governments who have lent them their own currency, is to credit the accounts of the lender Governments in that currency, an action which they have full authority to do, absent any political constraint they may have placed on themselves preventing them from exercising their full monetary sovereignty.

We call such Governments “sovereign” in their own currency. And because they have this kind of sovereignty, they also have flexibility to facilitate economic activity to accomplish public purposes that Governments without that kind of sovereignty don't have. But with that fiscal flexibility also comes fiscal responsibility – the responsibility to use the operationally unlimited spending power of an economically sovereign government to use that spending power for public purpose and not for private gain.

One of the Governments that fit these criteria and so can never go broke is the US Federal Government. Other common examples are Japan, Australia, New Zealand, and Canada, and the UK. Governments that don't fit these criteria and that can go broke include the nations of the EU, such as Greece, Portugal, Spain, and Italy. Even France and Germany can go broke, since they no longer issue their own currency. Other examples include all those developing nations with loans from the IMF, the World Bank, and other international authorities that must be paid back in US Dollars, or any other currencies they cannot issue; as well as state, local, provincial, and other governments subordinate to a super-ordinate currency-issuing authority such as California.

Most governments that are sovereign in their own currency haven't been fiscally responsible in a very long time.

While some have performed better than others in seeking and achieving public purposes, most have continued to act as if they are constrained by the gold standard, and have attempted to either reduce spending at the expense of the less well off, or to fail to pursue programs for full employment, or to fail to make enough investments that will fulfill other pubic purposes. In most of these cases, deficit hawkism and specifically the desire to either reduce deficits, or to balance budgets, has trumped the desire to fulfill public purposes.

In short, governments sovereign in their own currencies have been acting like governments on the gold standard, or those who owe debts in currencies they don't issue. They have been acting in a fiscally irresponsible way given their fiat monetary systems, while at the same time claiming to be fiscally responsible.

They can get away with this, because very few people make the distinction between governments sovereign in their own currency and governments that are not. And even fewer go on to recognize that what may be fiscally responsible for gold standard governments, or governments that are not economically sovereign, is most certainly fiscally irresponsible for economically sovereign Governments.

In systems where governments are economically sovereign like the United States, it is a big mistake to measure how well the nation is doing fiscally by using deficit, the national debt, or debt-to-GDP ratios. That mistake is one the United States and most other nations with monetary sovereignty are making right now.

Those measures, in fact, are the wrong things to measure. The government is a scorekeeper that can always credit accounts when it needs to spend or pay what it owes, or even set interest rates by flooding the market with reserves and driving short-term interest rates down to near zero. In such systems, the money is always there for the non-governmental sector, not in the sense that the government has accumulated some physical stock of it, but in the sense that the Government can always spend or pay back by crediting accounts, regardless of any physical stock it may have.

In such systems, fiscal responsibility is not about what the Government has accumulated either in debt or in surpluses, since given its unlimited ability to create new currency, these neither constrain nor support its further ability to spend What it is about, however, is the Government's success in spending on worthwhile things that produce actual value, rather than spending on worthless outcomes.

Why Are We Self-limiting Our Currency Sovereignty?

There are a few contributing reasons. First, most Americans don't understand that the power of Government to help the economy to recover from recessions and to achieve full employment, is dependent on the ability of the Government to deficit spend and to add net financial resources to the private sector. To the extent that the ability to deficit spend is limited by fiscal rules, the fiscal sovereignty of Government is impaired, diluted, or, in the case of balanced budget amendments like the one gathering steam in Congress, largely destroyed.

Second, most Americans don't understand that deficit spending and the resulting deficits and debts, carry no solvency risk. They view the US Government as an analogue to a household, and they think that, like a household, the Government cannot spend more than the revenue it raises through taxing or borrowing without risking insolvency, and that the more it borrows, the more it will need to borrow and the less its ability to borrow will be. Of course, the Government is different from a household in many ways, but most importantly, in that: all money in the United States ultimately derives from Government-issued money, and the Government, of course, can always add more money to the private sector if it chooses to do so.

Third, most Americans don't understand that every dollar of Federal deficit spending adds a dollar of net financial assets to the non-Government sector of the economy.

The asset can be base money, if the Treasury is allowed to spend without issuing debt, as it sometimes has been, or it can be in Treasury securities if it is required to continue debt issuance. Many think that when Government deficit spends it impoverishes the private sector, because it competes with it for resources. But this is clearly not the case, when there is an output gap and much of our productive capacity is unused.

Fourth, most Americans don't understand that global elites and corporations don't want the United States to retain its currency/fiscal sovereignty, because they make more risk—free money if the Government's currency power is constrained, and if we must buy/”borrow” our previously created USD, rather than make more. So, long as we issue debt instruments rather than just issue currency, they have a risk--free place to put the money they've previously acquired, and get an interest return besides. Over the next 15 years, the interest paid on the debt will be roughly $12 Trillion. If the Government can and does use its full currency sovereignty, and deficit spends, without issuing further debt, then the global elites can say goodbye to that money.

Fifth, global elites recognize that if Governments use their power to create currency to benefit any other groups other than the global elites themselves, then that potentially harms the elites and makes their USD holdings worth less. Perhaps not immediately, because demand is slack and businesses will try to increase production rather than raise prices for their valued goods. But, eventually when full employment is reached, they fully expect that either the need to regulate inflation will subject them to increased taxes, or, alternatively, the occurrence of inflation will cause the de-evaluation of their own money and Treasury Securities.

Conclusion

Issues about governments sovereign in their own currencies, as well as others having to do with fiscal sustainability and fiscal responsibility have been addressed at the Fiscal Sustainability Teach-In Counter-Conference last April 28th. It provides the answers to the continuing attempts of the deficit hawks and austerity mongers to orchestrate and implement a political process that will result in transferring more wealth from the middle class and the poor to the very well-off and the corporations, and that has already resulted in the failure of many nations, including our own, to end the sufferings of the unemployed and others victimized by the wholly avoidable crash of 2008.

The primary anti-deficit hawk message of the Teach-In was this: Since the United States Government is sovereign in its own currency: We. Are. Not. Running. Out. Of. Money. The. Money. Was. There. All. Along. The. Money. Is. There. Now. The. Money. Will. Be. There. Tomorrow. And. It. Will. Be. There. For. Our. Children. And. Our. Grandchildren. Too.

This is a message that needs to be sent to Congress, to the President, and to Republican budget-cutters like Paul Ryan, Jon Kyl, Mike Pence, and all the tea party folk, whose “pay off the national debt by cutting spending and taxing to get a surplus,” austerity nonsense, will ruin the United States, and create the second great depression, if we go along with it. We must not forget that every dollar less of deficit spending translates to at least a dollar subtracted from the dollars available to the non-Government sector, and the amount may well be more than a dollar if the dollar less is in a high fiscal multiplier segment of the economy. The attempts by budget-cutters to cut high-multiplier deficit spending will accelerate the downward spiral of the macro-economy, especially as compared with the impact that increased taxes on the wealthy may have had.

Finally, I have to wonder why the very legislators who are always so quick to wrap themselves in The American Flag, are also the ones who are quickest to put forward and implement fiscal rules that will constrain American currency sovereignty and subject the best interests of the American people and the public purposes of the United States to the interests of globalizing elites, foreign Governments like China, Japan, Middle east oil exporting nations, the Eurozone, Wall Street, the bond markets, and the wealthy like themselves. The fiscal rules Congresspersons have implemented and new ones they are seeking to implement to force the nation to pay off the national debt through economic surpluses, have the effect of subordinating the national interest, which they are elected to uphold, to the interests of multi-national corporations, global elites, and foreign nations.

We must recognize this problem for what it is. It isn't just a technical issue of economics. It's an issue of patriotism. It's an issue of whether our economy will be run for we, the people, or interests both domestic and foreign who place their own needs for more wealth above the interests of most Americans to be able to influence our own economic futures and opportunities.

If you're really worried about your children and your grandchildren, not to mention yourself, then you need to stop the deficit hawks and the deficit doves from destroying the economic sovereignty of the United States with their fiscal rules. You need to insist instead on the freedom and economic independence of the Government from the bond markets and all other elite interests. You need to insist that we act in our own national interest and not in the interest of the global elites. You need to insist that the Government keep its spending/currency creation power intact and use it for the public purpose. You need, in other words, to insist that we remain a Government sovereign in its currency, and to begin to act like one, taking responsibility for the miserable state of the economy within our national borders.

(Cross-posted at All Life Is Problem Solving and Fiscal Sustainability).

Paul Takes Another Swipe at MMT

Joseph M. Firestone — Sat, 26 Mar 2011 15:07:41 -0400

The Modern Monetary Theory (MMT) approach to economics must be starting to make some waves, because today, Paul Krugman, followed his earlier attack on it and his debate with Jamie Galbraith and others last summer, with another swing at MMT. The debate last summer was an extensive one at Paul's blog site at the New York Times, and, in addition, there were a number of posts at other sites replying to Paul. The debate was a classic in the developing conflict of views between the “deficit doves” (represented by Paul) and the “deficit owls” (represented by Jamie Galbraith and other MMT writers).

Given the earlier debate, you'd expect that Paul's second try at MMT would reflect a bit of learning on his part, and also a characterization of the views of MMT practitioners that is a little more fair than he provided in his first attempt. This post will analyze Paul's new attack and assess how much he's learned. But first, I'll review the earlier debate.

Background: The First Engagement

Paul Krugman, well-known for his opposition to the austerity concerns of the deficit terrorists and his advocacy of additional Government stimulus to lower unemployment and end the recession, just ignited a paradigm conflict which promises to clarify for many, the issues dividing “deficit doves” like Paul, from the 'deficit owl” economists who take a Modern Monetary Theory (MMT) approach to economics, which holds, among other things, that Government deficits and surpluses are not, in themselves important, and that Government spending has to be evaluated relative to its impact on public purposes. Paul said:

”Right now, the real policy debate is whether we need fiscal austerity even with the economy deeply depressed. Obviously, I’m very much opposed — my view is that running deficits now is entirely appropriate.

"But here’s the thing: there’s a school of thought which says that deficits are never a problem, as long as a country can issue its own currency. The most prominent advocate of this view is probably Jamie Galbraith, but he’s not alone.”

That's not what Jamie or the other Modern Monetary Theory (MMT) economists say either in his testimony, or elsewhere. What they say is that as long as a Government can issue its own currency, and has not incurred debt in foreign currencies making it subject to its bankers, then it can never default on its debts, because it has “run out of money” (become insolvent). It can voluntarily decide to default, i.e. refuse to spend to fulfill its obligations, for various political reasons. But if it has an understanding of its real monetary powers and the will to persist, it can never be forced to default because of decisions made by banks, other nations which hold its debts, or international credit agencies which either foolishly or malevolently, downgrade its credit even though it cannot default. So, Governments sovereign in their own currency never present any solvency risk to investors, or to creditors they've made promises to, however great their deficits or national debts may be, barring political stupidity and a decision to voluntarily default when there is no legal or economic need to do so.

Paul also says:

”Now, Jamie and I are, I think, in complete agreement about what we should be doing now. So we’re talking theory, not practice. But I can’t go along with his view that

So long as U.S. banks are required to accept U.S. government checks — which is to say so long as the Republic exists — then the government can and does spend without borrowing, if it chooses to do so … Insolvency, bankruptcy, or even higher real interest rates are not among the actual risks to this system.

OK, I don’t think that’s right. To spend, the government must persuade the private sector to release real resources. It can do this by collecting taxes, borrowing, or collecting seigniorage by printing money. And there are limits to all three. Even a country with its own fiat currency can go bankrupt, if it tries hard enough."

I'm not sure what Paul means by “real resources.” But if he means non-financial resources, then I think the problem is one of getting the private sector to accept Government fiat money in return for those 'real” resources. Why will the private sector go along with this “as long as the Republic exists . . .”? Because the private sector needs Government fiat money to pay its taxes, since that is the kind of payment the Government requires. As long as it needs Government money for this purpose, it can be “persuaded” to exchange it for resources.

If Paul includes financial resources in the category of “real resources,” then the Government can tax or borrow to get the private sector to release some of its financial resources. But when it creates money itself, without borrowing or taxing, it's not persuading the private sector to release financial resources, only non-financial resources.

Here's Paul again on debt service:

”Let’s think in terms of a two-period model, although I won’t need to say much about the first period. In period 1, the government borrows, issuing indexed bonds (I could make them nominal, but then I’d need to introduce expectations about inflation, and we’ll end up in the same place.) This means that in period 2 the government owes real debt service in the amount D.”

But, the Government doesn't have to issue debt if it spends in period 1. If it chooses not to, it won't owe real debt service in period 2. So any further argument based on the inference that Government must owe debt service in period 2 is questionable.

Paul goes on to talk about how that debt service may be fulfilled. He mentions that the Government can get a surplus of current revenue relative to current spending, but also asks us to imagine constraints on that possibility, and then brings up the “printing press.” He says:

”But the government also has a printing press. The real revenue it collects by using this press is [M(t) - M(t-1)]/P(t), where M is the money supply and P the price level.

”What determines the price level? Let’s assume a simple quantity theory, with the price level proportional to the money supply:
P(t) = V*M(t)”

I think there's more than a little slipperiness here. First, there's the assumption that there must be borrowing and debt service, and therefore “debt.” This assumption becomes very important to Paul's argument later. Second, Paul shifts the ground by talking about “real revenue” and defining it as above. The debt service obligations of the Government are satisfied by nominal revenue, not “real revenue,” if by this Paul means revenue adjusted for price. Third, Paul's expression for real revenue deflates the change in quantity of money by the price at time t, but why not by the change in price (P(t) – P(t-1)? In other words, why isn't he looking at the change in real revenue, rather than a change expression biased toward time (t)? Fourth, he asserts that P(t) is determined by M(t) scaled by a proportionality constant “V.” But what is “V”? He doesn't say. But another, more complete formulation of the Quantity Theory of Money by Bill Mitchell is:

”. . . MV = PY, where M is the stock of money, V is the velocity or the times the stock turns over per measurement period, P is the price level and Y is the real output level.”

Looking at this expression, and re-arranging so that we get: P/M = V/Y, we see that Paul's proportionality constant “V” = V(velocity)/Y(Real Output). As Bill Mitchell says, to work with the quantity theory, economists have to assume that velocity is constant at a particular point in time, and that Real Output refers to that value at full employment so that it too is a constant. Only then, is price a simple function of the money supply.

However, velocity is generally not constant but varies widely in any economic system. And, in addition, Real Output at full employment is not the condition assumed in the Modern Monetary Theory formulations Paul is criticizing. In formulations such as Jamie's, Government spending is needed because the non-Government sector is running too low a deficit or a surplus, and this is causing low aggregate demand and unemployment. In short, the quantity theory, given its assumptions, is only applicable when an economy reaches full employment. Only then will its application predict price inflation if Government deficit spending continues.

However, MMT also predicts that inflation becomes a danger when the economy reaches full employment, so the question is, what is Paul trying to say that is different from what Jamie and other MMT economists would say? Well after presenting his model in a little more detail, and a graph showing the inflation rate increasing to infinity when debt gets too great, his conclusion is:

”So there is a maximum level of debt you can handle. In practice, if it makes sense to say such a thing with regard to a stylized model, at some point lower than the critical level implied by this model the government would decide that default was a better option than hyperinflation.

"And going back to period 1, lenders would take this possibility into account. So there are real limits to deficits, even in countries that can print their own currency"

And comparing this to his earlier quote from Jamie above, we see that this conclusion postulates hyperinflation and voluntary default as issues that can come up, but not as Jamie says, “insolvency,” or “bankruptcy,” if by this one means running out of money rather than voluntary default. But what about “high interest rates” and the Government's inability to borrow? Doesn't Paul have a point here?

I think not. It's Paul who constructs the situation as one in which the Government must borrow and perform debt service, and it is he who assumes that the interest rates the Government will pay will be determined by the market. Jamie and the MMT theorists make no such assumptions. That is why Jamie says:

“. . . the government can and does spend without borrowing if it chooses to do so . . . “ and also that “ … Insolvency, bankruptcy, or even higher real interest rates are not among the actual risks to this system.”

In other words, to successfully meet this point of Jamie's, Paul needs to discuss the situation of increasing deficits, rather than the situation of increasing debt, and then show that the hyperinflation that would accompany very high deficits could make the Government insolvent. Instead, however, he shifts the ground of the argument and ends up claiming that the money supply and the debt could reach levels high enough that the resulting price increases (inflation) would induce the Government to voluntarily default, even while it retained the authority to credit private sector accounts to pay obligations in its own currency.

This, of course, could very well happen, since political leaders are free to do all sorts of things they are not forced to do by actual constraints on their authority or capability. But it is the hyperinflation issue Paul is raising here, and also the issue of voluntary political default, not the issue of economic solvency risk which Jamie was speaking to and which Paul himself originally raised in his blog post.

After Jamie and others responded to Paul's post, many claiming that Paul had distorted MMT, and Jamie showing that there were wide areas of agreement between them, and also that increases in the quantity of money would not flow directly into price increases in the absence of full employment, Jamie ends with:

”My position is that the government should focus on real problems: unemployment, care for the aging, energy, climate change, and the disaster in the Gulf of Mexico.

”The so-called long-term deficit is not a real problem. And the capital markets demonstrate every day that they agree with this judgment, by buying long-term Treasury bonds for historically-low interest rates.”

To which Paul responded:

”My response: there’s no question that right now there is no problem: if the Fed issues money, it will in fact just sit there. That’s what happens when you’re in a liquidity trap. And there’s also no question that right now, the proposition that the government can “create wealth by printing money”, which some other commenters call absurd, is the simple truth: deficit-financed government spending, paid for with either debt or newly created cash, will put resources that would otherwise be idle to work.

”But we won’t always be in this situation — or at least I hope not! Someday the private sector will see enough opportunities to want to invest its savings in plant and equipment, not leave them sitting idle, and the economy will return to more or less full employment without needing deficit spending to keep it there. At that point, money that the government prints won’t just sit there, it will feed inflation, and the government will indeed need to persuade the private sector to make resources available for government use.

”And that’s why I don’t accept the idea that deficits are never a problem.”

Of course, as Scott Fullwiler replied to Paul, this conclusion and also Paul's first post both set up a “straw man,” because Jamie never claimed that deficits are never a problem, and even pointed to circumstances (conditions of full employment) where deficits could lead to inflation. Given the comments on Paul's first blog, including a very clear comment by Marshall Auerback, it should have been clear to him that he was distorting the position of both Jamie and MMT. But evidently, Paul didn't want to admit that.

Jamie himself responded to Paul by calling attention to their very close agreement on what ought to be done to end the Great Recession. But then he asks the key political question of the coming months from then until now: “Should we, or should we not, act *today* to cut *projected* deficits at some future date?” Say by cutting Medicare and/or Social Security or other valued programs. And Jamie answers that question with a resounding “no.” And adds that there's no economic reason to cut these programs, that the forecasts suggesting large deficits and high interest rates after a full employment recovery are inconsistent, implausible, and contradictory, that good policy can't be based on bad forecasts, and that we ought to solve the unemployment problem first and then, as in the 1990s, tax revenues will rise and deficits will shrink. And then he ends with:

”Paul, I challenge you to drop the long-term deficit argument entirely -- it will be used in a few months, in a dishonest way by unscrupulous people, to support cuts in Social Security and Medicare that cannot be justified by economic logic. These are cuts which, I am sure, you will oppose when they are proposed.

”Don't set yourself up.”

Of course, here Jamie is referring to the deficit terrorist coalition in Washington, DC led by Peter G. Peterson, and his network of organizations, and now also encompassing CNN, The Washington Post, many in Congress and key elements in the Administration, including President Obama and Jack Lew, the Director of OMB. Some deficit terrorists have been taking the line lately that now is not the time for spending cuts and perhaps even is a time for further stimulus, but that we must plan for reducing deficits now, and must establish a legislative framework to enact and implement cuts in future years that will keep us on an incremental course toward eventual surpluses. And they call for shared pain and even across the board spending cuts, including cuts in entitlement programs to place us on a long-term path of deficit reduction without reference to the public purposes that Government needs to, and ought to, fulfill in the future.

Jamie and the MMT economists are opposed to the very idea, the very framing of Government's role in the economy in a way that makes fiscal policy subject to projections (always notoriously unreliable) of deficits, national debts, and debt-to-GDP ratios. The position of MMT is that these numbers are just endogenous consequences of real economic activity including Government fiscal activity, and that it is this activity that ought to drive them, and not the other way around. In their view, and in mine, as well, the role of Government in the economy is to spend to enable people to fulfill what Jamie's father, John Kenneth Galbraith, called “the public purpose.” As Jamie says: “. . . the government should focus on real problems: unemployment, care for the aging, energy, climate change, and the disaster in the Gulf of Mexico.” It should not be spending time and resources worrying about a long-term deficit crisis that is nothing but a fantasy.

The New Engagement

In his renewed criticism today, Paul says:

“Right now, deficits don’t matter — a point borne out by all the evidence. But there’s a school of thought — the modern monetary theory people — who say that deficits never matter, as long as you have your own currency.”

Now this is almost word for word the same thing that Paul said earlier (see above) in the face of many comments and other posts in the blogosphere denying this, and outlining the MMT position. Paul has simply ignored what Jamie, and other MMT commenters told him, and he's also ignored posts like Randy Wray's at New Deal 2.0, and my own, rehearsed just above, that appeared at the time, as well as others, which very clearly stated that MMT economists don't say that.

Paul has no quotes from MMT writings supporting his position, he has no links to anything to support it. He just makes the same error once again, even after being told in comments on his own blog by MMT authorities that he erred, and also after his error was recorded in discussions easily available over the web in the progressive blogosphere.

The conclusion is inescapable that either Paul deliberately misconstrues the MMT position so he can undermine it, or has never bothered to research what people have said about the debate in July of last year. Taking the more charitable of the two interpretations, it is simply shoddy research to fail to acknowledge the views of people who are telling you that your characterization of their views is demonstrably wrong, and are explaining to you that they do think that deficits matter, and exactly under what conditions they do, which by the way are the same conditions under which Paul seems to think they matter. Specifically he says:

”So suppose that we eventually go back to a situation in which interest rates are positive, so that monetary base and T-bills are once again imperfect substitutes; also, we’re close enough to full employment that rapid economic expansion will once again lead to inflation. . . .

Suppose, now, that we were to find ourselves back in that situation with the government still running deficits of more than $1 trillion a year, say around $100 billion a month. And now suppose that for whatever reason, we’re suddenly faced with a strike of bond buyers — nobody is willing to buy U.S. debt except at exorbitant rates.”

Well, first, how could there be deficits of $1 Trillion, with the economy at or close to full employment? Wouldn't the automatic stabilizers begin to produce great amounts of tax revenue the closer we got to full employment? Wouldn't we begin to approach surpluses if the Government were not deliberately attempting to spend more than the productive capacity of the private economy could absorb? Why would the Government do that ? Why would it keep on spending to create a deficit of $100 Billion per month, as in Paul's silly scenario?

That it should do so in a situation of full employment is not a prescription of MMT. It's just bad economics. In addition, MMT predicts inflation if the Government tries to do that. This is one of the circumstances in which MMT economists think that deficits matter.

As for the hypothetical strike of bond buyers, MMT research makes it clear that bond market rates aren't under control of the bond market, but can be determined by the Fed and the Treasury working together. Bond market rates can be driven down to near zero if the Government wants to do that, as the Japanese Government did. Since any return at all on the USD that buyers hold is better than just letting their money sit in reserve accounts, and since there's no solvency risk for the US Government, a point Krugman is no longer contesting, bond buyers will always buy Treasurys if they hold USD, because making something on your money is preferable to making nothing at all. Further, if people acted irrationally, and simply refused to buy, then the US Government, including Congress could simply allow the Treasury to spend without debt issuance. In that case, the bond markets would no longer be relevant at all, and Paul could just forget about them. In short, the first two assumptions in Paul's scenario are unrealistic, contrary to what MMT policy prescribes, and the prediction that inflation would occur under these conditions is a prediction of MMT anyway.

So then what? The Fed could directly finance the government by buying debt, or it could launder the process by having banks buy debt and then sell that debt via open-market operations; either way, the government would in effect be financing itself through creation of base money. So?

Well, the first month’s financing would increase the monetary base by around 12 percent. And in my hypothesized normal environment, you’d expect the overall price level to rise (with some lag, but that’s not crucial) roughly in proportion to the increase in monetary base. And rising prices would, to a first approximation, raise the deficit in proportion.

So we’re talking about a monetary base that rises 12 percent a month, or about 400 percent a year.

Does this mean 400 percent inflation? No, it means more — because people would find ways to avoid holding green pieces of paper, raising prices still further.

I could go on, but you get the point: once we’re no longer in a liquidity trap, running large deficits without access to bond markets is a recipe for very high inflation, perhaps even hyperinflation. And no amount of talk about actual financial flows, about who buys what from whom, can make that point disappear: if you’re going to finance deficits by creating monetary base, someone has to be persuaded to hold the additional base.

This last is Paul's Quantity Theory of Money model, now formulated in an example rather than as a formal model. So, even though the example is new, the content of what Paul is saying hasn't changed much from his first engagement with MMT last summer. He's off insolvency as a problem, but has doubled down on the view that MMT isn't concerned about inflation. One of the MMT critiques of Krugman's view offered at the time was Randy Wray's post at New Deal 2.0, entitled: “Deficits Do Matter, But Not the Way You Think.” Randy calls this “. . . Krugman's “infinite inflation” scenario,” and he replies to it in this way.

”OK, we never claimed that a sovereign government will necessarily adopt good economic policy. The last time the US approached such a situation was in the over-full employment economy of WWII. Rather than bidding for resources against the private sector, the government adopted price controls, rationing, and patriotic savings. In that way, it kept inflation low, ran the budget deficit up to 25% of GDP, and stuffed banks and households full of safe sovereign debt. By the way, Jamie Galbraith’s father, John Kenneth Galbraith, was the nation’s chief inflation fighter. After the war, private spending power was unleashed, GDP grew relatively quickly, and government debt ratios came down (not because the debt was retired but because the denominator — GDP — grew more quickly than the numerator — debt; see here). In other words, Galbraith, senior, used rational policy to avoid the Zimbabwean fate. I do not understand why Krugman prefers to believe that our policymakers would choose hyperinflation over more rational policy. If there is anything that policymakers of developed nations in the postwar period appear to hate, it is rapid inflation. In other words, the policy choice will not be between hyperinflation and default, but rather rational use of inflation-fighting policy should the need arise in order to prevent hyperinflation.”

In fact, MMT writers frequently write about demand-pull inflation and the conditions under which it can occur. They are very concerned about the real outcomes of Government fiscal policy with special emphasis on both unemployment and inflation. They advocate managing fiscal policy using frameworks that make such real outcomes and their relation to public purpose the focus of fiscal policy. What they are against is the idea that fiscal policy should be managed using a framework that makes deficits, the national debt, and the debt-to-GDP ratio the focus of and regulator of fiscal policy, fiscal sustainability, and fiscal responsibility.

According to MMT, changes in these are the symptoms of what is happening macro-economically, and not the drivers of real outcomes. When you manage fiscal policy, short-term or long-term, to reach particular objectives defined as acceptable or unacceptable levels of these indicators, you are neither achieving fiscal sustainability nor fiscal responsibility. Instead, you are acting in a fiscally irresponsible manner, because you are giving the real outcomes of fiscal policy, the effects on people and on the economy, a lower priority, than you are giving the fiscal indicators.

True fiscal sustainability is the state of fiscal policy that leads to growing real national wealth and productivity, while seeing to it that growth in productivity and wealth is 1) shared equitably enough to fulfill public purposes, and 2) accomplished in such a way that it maintains and increases the economy's ability to produce valued goods and services in the face of challenges from the international economic and non-economic (political, ecological, cutltural, etc.) environments. True fiscal responsibility is implementing fiscal policy that will achieve that kind of fiscal sustainability. Neither the “austerian” deficit hawks, nor the more kindly deficit doves pursue real fiscal sustainability and real fiscal responsibility, because over the long term, both want to manage fiscal policy in in terms of its impact on fiscal indicators, and not in terms of its impact on real outcomes.

Conclusion

Along with Randy Wray, I also don't understand why Paul thinks the Government would choose not to fight inflation when we reach full employment, but instead keep spending beyond what the economy can absorb without inflation. In addition, I don't understand why he continues to imply that MMT policy advocates continuing to increase Government spending after we reach full employment, and also to say that MMT contends that deficits don't matter. He's been corrected on both of these points before. And while he does seem to have learned that Governments sovereign in their own currency have no solvency risk, he still refuses to confront the reality of what MMT has to say about deficits and inflation. He prefers instead to spar with imaginary strawmen, having nothing to do with MMT.

Most disappointingly, Paul's new post does nothing to advance the arguments presented in the first engagement. Seeing word of his post, I expected it to try to rebut the pushback Paul got from the MMT community last summer with some new, and fresh, arguments. Instead, this post either repeats part of the old one almost verbatim, or restates his little quantity theory of money (the “infinite inflation scenario”) in the form of an example rather than a model. It introduces no new content. So, why did he offer it? Is the MMT “deficit owl” position beginning to gain some traction in the Congress, or the Executive Branch, or the Washington think tank world, or the MSM, so that Paul feels he needs to offer “a deficit dove” challenge before things get out of control, and people start listening to and hearing the deficit owls? Just speculation, and wishful thinking, of course. But then again, why did Paul offer that seriously inadequate and very poorly researched post?

Finally, some who noted the first engagement between Paul and the MMT economists have wondered what the argument is about. They see both the deficit doves and the deficit owls as advocating against austerity now and favoring fiscal stimulus. They also see that for the long run both approaches seem to advocate vigorous actions against inflation one full employment is approached or reached. So, they ask, what difference does all this make?

I think the difference is that the deficit doves agree with the deficit hawks that United States has a long-term deficit/debt problem that we must manage now with long-term frameworks and plans revolving around cuts in certain areas (which they often very much disagree on). We must plan stimulus now and government austerity later when the private sector can handle it say the doves. We must have austerity right now and also plan if for the long-term say the hawks.

In contrast, however, the deficit owl orientation is that we have no long-term deficit/debt problem when it comes to solvency risk, and we are nowhere close to having to worry about deficits causing demand-pull inflation or hyper-inflation. So, the owls say: forget about long-term plans, based on necessarily unreliable projections, aimed at stabilizing fiscal indicators. Instead, focus on fiscal plans that will rebuild and reinvent our economy, realize full employment along with price stability, create environmentally sustainable economic progress, a great educational system, and other real outcomes that people value. If we do that, they say, the fiscal indicators will take care of themselves.

(Cross-posted at All Life Is Problem Solving and Fiscal Sustainability).

Trouble Is When We Take the Truth Off the Table

Joseph M. Firestone — Sun, 27 Feb 2011 01:03:11 -0500

Arianna Huffington is calling attention to “the great budget battle of 2011,” between the President and the Republicans. She correctly points out that whichever of the two sides win, we, the people, lose. She's right, of course, and says further:

Just look at this so-called "debate" we're having. The problem ostensibly on the table is the deficit. But, without any context, the raw deficit number is meaningless. If the country's debt were, say, $50 million, that wouldn't be a big deal. If some average American suddenly found himself $50 million in debt, well, that would be a big deal. And that's because the country's GDP is a lot bigger than the average person's income. So what we're talking about is really the debt-to-GDP ratio.

Yet the debate is concentrated almost entirely on the debt side of the equation and barely at all on ways to increase the GDP side. . . .

Arianna's right about the pure deficit number being meaningless and needing context. But it's also true that it needs the right context. The right context for deficits isn't simply GDP or comparing the size of a deficit to the annual volume of economic activity, and the right measure of whether we have a deficit problem or not, or how serious it is, is not the debt-to-GDP ratio. Implicitly here, Arianna is accepting the view that the debt-to-GDP ratio is an indicator of something that causes grave economic problems. But there is no empirical evidence that there is any relationship between that measure and negative economic effects when a nation has a fiat, non-convertible currency, a floating exchange rate, and no external debt in a currency not its own.

So, she's claiming that the current debate is constrained because only the debt side and not the GDP side of the deficit/debt issue is being debated, but I think it's constrained because nearly everyone in the mainstream, including Arianna, refuses to debate whether there are any deficits, debts, or debt-to-GDP ratio levels that make it necessary to either increase taxes or cut spending, or, alternatively to avoid further tax cuts or spending increases. Please don't misunderstand. I'm not suggesting that we shouldn't cut spending and/or taxes in certain areas, or increase spending and taxes in others. What I'm saying, instead, is that any fiscal proposals at all need to be evaluated according to whether their consequences are likely to be in accord with public purposes, and not according to whether they either raise or lower deficits, the national debt, or the debt-to-GDP ratio.

In short, I'm suggesting that there is no deficit/debt problem for the United States at all. And I'm asking why the debate that Arianna refers to doesn't start with the bedrock question of whether there is a deficit/debt problem, and only when that question is settled, and only if necessary, move to the subsidiary question of whether the present focus on spending cuts ought to be broadened to the GDP context, or for that matter to the question of tax increases on the wealthy?

Arianna continues:

. . . How has the playing field of what is acceptable in this debate been so shrunken that the only two competing proposals still allowed on the field are the president's cuts and the House GOP's draconian cuts?

Well, it was no accident. And, as it turns out, there's an entire field of study based on the dynamic being played out: Agnotology. Coined by Robert Proctor, a historian of science at Stanford University, the word means the study of ignorance that is deliberately manufactured or politically or culturally generated. "People always assume that if someone doesn't know something, it's because they haven't paid attention or haven't yet figured it out," Proctor says. "But ignorance also comes from people literally suppressing truth -- or drowning it out -- or trying to make it so confusing that people stop caring about what's true and what's not."

Sadly, this is quite to the point. But it doesn't apply only to the present debate in the sense that the wider context of how the debt-to-GDP ratio might be reduced through alternative tax and spending policies designed to increase GDP is being “drowned out” or suppressed. It also applies to it in the sense that most media outlets including blogs with wide audiences are “drowning out” or suppressing post-keynesian and other heterodox economic viewpoints on the deficit/debt debate.

Ignorance of these positions is being manufactured and maintained by all of the mainstream media and by much of the alternative media, too. The way it is maintained is partly by ignoring the existence of alternative views about whether there is a deficit problem; partly by distorting and misrepresenting these views when they are, infrequently, able to find expression in popular outlets, and finally, by not supporting and fostering open debates between different fiscal sustainability/responsibility approaches. Using these methods, the media have made it difficult for any views to gain currency except deficit hawk and deficit dove views on the deficit. It's as if the media, including much of the blogosphere is frozen in the deficit hawk/dove neo-liberal polarization, just as politics in Washington is frozen into its narrow left-right polarization. However, there is a deficit owl position in the fiscal sustainability/responsibility debate, and it needs to be considered seriously by everyone debating these issues because 1) it may be right; and 2) the deficit hawk/dove polarization has worked out very poorly for the doves.

Why? Because the deficit dove position, in its most enlightened form represented by Paul Krugman, Joe Stieglitz, Robert Kuttner, Simon Johnson, and much of the Washington, DC progressive establishment starts by granting the premise of the deficit hawk position, namely that the debt-to-GDP ratio is important, and that we must monitor Government spending with reference to its impact on this ratio. Now, these folks, as the old saying goes, “haggle over price.” The hawks think that the ratio has to go down now and that we can't expect the increase in the GDP half of the ratio to outpace the increase in the debt half. The doves believe that we have time to bring the ratio down and that if we do things right, then we can lower it by growing faster than we borrow, raising taxes on the wealthy, and by cutting things like Defense spending, and the rate of growth of health care costs.

But when the two sides debate, the compromise that comes out of that debate always means agreement on the need to manage fiscal policy with the goal of decreasing the debt-to-GDP ratio, and on some plan to reduce that ratio by spending less, taxing more, and just accepting CBO's future GDP growth projections, which are both very conservative and extremely unreliable, as all long-term projections have always been. This leads inevitably to a shared pain and sacrifice scenario for various plans for decreasing the debt-to-GDP ratio over the long term. And this mantra of shared pain and sacrifice then inevitably devolves into a debate about how that sacrifice should be shared. In today's political system, the wealthy and powerful, in the end make no sacrifices, and in fact gain new advantages after these debates. But working people somehow always get called on to make any financial sacrifices that are implicit in the deficit hawk/dove position. Hence the 99ers, the long-term unemployed, Medicare recipients, public employees in Wisconsin, Ohio, New Jersey, Indiana, and the like.

The deficit doves fight back when spending cut proposals threaten programs like Social Security, Medicare, and various “discretionary” programs that are very important to many people. But the pushback from the doves while fact-based and logical, is designed to avoid specific cuts, like preventing Social Security cuts. It is not pushback against the very idea of deficit cuts and managing Federal fiscal policy with reference to the deficit/debt “problem.” So, for example, a year after the President appointed his Catfood Commission, and a large coalition of progressive organizations picked apart the logic and facts supporting the Commission's leaked views on Social Security, it appears that a lot of the momentum in back of Social Security cuts has been blunted, but, as Arianna says, the debate is now down to a choice between the President's proposed, and very damaging to the economy, cuts and the GOPs “draconian” ones. But what can one expect from a debate that concedes the major premise of the deficit hawks in the first place?

If we had been fighting over the past two years about whether there really was a deficit problem, and whether it was ever proper to manage fiscal policy with an eye toward deficit and debt indicators, we would be looking at different debates today. We would not be down to damaging cuts vs. draconian ones, but to whether we should have any spending cuts at all, or instead should be spending whatever it takes to reach full employment and solve our other national problems. In other words, we'd be having the Hoover/Roosevelt debate right now, not the Obama/Tea Party one.

So this is my advice to Arianna. If you want a broader debate, then structure some between deficit doves and deficit owls. That is, get the Keynesians like Krugman, Johnson, and Stieglitz arguing with people who follow the Modern Monetary Theory (MMT) approach like Randy Wray, Warren Mosler, Stephanie Kelton, Scott Fullwiler, Marshall Auerback, Mike Norman and Jamie Galbraith. And get Bill Mitchell participating from Australia. And get some Congresspeople exposed to these perspectives. Then you'll see some fireworks, and you'll also begin to structure a debate that won't be about cuts, but about what we can do to get the economy growing rapidly and building the foundation our grandchildren will need to keep the dream alive.

Often when we're debating issues, it's not about “drowning out” or suppressing the truth from our point of view. What it's about, instead, is suppressing alternative points of view that we don't think can possibly be the truth, because their implications conflict with our preconceptions, and so are not worth taking our time to learn. The problem with this is that we're too often wrong about what can't possibly be the truth, and as a result we take the truth out of the debate before it has been tested against competing points of view. We can't continue to let that happen in the debate over fiscal policy. If we do, we may well be dooming working Americans to a future of needless continuing privation that will threaten the economic basis of American Democracy.

(Cross-posted at All Life Is Problem Solving and Fiscal Sustainability).