KRUGMAN’S RESPONSE….
Paul Krugman posted his response to the original MMT piece. If you have some time the comments from the original piece are illuminating and 99:1 against Krugman. Anyhow, in his response he writes:
“A followup on my printing press post: I think one way to clarify my difference with, say, Jamie Galbraith is this: imagine that at some future date, say in 2017, we’re more or less at full employment and have a federal deficit equal to 6 percent of GDP. Does it matter whether the United States can still sell bonds on international markets?
As I understand the MMT position, it is that the only thing we need to consider is whether the deficit creates excess demand to such an extent to be inflationary. The perceived future solvency of the government is not an issue.
I disagree. A 6 percent deficit would, under normal conditions, be very expansionary; but it could be offset with tight monetary policy, so that it need not be inflationary. But if the U.S. government has lost access to the bond market, the Fed can’t pursue a tight-money policy — on the contrary, it has to increase the monetary base fast enough to finance the revenue hole. And so a deficit that would be manageable with capital-market access becomes disastrous without.”
This is a classic retort (and honestly, one I expect from someone just learning MMT). If you skip the logical sequence of events in any economic reality you can discredit anything. What Professor Krugman fails to address is why the USA will lose “access to the bond market”. This is a crucial step in the progression here. Why will savers suddenly lose their desire to save in $USD? Why will the Primary Dealers stop purchasing the bonds? Why will the buyers strike?
If it is due to high inflation then it is safe to say that the US economy has either rebounded sharply (in which case the buyers strike argument is bunk to begin with) or output has utterly collapsed (in which case you need to elaborate on the reasons why there is going to be some collapse in US economic output). If his 2017 scenario involves a much stronger economy and something resembling full employment then a 6% budget deficit would be inappropriate and as previously stated, would not be recommended by any MMTer. Interestingly, the budget deficit could fall to 6% in an environment in which the government begins a form of austerity measures, but as Professor Krugman has often said, this will likely lead to a Japan scenario and a more deflationary outcome (in which case the collapse of the US government bond market is nonsensical). He doesn’t explain the sequence of events so we have no way of knowing (I believe he has intentionally left out the details because his scenario is not realistic).
Either way, we appear to be making a one way argument down the nonsensical hyperinflation route which requires a great deal more analysis and explanation than just “the USA will lose access to the bond market”. Professor Krugman does no such thing, so while his comments may appear valid at first glance, they are in fact highly misleading.
None of this even touches on the operational realities that MMT discusses (the fact that bond markets fund nothing in the USA – a fact that Professor Krugman clearly doesn’t even begin to understand), but the sequence of events is important nonetheless. If you skip this crucial step you are merely creating a strawman argument and Professor Krugman is using his heavyweight stature in the field of economics to blow right thru that strawman with the assumption that his opinion is enough to validate the argument in the first place.
Unfortunately, his argument is the logical equivalent of debating with someone about the potential decline in oxygen levels in the atmosphere and concluding with the absurd statement that “if the oxygen runs out tomorrow we will all die”. Of course this is true, but one must first explain what will lead to the lack of oxygen and the specific sequence of events. If you fail to do so you have failed to prove a point in the first place….Professor Krugman fails to connect the dots in a rational and logical sequence of events and it entirely discredits his conclusions.
Wow. Those comments are a real smackdown. Good to see. I lost a lot of respect for Krugman this weekend.
Yup.
It’s tough. It’s really hard to see your viewpoint Cullen until you really put some time into understanding MMT. Otherwise, Krugman and everyone else just won’t get it.
Sad.
I am no fan of the Krugmonster! Still I am lost on MMT and I have spent time on it! Here is what I wrote a while back:
So how come every Japanese, British, and American is not given 50,000 a year from age 16 to death if printing money is so easy and with no consequence? This is where the MMT fails big time, they like to promote the printing press, but only in ways that are book keeping games between central banks. No country with it’s own currency should not have 100% millionaires by their reasoning, yet it is not so.
I know its way too simple, but this argument gets in the way. Not trying to be a pain but thats how I see it.
“So how come every Japanese, British, and American is not given 50,000 a year from age 16 to death if printing money is so easy and with no consequence?”
No MMT’er would ever say that there would never be ANY consequences. It’s all about real and available resources. If the resources are not available it wouldn’t matter if you handed out $50 let alone $50,000. But if 10% of your population is unemployed and 25% of your industrial capacity sits idly by rusting, why not spend that into useful production?
You can’t make everyone rich with MMT by giving out money, but you can steer the economy so that everyone is employed and that the economy is making investments into its future growth.
Did you read Cullen’s response? He/MMT clearly states that such level of spending would generate inflation and potentially hyperinflation. So MMT does not say printing comes without consequences.
This is so wrong it’s not even funny.
MMT isn’t actually about money; it’s about stuff.
Monetarists worry about money so much they are frightened to put it in their models.
MMT just says there need to be enough money so that no stuff fails to be made by the economy due to the simple lack of money. It then provides a simple and straightforward model of how to make sure that is the case.
Monetarists like to run the economy well below its real capacity because they worry about money too much.
MMT says that money has to be spent before it can have economic effect.
Monetarists think dollars in bank reserves magically cause inflation even though they are not being spent on anything, whereas bonds magically stop that process even though there is a liquid market in them that can turn them into cash instantly. That’s because they worry about money too much.
Monetarists worry about money.
Ordinary people worry about starving due to the lack of a job.
Neil, well put. this was a helpful explanation.
“MMT just says there need to be enough money so that no stuff fails to be made by the economy due to the simple lack of money. It then provides a simple and straightforward model of how to make sure that is the case.”
Well, in the capitalistic society (and not some buddhist temple), there is alway a NOT ENOUGH MONEY problem. So this is the most ridiculous argument ever.
As I see it, in the last 10-20yrs, money has become from not enough to too much and sloshing around in bubbles. Instead of suppling “enough” money, the system oversupplies money and CBs use it to “stimulate” the economy and have made it a crack addict, overstimulated.
InvestorX
When speaking of “money” you really have to define what “money” is. First you can say “money” is a financial asset with duration zero (but, as often said, you can easily count bonds as “money”, especially for banks that don’t go shopping at the mall).
Further I distinguish 2 forms:
The “money” (often called “liquidity”) sloshing around due to easy CB monetary policy is vertical money (I say “commercial/shadow bank money”, seen in M2, M3). Easy monetary policy (=making credit “cheaper”) doesn’t add net financial assets to the private sector, all it does (when it works) is increase the leverage of the private sector (private sector goes deeper and deeper into debt, as loans create deposits = “commercial/shadow bank money”, which is just a CLAIM on “central bank money”, so not “real money”. This is btw a problem when you have a classic bank run).
In contrast fiscal policy (deficit spending) actually adds net financial assets to the private sector (by adding horizontal money = “central bank money” = “real money” = reserves/currency, increasing the monetary base) allowing it to net save (paying down private debt) without contracting the money supply (remember paying down private debt destroys vertical money = “commercial/shadow bank money”) and causing a depression. So fiscal policy allows deleveraging of the private sector, if it doesn’t want to go deeper into debt because of messed up balance sheets (as we see atm).
Sorry, I mixed up horizontal and vertical money: Of course horizontal money is “commercial/shadow bank money” and vertical money is “central bank money” (“real money”). Just interchange the terms in my comment above.
Mitch,
thanks for your response (and excuse my late reply).
So it seems that according to MMT “the private sector net saves” = the ratio of “real money” (or ~ monetary base) is increasing relative to the ratio of (debt + money).
So deficit spending has two core functions:
1. Allows deleveraging without a depression -> I am not sure that it is self evident that this is a good choice, it is like enjoying different types of ice cream. I prefer a quick system clean up and a fresh start, giving opportunity to the prudent with dry powder to come ahead, while many of the rent suckers TBTF fail.
2. Reduces systemic risk, by providing more “equity” so to say to the leveraged edifice -> This sounds good in the first place. But it also allows for even further leveraging of the edifice. So if the latter occurs, it is also not clear it is a good choice (sounds pretty bad to me in the current situation).
InvestorX
Well, in the capitalistic society (and not some buddhist temple), there is alway a NOT ENOUGH MONEY problem. So this is the most ridiculous argument ever.
Heard of hyperinflations?
Sure the US bond market funds nothing, but don’t you think it is necessary to sterilize the money creation due to massive government deficits? Otherwise inflation would be rampant. I do not agree with you that the UST market should be abolished. I think that is the real reason Congress requires it, rather that it being an archaic throwback from the gold standard days.
A deficit followed by the issue of securities is NO LESS inflationary than a deficit not followed by the issue of securities.
To understand this, think of who are the general buyers of Treasury securities. Almost all securities are held by foreign governments, pension and investment funds, and banks or insurance companies. Will the owners of these securities suddenly go on an inflationary spending binge if their Treasuries are replaced with cash? Of course not. They are saving for a reason – they want and have to save.
Think of it another way. Quantitative easing is essentially the issuing of securities in reverse. It is undoing the original process. Has QE suddenly given the non government sector “more spending power”? Of course not. The non government sector had securities assets, and now has cash assets. These savers have swapped their assets with ther Fed.
And if QE doesn’t give the private sector more spending power, does the issue of securities take spending power away? No. Government securities holders can instantly sell their securities in a tremendously liquid market if they wanted to start spending.
This is a key point in MMT, and it must be understood. Play around with the balance sheet at:
http://econviz.com/balance-sheet-visualizer.html
Cullen it appears you are erasing my messages again, you are doing evil and turning to the darkside, I gave some good points by educated MIT economists, and rather than debate them, you just erase them, that is sad dude. You will publish the messages here where people thought krugman was doing that, but you are a hypocrite. I will make sure the other places I post are made aware of your cowardness to engage in real debate with dissenting comments.
Nothing gets by the filter that involves insults, racist commentary or anything derogatory. So far, 95% of your comments involve some form of hateful message (or threat as this one does). So yes, in my house, that doesn’t fly. This isn’t your open forum to insult and denigrate other people and I won’t tolerate it.
I respect your right to free speech, but I do not respect your right to insult anyone else and I will not put up with it. If your comments are reasonable and rational then they get approved. If they’re not then I will not expose the other users to them. The comment section is a privilege. Not your right. There is nothing here that requires me to allow anyone to comment on anything.
Sorry, but this is my site and I will not let it become corrupted by people who cannot behave. If you want to cry about censorship then fine. I could really care less.
I fail to understand how posting this link is racist? She talks about how the oxygen comes out of our youth’s education and that will be the downfall of america.
http://www.booktv.org/Watch/12291/After+Words+Dambisa+Moyo+How+the+West+Was+Lost+Fifty+Years+of+Economic+Folly+and+the+Stark+Choices+Ahead+hosted+by+Dan+Mitchell+Cato.aspx
Look, just keep it clean and rational. Don’t insult anyone and you’ll be fine. But you’re stretching it on just about every one of your comments….
Also, when you leave these kinds of comment I get an email from the spam filter which means I have to log in and approve the comment. As much as I enjoy the interactions on this site I do not appreciate getting emails on the weekend with regards to people who can’t behave….just act like an adult. That’s the only thing I ask for from readers….
NTPTP:
Cullen runs one of the best blogs in the world, in part because his comment section is simply outstanding.
There are 10,000+ sites that welcome inflammatory commentators.
Thanks to Cullen’s diligence (and the remarkable patience I have witnessed), this is not one of them. Maybe you like the site for the same reasons I do.
BTW, it is unpatriotic not to pay ANY taxes. Sure, do everything you can to see that the money collected is spent how you wish: sure, follow every legal method of minimizing your taxes, but to boast that you are a non-tax paying “tea” partier is the equivalent of showing up at the neighborhood potluck*, and proudly saying you would NEVER bring a dish to share, then proceeding to fill up your plate.
Not something to be proud of, not at any gathering that I would care to participate in.
But, perhaps you meant it ironically, poking fun at tea partiers that do not pay taxes. If so, it doesn’t come across that way.
* Not sure how wide the usage is for the term “potluck”. Very common in the Pacific NW, it means everybody brings food to share at a gathering.
Perhaps you should stop swearing and making insults in your comments then…
Nobody elses comments get filtered – and that’s because we behave like adults.
Literally. NO ONE else’s comments get filtered except for the occasional one that gets caught up for silly reasons. And I always approve those in short order…
I’ve linked to the MMT posts and comments about Krugman 1 and 2 here if you want to cut to the chase. Bill Mitchell, Warren Mosler, Rob Parteneau, Marshall Auerback and other MMTers have commented on Krugman 1. The comments to Krugman 2 aren’t up yet. I’ll link to the most relevant ones when they appear, as well as put up links to future posts by MMT’ers, which I am sure will be forthcoming.
Good stuff Tom. Thanks. Those comments are 95:1 against PK. His head must be spinning right now…
In my more tinfoil hat conspirary moments, I get the feeling Krugman was posting a deliberately provocative story to judge the current level of MMT acceptance in the blogosphere. I think he got his answer. Then I take a deep breath.
Right. And the response is nothing short of extraordinary! Looks like MMT is taking over the internet
Maybe another time when things cool down we can get back to my query. I want to get this, but I am coming up short. I can admit it (MMT) may be beyond me. How can anyone say how much printing, monetizing debt, etc is too much? Who says?
you can’t separate it from context. if there is significant demand-pull inflation, then the deficit is too large. but it’s never the deficit in and of itself irrespective of macroeconomic factors that should be the focus. mmt tries to shift the debate towards those factors that matter
GYSC, think of deficit spending as filling the gap left by (a) unemployment/economy operating under capacity and (b) non-govt sector’s (both domestic and foreign) desire to net save in your currency. (a) and (b) are connected, of course. If the spending goes toward expansion of economy it is not inflationary. If the spending goes towards savings, then again, by definition it is not inflationary. Only when you spend in excess of these gaps do you start getting inflation.
Is that clearer?
Also see this comment, thanks
GYSC
Maybe another time when things cool down we can get back to my query. I want to get this, but I am coming up short. I can admit it (MMT) may be beyond me. How can anyone say how much printing, monetizing debt, etc is too much? Who says?
Stick with it. Its worth it.
For me I just spent time in this ‘library’ in the ‘Debriefing’ and ‘Economics’ category and it blew me away
http://bilbo.economicoutlook.net/blog/?page_id=1667
My version is probably easier for the layman to grasp: http://pragcap.com/resources/understanding-modern-monetary-system
Like GYSC, I am (still) working to grasp MMT. I think undersdtanding the concrete steps MMT suggests we should take now with the current economic conditions would help. I suspect you have already written on this subject, might you provide the link?
Thanks
I have found that Frank Ashe’spaper
“A Kindergarten Guide to Modern Monetary Theory (Days 1-3)” is an extremely good exposition of MMT
What I find astonishing about this argument is that it says if you get a 6% deficit at full capacity it will be expansionary.
As you point out it excludes the journey, but it also demonstrates a fundamental difference of the MMT approach. The deficit is the non-government sector(s) surplus – it is an outcome not a target
MMT targets unemployment and stable prices. If you get to full capacity with a 6% decifit while following MMT policies then you will have low unemployment and stable prices. The 6% deficit is prima facie evidence that the non-government sector ‘desires’ in aggregate to hold the monetary base.
Because if they didn’t there wouldn’t be a 6% deficit.
The government can choose what it spends. How much of that turns into taxation and how much into non-government surplus depends upon the response of the other sectors. The government can’t determine those precisely.
The approach of the classical economists seems to be to deal in snapshots and state assumption. Hence the criticism of Steve Keen here: http://www.debtdeflation.com/blogs/2011/03/04/%E2%80%9Clike-a-dog-walking-on-its-hind-legs%E2%80%9D-krugman%E2%80%99s-minsky-model/
“The mathematics is complicated, and real brain power was exerted to develop the argument—just as, obviously, it takes real brain power for a poodle to learn how to walk on its hind legs. But it is the wrong mathematics because the analysis compares two equilibria separated by time rather than being truly dynamic by analyzing change over time regardless of whether equilibrium applies or not, and wasted brain power because the initial premise—that aggregate debt has no macroeconomic effects—was false.”
Neil:
Exactly. Since we don’t know what Krugman has assumed for private debt levels, we don’t know how private saving might be aplied so it may very well be non-expansionary.
Reminds me of Friedman’s famous classroom lesson where he posited that if the supply of money magically doubled overnight, prices would “of course” have to double. Of course not! The desire to save, the private debt level, and tax rates have a little bit to do with it.
“Reminds me of Friedman’s famous classroom lesson where he posited that if the supply of money magically doubled overnight, prices would “of course” have to double. Of course not! The desire to save, the private debt level, and tax rates have a little bit to do with it.”
Take the level of income as given, hold desire to save, debt levels and tax rates constant and I’d say Friedman was basically correct.
Why would the level of income stay the same!? You send a demand signal and if there is spare capacity, it get picked up, methinks.
“Why would the level of income stay the same!? You send a demand signal and if there is spare capacity, it get picked up, methinks.”
Because I’d like to know the partial effect of increasing the money supply is on the price level/inflation, so I made it an assumption. Lots of MMTers have told me that it won’t make a difference (e.g. Mosler). I think this is wrong.
“The approach of the classical economists seems to be to deal in snapshots and state assumption”
Steve Keen is totally off-base here. That might have been the approach of K&G in that particular paper, but in reality comparative statics (comparison of static equilibria) is just one tool that people use. Economists have been doing dynamic analysis for years (e.g. dynamic stochastic general equilibrium models).
“The government can choose what it spends. How much of that turns into taxation and how much into non-government surplus depends upon the response of the other sectors. The government can’t determine those precisely.”
Isn’t this similar to the critique of Monetarism that the Fed cannot affect the money supply through reserves as effectively as it believes?
Can we expect govt, through MMT policies, to allocate its spending effectively to productive assets in order to close the output gap?
I can see that tax breaks would be the more effective of the two, however.
N. Mankiw is out w/ an anti-debt diatribe in “The Times”:
http://www.nytimes.com/2011/03/27/business/27view.html?_r=1&partner=rss&emc=rss
When will these people learn?
GYSC, Also read Warren Mosler’s 7 Innocent Frauds available for free at moslereconomics.com. I’m a dentist for cryin’ out loud. Imagine how I felt with this stuff in the beginning. Keep reading. http://mikenormaneconomics.blogspot.com is also helpful. Tom Hickey and Matt Franco et. al. are frequent contributors and add insightful comments to the various posts. Cullen’s “best of” is great. Randy Wray and Bill Mitchell have a series of YouTube videos that are a great start. I am actually having a great time learning this stuff though admittedly I am merely on the sidelines- just a voyeur.
Good stuff Cullen,
Plain and easy to follow. and your right folks like this Krugman. Think that all they have to do is say something and it should be taken as the gospel even though they can’t prove it.
Thanks
Cullen,
You’re resorting to hyperbole in support of your position, I’ve been to the comments section while keeping an open mind on the debate and there are plenty of the 165 so far who clearly are not pro-MMTers.
Many of the commenters to the original are as you might expect, like you, MMTers arguing their point of view so the count is alone not proof that MMT is “right” as you imply via the eye catching 99:1 first line. Many people in agreement with Dr K’s views are happy to read but not comment (I believe his was the top Blog site as voted by his peers)
If you are so convinced, you don’t need to resort to “cheap” journalistic attention grabbers in support of your own position! In my experience when people shout loudly they’re often sending another message entirely.
Cy,
you’re 100% right. I guess I was just shocked by the level of pushback. I didn’t mean to exaggerate, but I clearly did.
Best,
Cullen
Cullen
You are underestimating Krugman, he is much smarter than you think. After all MMT isnt so difficult and I’m pretty sure he understands it very well but still rejects it. Here’s why: at full employment you can’t monetize debt by Fed for too long because it will lead to hyperinflation (he proved it last year with a simple model). So the other two options to prevent hyperinflation and sustain given government spending are either tighter monetary policy (higher interest rates) or tighter fiscal policy (higher taxes). And it’s pretty obvious that it’s easier to rise rates by Fed than convince Congress to rise taxes.
And the last thing: currently we have high deficits but MMT believers think that by increasing net spending (and deficits) we can reduce output gap and that will decrease deficits so the problem of high deficits will go away. But Krugman is aware that it is not certainty and it is possible that after returning to full employment we still will have high deficits and we shouldnt monetize it by Fed. So a monetary policy (out of liquidity trap) can be a very valuable tool and we shouldnt abandon it.
Tom, you still don’t get it. First, the Fed does not “monetize the debt.” That is a gold standard term. Secondly, MMTers have said a million times that as the economy returns to full employment, we should make sure to decrease the deficit.
wh10
By monetizing debt I mean increasing monetary base by the amount of deficit. It fits well to the problem we are discussing.
I am not so sure because Warren and Randy said many times that by increasing net spending (and deficits) we can automatically reduce deficit sufficiently (by reducing output gap). It can be true but it is not obvious and may not be true so the question remains in which way to reduce deficits. And Krugman doesnt want to abandon monetary policy. And I think he is right.
Cullen
I think that he purposedly didnt write everything he wanted in his first post about MMT (in later posts he clarified his position). I think that he just likes to play with his opponents (from different economic schools) but in the end he usually wins the debates with other economists.
This debate was actually resolved last summer when he and Jamie Galbraith faced off. And PK was far from ever winning that one….Now PK is trying to rehash it by making a slightly different point. And again, Jamie served him up on a platter.
Cullen
I agree that MMT followers (and your site especially) did a great job to promote new way of thinking about deficits. But the problem of the possibility of high deficits at full employment remains and we have to think about it. But right now the problem is not that deficit is too large but too small. And I think Krugman agrees with that so escalating this debate is not necessary.
At full employment I think most MMTers would be in agreement about a balanced budget or a VERY small deficit….but we’ll approach that “problem” when and if it ever arises. At this pace, I am not counting on it….
Cullen
“At full employment I think most MMTers would be in agreement about a balanced budget or a VERY small deficit”
OK but MMT theory should answer if deficits will:
a) disappear automatically (or at least decrease substantially) because of reduced output gap, or
b) they should be covered by tax increases or
c) by interest rates increases (in this case credibility in financial markets is essential – this point Krugman is making).
Right now I don’t see that there is one proposition by MMT people what action should be taken if the deficits will persist at full employment.
Cullen
Besides even balanced budgets at full employment could not be enough if debt level is very high. That is because if debt is very high government may not want to pay high interest rates because this can substantially increase deficit. This can convince investors to move their money to other assets (at full employment there are other good investment opportunities not only government bonds) and obviously it can be inflationary. So it may be true that during boom years we should have surpluses to pay down debt (at least if this debt is very high). And I think that Krugman agrees that surpluses may be necesary if there is full employment with high level of debt.
This can convince investors to move their money to other assets (at full employment there are other good investment opportunities not only government bonds) and obviously it can be inflationary.
Inflationary in those other assets, yes. I can see real estate prices go up. But inflationary across the economy? Consumption items?
Peter D
“Inflationary in those other assets, yes. I can see real estate prices go up. But inflationary across the economy? Consumption items?”
There is this accounting identity: budget deficit=change in debt + change in high powered money (you can check it at billy’s blog) and of course surplus=-deficit. So if investors decrease their holdings of government debt it must be offset by budget surplus and/or increase in high powered money(monetary base). At full employment you shouldnt increase monetary base (I think MMT agree with that) so the only option is budget surplus. The question of course remains whether investors would like to decrease their holdings of government debt. And right now it is not a problem because we are in liquidity trap and investors want government debt even more than they currently own. So deficits are good because they increase NFA held by the public. But in the future when we are out of liquidity trap (or close to full employment) the problem may arise because government debt will not be so attractive especially if debt will be high. And government will have to either pay higher interest rates but this may increase deficit substantially (and we agree that at full employment it’s not good) or budget surplus may be necessary to pay off the debt.
Tom,
At full employment you shouldnt increase monetary base (I think MMT agree with that) so the only option is budget surplus.
You still have CAD to worry about, so it is possible there will not be a surplus. And some non-discretionary govt spending. And then also some spending that can only be done by a govt (too big or ROI is unquantifiable.)
The question of course remains whether investors would like to decrease their holdings of government debtBut in the future when we are out of liquidity trap (or close to full employment) the problem may arise because government debt will not be so attractive especially if debt will be high. And government will have to either pay higher interest rates but this may increase deficit substantially (and we agree that at full employment it’s not good) or budget surplus may be necessary to pay off the debt.
MMT says the govt does not need to issue debt. Govt Debt is a subsidy tot he non-govt sector holding $US. And if the debt is high at full employment, then something is wrong. You’re probably undertaxing.
Peter, not only are you holding savings preferences constant, you’re saying that the desire to save is unrelated to the return on saving (vs consumption). This is a very static analysis of the situation!
Vimothy
“you’re saying that the desire to save is unrelated to the return on saving (vs consumption).”
I am saying it is unrelated to return on saving in the form of govt bonds. there are plenty of saving vehicles out there whose rate will adjust to reflect the disappearance of the govt bond channel. I will pick up out discussion over at heteconomist when I absorbed your latest response.
As I see it, under full employment your deficit should only offset the CAD and the domestic sector’s desire to net save in $US. Both are non-inflationary. Now, if you still want to send on a space program or something like that, then the voters will have to decide that they prefer the govt to take this on and be ready to be taxed for it (either thru real tax or the back-door tax of inflation)
Peter D
“And if the debt is high at full employment, then something is wrong. You’re probably undertaxing”.
But if we have balanced budget at full employment (something MMT favours) and we are undertaxing this means that you are advocating budget surplus. And I can agree with that.
I think the major problem with MMT is that it is good as long as we are in liquidity trap. Out of it you have to take into consideration invetors attitude because otherwise you should be prepared to make big budget surpluses if investors will not like government’s policy (of course if we dont want high inflation.
I think I misled you when I said “And if the debt is high at full employment, then something is wrong.”
I meant deficit (for me this is debt in broader sense – not just US Tsy Bonds). If the govt stops issuing new debt, as in MMT “no-bonds” proposal, then the past debt will be phased out and no new debt incurred.
Now at full employment, the only reasons for deficit to be high would be (a) to offset CAD (b) to offset non-govt domestic sector’s desire to save $US ((a) and (b) should be abbreviated as “non-govt sector’s desire to save in $US”) and (c) to pay for non-discretionary govt spending (SS, Medicare, Military, the cost of govt etc) + programs that the public decided should be run by the govt (my space program example.) If you have deficit that is too high under this circumstances – and “too high” means you’re getting demand-pull inflation – then you’re undertaxing.
Peter D
“If you have deficit that is too high under this circumstances – and “too high” means you’re getting demand-pull inflation – then you’re undertaxing”
I agree with your statement but there are two problems you should consider:
1. You can have high deficit because interests payments are high (because debt is high) and it means that you have to either decrease other government spending or increase taxes. Or you have to convince market that you are responsible and your problems are transitory and maybe then investors will accept more moderate interests rates. Again this is something Krugman war trying to emphasize.
2. You can have balanced budget but very high debt and if investors will lose faith in your policy they can show you their back. In this case you will be forced to have budget surpluses (by taxing or decreasing other expenditures.
So again market trust is very important.
Tom, you are looking at it all backwards!
You can have high deficit because interests payments are high (because debt is high) and it means that you have to either decrease other government spending or increase taxes. Or you have to convince market that you are responsible and your problems are transitory and maybe then investors will accept more moderate interests rates. Again this is something Krugman war trying to emphasize.
2. You can have balanced budget but very high debt and if investors will lose faith in your policy they can show you their back. In this case you will be forced to have budget surpluses (by taxing or decreasing other expenditures.
So again market trust is very important.
No, no, no! Interest rate is a policy choice! You can stop issuing debt altogether and not worry about interest or, less “radical” issue only short term T-bill that pay at about Fed Funds Rate – your policy choice. You’re not dependent on markets to spend.
There is plenty of MMT resources on that, you can start with this and this.
QE is debt monetization by definition, see this thread, where Warren Mosler says so. It doesn’t matter, though
Semantic point though. Monetization implies that the banks have been given a “fuel” they did not previously have. While Warren might be right from a very technical (and debatable point) the fact is that there is no more NFA’s in the system than there was prior to QE so nothing has actually been monetized.
Peter D
“You’re not dependent on markets to spend”
I’m sorry Peter but your statement is only valid in liquidity trap. I read billy’s blog regularly and know MMT pretty well. Out of liquidity trap or close to full employment (and if debt is high) you are either dependent on the market trust or you have to run budget surpluses (or at least substantially cut net spending). Otherwise you will generate high inflation. Krugman showed the case of France and England from XVIII century and it’s worth reading.
Tom, show me where Billy would support your statement. You need to come with a realistic scenario where you have full employment and high deficit which is not due to one of the points I made before (a, b and c). And read the links I supplied, they explain how the interest rate is a policy choice and how you don’t need to issue debt at all.
Peter D
I didnt say that I agree with billy only that I read his blog so I know MMT quite well. And I cant accept it fully.
“And read the links I supplied, they explain how the interest rate is a policy choice and how you don’t need to issue debt at all”
Peter the only thing Scott is proving is that issuing new debt in the form of treasuries or reserves can be inflationary. He wants to disprove that selling new bonds is better than printing new notes (i.e. supplying bank reserves) in terms of inflationary consequences. I’m fine with that.
But the problem can be different. The problem of not wanting to hold government debt. I will illustrate it with the Warren Mosler book “SEVEN DEADLY INNOCENT FRAUDS OF ECONOMIC POLICY” (altough I regret that he didnt emphasize it).
Page 40: “So what happens if China refuses to buy our debt at current low-interest rates paid to them?”(…)”They can leave it in their checking account.”(…)”There are no negative consequences of funds being in a checking account at the Fed rather than a savings account at the Fed.”(…)”If they want something other than dollars, they have to buy it from a willing seller, just like the rest of us do when we spend our dollars.”
Fine. But out of liquidity trap or close to full employment such increase in spending has to generate huge inflation. I’m pretty sure that you can agree with that. So convincing investors to hold government debt will be important in the future. So again market trust is very important.
Tom,
Warren and the other have been writing about MMT well before the liquidity trap. In fact, many of them predicted the liquidity trap before it even happened. MMT works just fine outside of a liquidity trap. Again, I think you’re viewing it incorrectly. MMT is not a policy prescription. It is a description of the monetary system. The US govt has run deficits for the majority of its 200+ year existence. The majority of that existed without a liquidity trap. I think people are imagining this extraordinarily different world under MMT. No. It’s not really that different than the one we’ve always operated within….
Cullen
I respect your devotion to MMT but even these guys admit that altough there is no problem of solvency there can be a problem of inflation. And this can happen only outside liquidity trap when we will be closer to full employment. And I can agree that deficits can be necessary and desirable even outside liquidity trap (they are the source of new money that growing economy may need in order to avoid deflation). But I cant agree that level of debt completely doesnt matter. Investors can show their back to government debt and that can cause a lot of problems. We can think about old debt as an unspent money. So spending it at full emplyoment could be very dangerous (inflationary or it can enforce huge budget surpluses).
I have never rejected the inflation concerns. In fact, I’ve covered it quite thoroughly. Please see the following:
http://pragcap.com/resources/understanding-modern-monetary-system
http://pragcap.com/hyperinflation-its-more-than-just-a-monetary-phenomenon
Cullen
I like your writings and I agree with most of it. I just think that we shouldnt completely lose from our sight potential (in the future) deficit and debt problems.
Tom, if Chinese don’t want US dollars they’ll have sell their stuff to somebody else, our CAD will go down and with it our deficit.
And the private sector cannot refuse to hold US dollars as long as you are able to enforce taxation. Tax liabilities can only be extinguished in bank reserves or cash, both of which are supplied by the US govt.
“But out of liquidity trap or close to full employment such increase in spending has to generate huge inflation.”
No! Only if it is in excess of (a) non-govt desire to save in $US and (b) not taxed enough to support non-discretionary govt spending and govt programs approved by the electorate.
Peter D
I’m sorry to say that but I’m not sure you understands it thoroughly.
“Tom, if Chinese don’t want US dollars they’ll have sell their stuff to somebody else, our CAD will go down and with it our deficit.”
That is true but US-China trade deficit realized in one year is only a small portion of US assets accumulated by Chinese so the net effect out of liquidity trap has to be inflationary if chinese want to spend their dollars on US real stuff (not bonds).
“And the private sector cannot refuse to hold US dollars as long as you are able to enforce taxation. ”
Yes but private sector can refuse to hold US dollars in excess of expected tax obligations. They may want to hold real assets and again falling money demand can generate inflation.
Tom ,we’re talking past each other. You start with the premise of falling demand for dollars, while I am trying to explain how this whole premise is unrealistic.
You want to convince me that high deficits could be inflationary? Yes, they could, but these would be wrong high deficits, because they would be in excess of the non-govt sector’s desire to save in $US, as I said probably 100 times by now. And why would that happen? If you have a stupid government spending on stuff that it shouldn’t be spending (and not taxing enough for that) this is not an MMT problem. MMMT is not saying that you cannot drive your car (~economy) into a ditch, it is just saying: recognize that you have a car and don’t try to ride it as if it were a horse-driven cart.
And the whole premise of bond markets loosing faith in US economy which is running at full employment – ridiculous!
Peter D
“You start with the premise of falling demand for dollars, while I am trying to explain how this whole premise is unrealistic”
It’s not a premise it’s possibility and it should be taken into consideration in the future (not now).
“You want to convince me that high deficits could be inflationary? ”
Not only deficits but also high debt which MMT ignores (check billy’s blog).
“Yes, they could, but these would be wrong high deficits, because they would be in excess of the non-govt sector’s desire to save in $US, as I said probably 100 times by now. ”
Peter deficits cant be in excess of the non-govt sector’s desire to save in $US (if you skip current account).
You are talking about ex-post accounting identities which are true of course at the end of the period, but this doesnt mean variables at the both sides of the identity are constant during this period. For example invetors can suddenly dump government debt (e.g. because of low interest rates imposed by Fed) and it can immediately generate either inflation or budget surplus (not in liquidity trap).
“If you have a stupid government spending on stuff that it shouldn’t be spending (and not taxing enough for that) this is not an MMT problem.”
I agree that inflation can be a consquence of stupid policy but not exclusively because of this. If investors go on strike and wont buy government debt inflation is inevitable (or enforced budget surplus)
“And the whole premise of bond markets loosing faith in US economy which is running at full employment – ridiculous!”
Peter but that is potentially big problem. The full employment can be achieved by increased net spending (high deficits) which will not sufficiently decrease output gap and taxes will not rise automatically in sufficient amount. And that can undermine market confidence.
Once again: I’m not against MMT (it correctly describes current situation) but you shouldnt cling to in every situation.
You don’t seem to understand that debt issuance is unnecessary if you pay IOR (interest on reserves) as the Fed does since Oct 2008.
And even if you issue bonds (to drain excess reserves in order to control the overnight rates when you don’t pay IOR, NOT to “finance” the US) there is no problem in finding buyers:
If the Chinese decided to buy “real assets” someone else has to sell these “real assets” to them. So the seller gets the Dollars the Chinese had, and the Chinese get the assets. Maybe the price of the assets goes up in Dollar terms, but the Dollars are still there and need to find a place, so the asset seller buys US bonds if he wants to earn interest. Voila!
Also remember that reserves can’t be removed by the private sector. Only the public sector can do this by taxation / bond issuance (Treasury) or OMOs/reverse repos (Fed).
And of course you also cannot convert/redeem reserves into Gold or something else.
Mitch83
“Maybe the price of the assets goes up in Dollar terms, but the Dollars are still there and need to find a place, so the asset seller buys US bonds if he wants to earn interest. Voila!”
You are right as long as inflation remains moderate but if too much debt will be liquidated it can spiral out of control. And insolvency may be a cheaper option than hyperinflation because nobody will want to buy governemnt debt at reasonable price.
“Also remember that reserves can’t be removed by the private sector. Only the public sector can do this by taxation / bond issuance (Treasury) or OMOs/reverse repos (Fed).”
Yes but again velocity of money can increase so much that insolvency can be a better option than hyperinflation.
Of course that is not current problem because of liquidity trap.
I am not underestimating Krugman. I know he is brilliant and trust me – I would never claim otherwise. But I do think he has a fundamental misunderstanding of MMT. His commentary about funding and solvency make it clear.
Thanks TPC and Peter. Helpful items and comments as always. Thanks again.
“Professor Krugman fails to connect the dots in a rational and logical sequence of events and it entirely discredits his conclusions.”
Here the logic of Cullen Roche:
I steal money from 3 peoples plus I steal money from 2 people. So in a rational and logical sequence of events, I have taken money illegaly from 5 people. Right?
The problem with MMT and Keynes is they are good with math but they don’t have any foundation in ethic. How can you justify central planning in economics? Interest rate? Inflation of the money supply? I suggest to Cullen Roche and Professor Krugman to read less in finance and more in philosophy. A good start could be with the Austrian School of Economics: Mises, Rothbard and Hayek. It is not because you can add numbers in a logical sequence that it is necessery a good model to explain “human action” and ethic. Someone believes totally in freedom or not. Someone believes in contract and property right or not. Anything between is intellectualy flawed.
Did anyone notice this piece from PK? It was in my Sunday op-ed section. He rightly attacks the austerity delusion currently in vogue, but I had to stop when he compared US deficit to Greece…
http://www.nytimes.com/2011/03/25/opinion/25krugman.html?partner=rssnyt&emc=rss
“But couldn’t America still end up like Greece? Yes, of course. If investors decide that we’re a banana republic whose politicians can’t or won’t come to grips with long-term problems, they will indeed stop buying our debt.”
Paul, Paul, Paul…
Greece does not issue it’s own currency. US does.
Still, I suppose US fate COULD follow Greece, if we adopt the euro…, but I am assuming that would likely take WWIII to occur, and for the US to lose.
Tom
“You are right as long as inflation remains moderate but if too much debt will be liquidated it can spiral out of control.”
Why? Banks can buy wahtever they want no matter if they have reserves or bonds on their balance sheets. So “asset price inflation” has nothing to do with “too much debt liquidation”.
The next thing is: “asset price inflation” does not equal price inflation.
“And insolvency may be a cheaper option than hyperinflation because nobody will want to buy governemnt debt at reasonable price.”
As bonds don’t “finance” the US, the US doesn’t have to ensure that debt is bought at a reasonable price. Bonds are a pure moentary tool, no fiscal financing tool.
And even if the US still issues bonds, it can always pay interest on those bonds no matter how high the yields.
ADD:
…Banks can buy whatever they want AND LEND HOW MUCH THEY WANT no matter if they have reserves or bonds…
Mitch83
“Why? Banks can buy wahtever they want no matter if they have reserves or bonds on their balance sheets.”
They can expand lending only if they can later buy reserves at reasonable price otherwise it’s not true. The price imposed by central bank can be to prohibitive (in order to reduce inflation).
“So “asset price inflation” has nothing to do with “too much debt liquidation”.”
I was talking about dumping government debt – read my comments to excerpts from Mosler’s book.
“The next thing is: “asset price inflation” does not equal price inflation.”
Yes but it is possible that rising for example commodities can increase not only headline inflation but also core inflation (especially if we are out of liquidity trap).
“As bonds don’t “finance” the US, the US doesn’t have to ensure that debt is bought at a reasonable price. Bonds are a pure moentary tool, no fiscal financing tool.”
It has to if it doesnt want inflation. And if you look at bonds as a pure monetary tool it only confirms my previous statement.
“And even if the US still issues bonds, it can always pay interest on those bonds no matter how high the yields.”
No because as I’ve said if inflation will be too high insolvency can be a better option even if per se it wont be necessary.
“Banks can buy whatever they want AND LEND HOW MUCH THEY WANT no matter if they have reserves or bonds”
No because of central bank policy. I’ve explained it above.
Tom, I think Scott Fullwiler addresses most of your concerns here.
“They can expand lending only if they can later buy reserves at reasonable price otherwise it’s not true. The price imposed by central bank can be to prohibitive (in order to reduce inflation).”
Banks charge the price (rate) first and acquire reserves later. What is the scenario where the CB would set the Fed Funds Rate to be too high? If you have high inflation MT would say that you’re not taxing enough, not that you need to hike up rates! MMT emphatically talks about using fiscal and not monetary tools to achieve full employment and price stability (functional finance). Your whole scenario is incoherent: People all of a sudden start dumping govt debt – where? Somebody else needs to buy this debt. People won’t buy new govt debt – their loss, if they don’t want to earn interest subsidy let them. Etc.
Peter please try to understand that we are debating full employment case not current liquidity trap situation. So again:
“What is the scenario where the CB would set the Fed Funds Rate to be too high? If you have high inflation MT would say that you’re not taxing enough, not that you need to hike up rates! MMT emphatically talks about using fiscal and not monetary tools to achieve full employment and price stability (functional finance).”
You can use either monetary policy or fiscal policy to cool inflation. But out of liquidity trap monetary policy can be more flexible because you dont need immediately to increase taxes by the whole congress. It’s sufficient that fed is doing his job (increasing if necessary interest rates).
“Your whole scenario is incoherent: People all of a sudden start dumping govt debt – where? Somebody else needs to buy this debt. People won’t buy new govt debt – their loss, if they don’t want to earn interest subsidy let them. Etc.”
Did you really read Mosler’s book or know how the monetary operations work? Because if you did you would know that moving money from saving accounts to checking accounts at the fed (investors stop rolling their debt) means that money is avaible to buy real stuff. And at full employment scenario it can give huge inflation boost. I’ve explained it already.
@Tom
“Because if you did you would know that moving money from saving accounts to checking accounts at the fed (investors stop rolling their debt) means that money is avaible to buy real stuff. And at full employment scenario it can give huge inflation boost.”
Not true.
The money on the checking account at the Fed (which only banks can have, NO INDIVIDUALS etc.), aka reserves, count as moentary base. Now read what Scott Fullwiler writes (thanks Peter D for the link):
“Returning to the main issue, Krugman here has invoked Assumption A—that the monetary base would matter if the economy wasn’t in a liquidity trap. The MMT response, as I’ve explained here, is that the size of the monetary base never matters per se. The currency component of the monetary base is entirely set in response to economic conditions, whereas reserve balances do not help banks “do” anything they couldn’t otherwise. Indeed, banks in Canada “do” exactly what banks in the US “do” even though the banking system in Canada has operated with 0 reserve balances for many years already.”
The size of the monetary base never matters per se (even if we aren’t in a liquidity trap) because banks can lend and purchase things no matter if they bonds or reserves on their balance sheets. For more detail read Scott Fullwiler (from Peter D’s link).
Mitch83
Ok I will look at Scott later. But I have to finish with you first:)
“Not true.
The money on the checking account at the Fed (which only banks can have, NO INDIVIDUALS etc.), aka reserves, count as moentary base.”
Mitch it doesnt matter if you have directly checking account at the Fed or indirectly (you have one in your bank it has at the Fed).
And we are not debating monetary base but something different (i.e. too much debt).
“The size of the monetary base never matters per se (even if we aren’t in a liquidity trap) because banks can lend and purchase things no matter if they bonds or reserves on their balance sheets.”
It is true but only in relation to banks and only partially because they are under influence of central bank which can manipulate interest rates to “enforce” proper behaviour by banks. But other entities can spend money on real stuff if interest rates are too low.
“Banks can as well buy these things when they have bonds instead of reserves (money on the checking account at the Fed), in the same amount.”
It’s true that banks can expand lending and create money and it can be inflationary. So the role of the central bank is to control it (e.g. by increasing interest rates). But we are talking about non-bank entity (for example China) which has a lot of government debt and if it will stop buying it there will be a lot of money to be spend on real stuff. And it is highly inflationary.
“Mitch it doesnt matter if you have directly checking account at the Fed or indirectly (you have one in your bank it has at the Fed).”
It matters. Your deposit in a checking account at a commercial bank is just a CLAIM on “central bank money” aka reserves/currency (aka monetary base).
If a country has reserve requirements (like the US), the banks have to hold a fraction of their customer deposits as reserves in their checking account at the Fed.
Only with reserves you can buy US Treasuries on an auction (primary market). If an individual wants to buy USTs, the corresponding bank buys them for him with their reserves, transferring the deposit on the checking account into a savings account.
“And we are not debating monetary base but something different (i.e. too much debt).”
The monetary base consists of reserves and currency.
To buy debt you need reserves. If the Fed buys USTs on the secondary market (like in QE2), it exchanges (swaps) USTs with reserves (increasing the monetary base).
So the monetary base is important when looking at US debt.
“It is true but only in relation to banks and only partially because they are under influence of central bank which can manipulate interest rates to “enforce” proper behaviour by banks. ”
The Fed (and PDs/Treasury) will always provide everything necessary to enable “financing” of the US, be sure.
“But we are talking about non-bank entity (for example China) which has a lot of government debt and if it will stop buying it there will be a lot of money to be spend on real stuff. And it is highly inflationary.”
Again, if China sells USTs, who cares (btw they would have to give up their peg to the Dollar in order to not buy infinite amounts of Dollars if the Dollar drops because of their selling and would have to stop exporting stuff to the US in order to not accumulate further Dollars)? Somebody else will have to hold these reserves and buy USTs.
If China dumps USTs like crazy (and crazily buying “USD real assets”) hurting the Dollar they will cut their own hand.
Did you really read Mosler’s book or know how the monetary operations work? Because if you did you would know that moving money from saving accounts to checking accounts at the fed (investors stop rolling their debt) means that money is avaible to buy real stuff. And at full employment scenario it can give huge inflation boost. I’ve explained it already.
You got the point exactly backwards! Money is always there to buy real stuff! This is what MMT term NFA is all about. It doesn’t matter if it is bonds or reserves – they are like saving and checking accounts. So, just as you’re never constrained by your savings account to buy stuff, neither is any of the bond holders. You really got the whole thing backwards! You don’t need to “bribe” bond holders with interest not to consume! They decided not to consume (~save) when they purchased your bond. If there were no bond, they’d have to look for another channel for their savings.
“They can expand lending only if they can later buy reserves at reasonable price otherwise it’s not true. The price imposed by central bank can be to prohibitive (in order to reduce inflation).”
If the Fed doesn’t pay IOR it does OMOs/repos/reverse repos to target excess reserves in order to get the overnight rate on the interbank market to their desired FFR.
So if banks lend without having excess reserves (as they normally do) the Fed HAS TO provide the necessary reserves to hold on to their target overnight rate. At a given rate the Fed has almost no control on the transmission from reserves to private lending (in normal times). It must be very prohibitive to really affect lending.
If the Fed pays IOR, bonds are not necessary (not even as monetary tool).
“I was talking about dumping government debt.”
No problem with it. If nobody wants to buy/hold on to US debt (highly unlikely, as you get no interest on reserves in contrast to bonds, and the private sector can’t get rid of reserves other than buying bonds, as well as bonds are “money” for most financial entities in the sense that they can pledge them as collateral on the repo market, sell them on the highly liquid bond market etc.) the US just stops issuing bonds.
In the end it’s all about one thing: Bond issuance doesn’t “finance” the US.
If you don’t understand this, you won’t understand my arguments.
Mitch83
“It must be very prohibitive to really affect lending.”
Mitch please try to understand that it is a goal of central bank to set interest rates in a way that banks wont lend “too much” (i.e. will not generate inflation).
“If nobody wants to buy/hold on to US debt(…) the US just stops issuing bonds”
Yes I know that you think that instead of issuing new debt government can just increase bank reserves (so called money printing). But I’m talking about something different. Old debt not rolled over can be used to buy real stuff (commodities, properties and so on). And it can be highly inflationary if debt level is very high and we are out of liquidity trap.
“In the end it’s all about one thing: Bond issuance doesn’t “finance” the US.”
But bond issuance/rolling can “freeze” old debt and not let it spill over to the economy which can be highly inflationary.
“If you don’t understand this, you won’t understand my arguments.”
Mitch I think that I understand MMT pretty well. Please try understand my arguments why MMT view on debt may not work outside of liquidity trap.
@Tom
“Old debt not rolled over can be used to buy real stuff (commodities, properties and so on)”
Banks can as well buy these things when they have bonds instead of reserves (money on the checking account at the Fed), in the same amount.
See Scott Fullwiler (in my above post) for details.
Mitch please try to understand that it is a goal of central bank to set interest rates in a way that banks wont lend “too much” (i.e. will not generate inflation).
That’s what they think and it just doesn’t work! The way to regulate bank lending is not thru reserve requirements (this totally doesn’t work, see “loans create deposits”) and not thru higher FFR (because this has the unfortunate effect of adding to the income channel and thus defeating some of the purpose). MMT doesn’t support this, see Mosler’s The Natural Rate of Interest Is Zero. Unless you stop using this argument as if it is consistent with MMT you’ll keep missing what we’re saying. MMTers want to abolish the Fed, for chrissake, since they have very little use for monetary policy! (The exception to this is Rodger Malcolm Mitchell, but he’s not a 100% MMTer and I am not too familiar with his arguments.)
The way to regulate bank lending if thru financial regulation and capital requirements.
OK Peter I’m tired already. I have only two questions:
Do you really think that if China decided not to hold US financial assets and instead buy real stuff in US there wouldnt be any inflationary schock? (let’s skip their internal problems that would emerge as a consequance we are talkin about US inflation)
Do you think that if US Congress every year were setting new tax rates to control inflation (or even more often take into account that Fed sometimes changes interest rates more then once a year) it could be efficient? And would you like to run business if you didnt know what taxes will be next year or maybe even next month?
Be honest please.
Tom, Chinese have limited options to buy real stuff in the US. But regardless, if they tired and sold their accumulated debt then somebody else would have to buy it and thus it is a wash in terms of inflation. What you’re likely asking is about maturing (non-rolled over) debt and current period trade deficit. This implies Chinese don’t want to save in $US anymore. What happens? As the debt matures (regardless whether you have it over time or one time) you’d have price level adjustments, which are non continuous. Inflation is a continuous rise in price level, not one time adjustments, which do happen all the time. Then and in parallel, according to this scenario, our CAD with Chinese reverses, since Chinese are no longer willing to sell us stuff for the same amount of dollars as before and are replaced by somebody else (including domestic, but as we’re talking full employment, then probably a further adjustment in the prices) till we reach a new indifference level. Then it settles. No further inflation etc.
And of course the whole scenario is highly unrealistic to begin with. For the Chinese to try to reverse their trade surplus with us, they’d have to find somebody else big enough (and running a trade deficit) to dump their stuff onto, and there just isn’t anybody like that. All adjustments like this are likely to be very dragged out.
Regarding tax rates, these better be set automatically via some inflation-targeted formula so as to take it out of Congress control. Similar to interest rate targeting by Fed, but more efficient, as stated above, and even less liable to be manipulated for political purposes. And just as people run businesses without know what the IR will be, they will adapt to changing tax rate. Wall Street will come up with tax rate derivatives to hedge the exposure etc. The idea is that the fiscal tool is much more efficient anyway, so, let’s move there.
Ok Peter this will be my last answer to you because I’m really tired and I cant understand how can you be so stubborn and not be able to answere simple questions.
“As the debt matures (regardless whether you have it over time or one time) you’d have price level adjustments, which are non continuous. Inflation is a continuous rise in price level, not one time adjustments, which do happen all the time. ”
Dude we are talking about a country which has US financial assets worth between 15-20% of US GDP. And youre talking about one time adjustment? You must be either uneducated or unintelligent. It could have devastating effects on US (and on China also but we are talking about US implications). And it doesnt matter if it is unrealistic or not. It only proves that level of debt matters and you cant deny it.
“Regarding tax rates, these better be set automatically via some inflation-targeted formula so as to take it out of Congress control. Similar to interest rate targeting by Fed, but more efficient, as stated above, and even less liable to be manipulated for political purposes.”
You must be really crazy if you think that any businessman would be happy with any “inflation-targeted formula” tax rate. More efficient? What are you talking about? What do you know about economy to think that it would be more efficient? If Congress was to change tax rates every year it would have devastating effects on the economy. And it would be upon high influence of different lobbyists and then effects would be even worse.
“And just as people run businesses without know what the IR will be, they will adapt to changing tax rate. Wall Street will come up with tax rate derivatives to hedge the exposure etc.”
So another deadweight loss because of different experts “helping” businessmen
to adjust to these weird ideas instead of concentrating on just doing business.
“The idea is that the fiscal tool is much more efficient anyway, so, let’s move there.”
Maby this idea is true in your head but not in reality. There is not any prove that fiscal policy is better then monetary policy outside of liquidity trap.
I’m now moving to Scott’s post.
Tom, I was not stubborn and was answering your questions. But you came up with unrealistic scenarios and expected a gotcha or something. Your idea that Chinese will commit a fiscal suicide by trying to stop rolling over their US debt all at once (even if it were possible in terms of maturities) is ridiculous. It is like saying but what if they attack us with a nuclear bomb – of course it is going to be painful, but it is not happening!
You must be either uneducated or unintelligent
This is not a way to talk, and I don’t appreciate it.
And it doesnt matter if it is unrealistic or not. It only proves that level of debt matters and you cant deny it.
OK, tomorrow a giant asteroid can hit the earth and kill everybody. It doesn’t matter if it is unrealistic or not, it proves that the asteroid menace matters and you cannot deny it. Come on!
You must be really crazy if you think that any businessman would be happy with any “inflation-targeted formula” tax rate. More efficient? What are you talking about? What do you know about economy to think that it would be more efficient? If Congress was to change tax rates every year it would have devastating effects on the economy. And it would be upon high influence of different lobbyists and then effects would be even worse.
It is not about being happy or not. Right now a group of unelected officials decide behind closed doors on interest rate targets. Do you think businessmen are happy about it? In fact, they accept is as a fact of life and move on. And the fact that it is more efficient is what out all experience of the last years is all about. Because the monetary tool hardly works. And why Krugman some years ago made a huge blunder recommending monetary solutions to Japan that did not work because the problem was never liquidity to begin with, but balance sheet recession. Because people decide to save vs spend not based on interest rate but based on economic outlook.
And tell me how is that coherent to advocate higher interest rates to fight inflation while a the same time lamenting the increased debt burden that it entails that can lead to … more inflation?
And finally how come even after I specifically state that tax rate should be adjusted automatically you keep trying to present my position as if I wanted Congress to change it every year? Who is unintelligent here?
Peter I didnt want to offend you, I was really tired yesterday I’m sorry.
I will try to convince you in another way.
There are this accounting identities (you can find them billy’s blog):
Deficits = Private Savings (Let’s skip current account: case of closed economy)
Deficits = change in government debt + change in high powered money
Let’s assume that debt=100% of GDP deficits=10% (case of US).
Now Peter please answer the question: what would happen if investors didnt want to hold US debt? What are the possible implications of these equations?
And please dont tell me about asteroids because people advocating government debt increase (in whatever form) should prove that there is no danger behind that policy.
And the fact is, you don’t have a stable tax rate anyhow even today! That’s why you need to buy TurboTax every year or pay the accountants to figure out all the little nitty gritty of tax advantages etc being phased-out or introduced. Under functional finance these adjustments are likely to be even more moderate.
Scott Fullwiler’s detailed answer:
http://www.nakedcapitalism.com/2011/03/scott-fulwiler-paul-krugman%E2%80%94the-conscience-of-a-neo-liberal.html
“Regarding reserve balances, the Economics 101 story is that banks use excess reserve balances to create loans. The reality is that a loan is created when a credit worthy borrower desires a loan at a bank’s stated interest rate (that is set consistent with the bank’s anticipated costs of liabilities and the anticipated credit risk of the borrower), and this loan creates a deposit for the borrower. No prior reserve balances necessary. If the bank is short its required reserves after creating the loan/deposit, it will borrow reserve balances in the wholesale markets; in the aggregate, the Fed will ensure sufficient reserve balances to meet requirements are available at its target rate, since that’s what it means to set a target rate. Should the borrower withdraw the deposit (as when a household takes out a mortgage and immediately uses the proceeds from the loan to buy a house), if the bank is short reserve balances to settle this payment it will automatically receive an overdraft to its reserve account and that it will clear by the end of business; again, the Fed ensures that sufficient aggregate balances are circulating that the target rate is achieved. For any individual bank, what matters is the cost of the liabilities the bank anticipates it will ultimately be left with as an offset to the newly created loan along with the capital charge associated with the loan. For this, it is the Fed’s target rate that can matter, but never the aggregate quantity of reserve balances circulating.
As an aside, it should be obvious that this all works exactly the same if a bank purchases, say, a bond from the private sector. The bank simply acquires the asset and credits the seller’s account with deposits. If this raises reserve requirements, then the bank acquires them in wholesale markets if necessary. If the seller banks at a different bank, then the bank may need to borrow in wholesale markets to cover an overdraft as it settles the bond purchase with the seller’s bank.
As with currency, an increase in reserve balances will occur in response to economic activity as reserve requirements increase after a loan has created a deposit (assuming the deposit ultimately remains a deposit and isn’t converted into a money market account or time deposit). More reserve balances don’t help banks make more loans; in the aggregate this will only reduce the overnight rate below the Fed’s target unless the Fed pays interest on reserve balances at its target rate as it has since late 2008.
This has been understood for decades by many heterodox economists operating under various titles such as MMT, neo-Chartalist, endogenous money, horizontalists, and Circuitistes. Particularly since 2008, an increasing number of mainstream monetary economists have started to figure this out, though it has yet to make its way to any of the undergraduate or graduate textbooks.”
Mitch,
Your comments all get hung up in the spam. I don’t know why. It must not like your German email address
. Perhaps try something else? Either way, I am not monitoring your comments so just an FYI….
Mitch83
I can agree with what Scott writes but he doesnt address the problem of accumulated debt.
And please read my questions to Peter and try to answer them.