By Stephanie Kelton
As followers of this blog have discovered, we work within a framework that has been dubbed Modern Money Theory (MMT). The approach itself is fundamentally descriptive, although there are logical ways to apply the principles of the approach to any number of policy-oriented (i.e. prescriptive) economic problems. Above all, we are committed to describing the way government spending works in a modern money system. Once that is understood, it becomes apparent that a government with flexible exchange rates and a sovereign currency (US dollar, British pound, Mexican peso, etc.) can afford to purchase anything that is for sale in its own sovereign currency.
This means that debates about “affordability” become inapplicable. As this becomes more widely understood, we can begin to have a completely different — and vastly more important — debate about the size and role of government. What do we, as Americans, want? Medicare for all? A job guarantee? High-speed rail? Renewable energy?
As promoters of MMT, we are all very keen on Abba Lerner, who was one of the first to articulate the foundations of the approach. Lerner believed that the government should maintain the level of aggregate spending in the economy (either by reducing taxes, increasing its own spending or a combination of the two) at the rate consistent with full employment. We agree. This is the overarching goal. How we get there is, as I said, a matter of (political/social) choice.
But we cannot ‘get there’ until we dispense, once-and-for-all, with the erroneous belief that deficit spending is reckless and irresponsible, something akin to “fiscal child abuse”, as Kotlikoff and Burns so disgracefully characterized it.
Insteaad, just remember this fundamental accounting identity:
Private Sector Surplus = Public Sector Deficit + Current Account Surplus
For me, this is the most important identity in economics. It holds true in every nation at every point in time, and it is useful when you run thought experiments like, for example, “What will happen to the private sector’s balance sheet position if the government’s budget is cut by X% of GDP and the current account deficit remains Y% of GDP?”
So, for example, in the US we have a current account deficit of, roughly, 5% of GDP. This SUBTRACTS from the Private Sector Surplus. So, the only way the private sector can have positive net savings (i.e. a surplus) is for the government to run a deficit that is LARGER than the current account deficit. This is exactly what the government has been doing, and it is the reason the private sector has managed to sharply increase its savings in the downturn. Cutting the public sector deficit will reduce the private sector surplus one-for-one in a closed economy (i.e. one with no foreign trade and therefore no current account). It is an easy way to demonstrate that the government’s deficit is the private sector’s surplus.
So the next time someone tells you that the US government cannot “afford” to keep its promises to retirees, fund the arts, build bullet trains, and so on, ask them whether they understand any of this!
** And, no, it does not follow that because the US government “can” do something that it “should” do it. It has the ability to puchase anything for sale in terms of its own currency. Let us accept that point and then debate whether, when, and to what extent it should exercise this power.
Stephanie, Thank you for detailed explanations and voice of realism in what is often ill-informed, emotion-laden, ideological rant. I suppose you have been aware of the 7-8 Mar 2011 IMF conference sponsored by Olivier Blanchard to re-think IMF assumptions on macro issues in light of recent crisis. http://www.imf.org/external/np/seminars/eng/2011/res/index.htm Although James Galbreath was in the audience for at least one session, it does not appear that modern monetary theory or even functional finance got much, if any, airing. I would have suggested that the IMF re-think first the role of government in terms of promoting low unemployment (if not full employment) and environment stability as well as traditional metrics of price stability and growth. But that did not happen. Instead, the same tired old discussions about deficits creating too high government debt levels with arbitrary Rogoff Rheinhart-type over generalisations on critical debt ratios. I did send an email to the conference at their designated contact address that perhaps they should have included a bit more balanced perspective and mentioned your name as well as others. Although it is wonderful that Blanchard is suggesting the IMF might want to re-consider its views, it appears this might not go much beyond endorsing capital controls in limited situations.
It seems so obvious, but why don't very smart, educated, and liberal economists understand all this? Children know that if you have a printing press in your basement, you don't need a job or to borrow money. But even Simon Johnson is adamant about getting the "fiscal house in order." Is it cynicism, ignorance, conflict of interest?
In a footnote? You deal with spending restraint in a footnote?? Preaching to the choir.
OK, so MMT can deal with the overall economy. What does MMT say about the inequality of income, wealth and the accumulation of private and corporate debt? The common person in Europe and Japan seems to have a much higher standard of living than the common person in the US, presumably because of a more even distribution of income and benefits.
Arthurian — Yes. We think unemployment is public enemy #1. You think it is inflation. So you are prepared to prevent millions of Americans who are ready, willing and able to work from securing employment (or, gasp!, being afforded the RIGHT to a job) because you believe we "need" the unemployed in order to keep the price of broccoli in check. Does experience matter at all? The unemployment rate fell to 3.7% during the so-called "Cllinton Boom". And …… did prices spiral out of control? Not even close! We enjoyed full employment AND price stability. So what is the basis for your concern? Some defunct macro construct? Phillips Curve? NAIRU? What is the transmission mechanism that gets you all worked up?Inflation, when it emerges, will be driven — as usual — by what's happening on the supply-side (commodity prices) of the economy. But have no fear, folks like you will connect the dots in an entirely predictable fashion: The Fed "pumped too much money into the economy" (think QE1 and QE2) and it caused prices to spiral out of control. But, by all means, don't let the facts stand in the way of your agenda. Jon Arts — Plenty. Read Jamie Galbraith. He is firmly in the MMT camp, and he has done terrific work in this area. Keynes understood this too, as did Greenspan! I keep meaning to write a blog on this topic, so maybe this is my motivation. I have been thinking a lot about the relationship between reductions in the marginal tax rate(s), rising inequality and asset price bubbles.In the meantime, look for posts by Eric Tymoigne, who has addressed distibutional issues related to the distribution of debt.
@JonLerner would probably be a good one to go to on this, though I don't have any particular references on hand. I also think a good starting point would be the last chapter of Keynes' General Theory (in which he addressed the second part of his famous quote: "The outstanding faults of the economic society in which we live are its failure to provide for full employment and its arbitrary and inequitable distribution of wealth and incomes.") Dated of course, but still a good, and pertinent, read.
Stephanie, don't attack Arthurian – he is pointing to an important hurdle that MMT has to clear if it wants to really make it to the masses. You have to make sure nobody thinks MMT is advocating a free lunch and this does require erring on the side of caution in your presentations. Like in your Huffington Post piece you were saying:And so the question is not whether the government needs to make "tough choices" in order to keep these vital programs afloat. The question is, will politicians make the toughest choice of all and tell the American people the truth: Social Security and Medicare face no financial crisis now or in the future.You need to assume that people reading this don't have all the mental shortcuts of MMT and what you're saying to them sounds ridiculously close to "you can spend all you want and have a free lunch".
some have argued that increasing the government deficit will increase both the private sector surplus and the current account deficit, and that while the former is good, the latter is considered a risky development on its own how would you respond to that?
Wow.Yes. We think unemployment is public enemy #1. You think it is inflation. So you are prepared to prevent millions of Americans who are ready, willing and able to work from securing employment (or, gasp!, being afforded the RIGHT to a job) because you believe we "need" the unemployed in order to keep the price of broccoli in check. No. I think the problem is a combination of inflation and unemployment. It is the same problem, unresolved, that was called "stagflation" back in the early 1970s. The problem has never solved because it is always handled as two separate problems.The right solution lies in the area of "the inequality of income, wealth and the accumulation of private and corporate debt." But inequality of wealth and income was a solution, applied by Reagan. The original problem is excessive accumulation of private-sector debt. Jon Arts' concerns are right on.
Excellent!And we all have our own way of saying the same thing. For example, you stated:"So, for example, in the US we have a current account deficit of, roughly, 5% of GDP. This SUBTRACTS from the Private Sector Surplus."I like to say it this way- Both residents and non residents (called the foreign sector) desire to save $US financial assets. So some of the US govt deficit winds up as savings by foreigners and some winds up as saving by the US domestic sector. So cutting the Govt. deficit is always a deflationary bias that reduces spending and employment, forcing the domestic sector to survive with less income and less savings, which is another way of saying more debt. Most people's savings are in pension funds, ira's, and other accounts, and your total savings is your actual savings minus your debt. So when you start using credit cards and loans instead of income it means your total net savings is going down. And when you pay down your debt your total net savings is going up.
Genuinely naive question here: What happens to a countries external trade and input costs if they're create money like this?
@Warren "forcing the domestic sector to survive with less income and less savings, which is another way of saying more debt"Savings and private debt aren't inverse to each other are they? It's possible that you can survive on less income without going into personal debt right??
What Dr Kelton says seems dead obvious once one sees how money operates as tokens (chartalism). Understanding this concept was a type of enlightenment (light bulb) for me.I suspect that most of our elected officials don't have this insight at all. Proponents of MMT should be making a concerted effort to lobby/educate our elected officials. Otherwise there is no chance of informed debate.
What happens to the value of the US dollar when the trillions of dollars issued by gov't go, not to the private sector to grow the economy, but instead to the big banks who then "invest" in ponzi-like speculative schemes or hoard commodities by "investing" in the futures market, or put it into various investments in the emerging markets; and in addition when the gov't pours further trillions into the wars abroad, creating a monstrous armaments-military complex?
Thank you, Stephanie, for sharing all these insights into how the economy functions. I can see the word is getting around. Here's a similar take I recently read coming from Canada: http://fictionalbarking.blogspot.com/2011/03/economys-flow-of-funds-is-closed-system.html
The chart attached to the blog http://fictionalbarking.blogspot.com/2011/03/economys-flow-of-funds-is-closed-system.html of Anonymous above is a great illustration. Stephanie, if your are going to expand on this all, there are two subjects that you also may consider: 1) the state and municipal deficits and debts, and 2) the expenditures on defense and wars. Relating to the second subject, we hear little about the direction of innovation and production to arms that are either destroyed or become obsolete, or about the negative multiplier of wars in that a $1000 bomb can easily destroy a $200,000 home or business plus many lives although the destruction [luckily?] occurs in foreign countries.
Usually simple is good but this analysis is simply too simple. It's the equivalent of telling us that "farts smell", i.e. thanks for the info.The key missing ingredient is the massive social collateral damage that ensues from continuing to follow the MMT formula. If it's so simple as MMT is there massive economic unrest in our country?Wouldn't it be more prudent for our leaders to let everyone know that most economic policy decisions create wealth redistribution and sacrifice? The delusion that our economic system lifts all ships needs to stop. Sure, Social Security may be there when you retire but do any of us really think it's going to enable the retirement utopia people have envisioned?Sorry, the MMT is completely linear. Sounds like another new finance paradigm to me.
Thanks, very informative post
Since you 're on the subject i 'd like to ask a few questions:1) A bit technical. When a government deficit is spent, an equal amount is issued as debt. Nevertheless, a percentage of the deficit needs to be retained as reserves on the banks on which it was deposited. Is it right to assume that the Central Bank will perform open market operations in order to allow for a $-for-$ debt issuance regardless of the required bank accounts reserve ratio?2) Who's the chicken and who's the egg in the 'double deficits' story? Is the trade (and current accounts) deficit an outcome of government deficits (and private sector saving desires) or the result of government policies (prioritizing industries, consumer product taxes, etc)? How can a government target it's deficit spending to increase it's domestic production instead of just increasing capacity utilization of it's trade partners?
Hello Kostas,Regarding 1, since the Fed is not allowed to provide overdrafts to the Tsy, what happens is the Tsy will issue securities for all of its deficit. If as a result of the deficit there is an increase in required reserves, then the Fed will engage in open market operations to add the balances. In the latter case, yes, the securities held by the non-govt sector have been replaced with reserve balances.Regarding 2, I would argue that the trade balance is about the blend of govt deficit, pvt saving desires, and rest of the world desired net saving. I don't think one can separate govt deficits from govt policies–the policy to prioritize industries, etc., will affect the trade balance (by altering the size of the govt deficit consistent with full capacity utilization), but so will the policy to more directly reduce a budget deficit (via reduced imports). Either one can lead, in my view. Then one must also add to the mix the motives of the rest of the world–e.g., for the US, the desired net $US saving by its trading partners clearly affects the magnitude by which govt deficits or govt policies as you've defined them would have to be altered to create a trade surplus. Best,Scott Fullwiler
Paul Krugman has (I believe) misrepresented MMT's position on government deficits (http://tinyurl.com/6auwnsr). According to him, MMT says that deficits never matter and then knocks down the straw man by saying that large deficits would be inflationary under full employment conditions. I like most of Krugman's blog and columns, but I think he hasn't done his homework on this one. Anyone from UMKC preparing a response?
"This is exactly what the government has been doing, and it is the reason the private sector has managed to sharply increase its savings in the downturn."Increase its net savings. The private sector can increase its savings all by itself–regardless of the govt's deficit.Further, your accounting identity is just an identity that links a bunch of nominal flows. It doesn't tell you anything about real GDP or real savings or any of that."a government with flexible exchange rates and a sovereign currency… can afford to purchase anything that is for sale in its own sovereign currency."If a govt's current real consumption is greater than the present discounted value of its real income, then it cannot afford to pay off its debts, by definition. That's what neoclassicals mean by a govt budget constraint.
Vimothy,You are criticizing the use of the sectoral balances approach because it doesn't "tell you anything about real GDP or real savings or any of that", and then you invoke the neoclassical government budget constraint. What am I supposed to do, criticize the GBC because it doesn't tell you anything about the exchange rate? Your assertion that the government "cannot afford to pay off its debts" completely misunderstands the issue. As the monopoly issuer of the US dollar, the US government can ALWAYS AFFORD to meet any/all dollar obligations on time and in full. It is the ISSUER of the currency. You and I are the USERS. The government's obligations — to bondholders, seniors, etc. — are ALL nominal. There is no obligation to provide REAL resources and, hence, no constraint on the government's ability to make payments.
Why do you care about nominal flows? If nominal income is increasing, but real income is decreasing, are we better of, as a whole? We are not. The nominal flows are interesting only insofar as they tell us about the underlying real flows, and to get to them you need economic theory and not just tautologies.Increasing nominal net saving, for instance, should not be an end in itself, because you can't tell if real private saving has increased simply by virtue of the fact that the sum of sector financial balances is zero.The GBC is not an identity–it is an inequality defining the condition the government must satisfy if it is to be able to discharge its obligations in real terms."As the monopoly issuer of the US dollar, the US government can ALWAYS AFFORD to meet any/all dollar obligations on time and in full"This is another tautology. To pay its debts in real terms, govt needs real income from tax revenue."The government's obligations — to bondholders, seniors, etc. — are ALL nominal"They are (mostly) denominated in dollars, I agree. You're saying that the government can borrow money and repay the debt in money that is worth less–but I think most people would prefer it if the govt did not increase its revenue through seigniorage and take that as a given. And since this is necessarily zero sum, the increase in its income via seigniorage comes at the expense of private income, i.e. that is (implicitly) a tax. We can incorporate this into the govt's intertemporal constraint as well.I dunno–I've given this a fair bit of thought by now and have my own take on MMT. I guess you probably think I don't understand or don't want to but there it is!Regards
"The GBC is not an identity–it is an inequality defining the condition the government must satisfy if it is to be able to discharge its obligations in real terms."I would reject this interpretation. All the IGBC does is tell you how big deficits can be, given the interest rate and growth rate, without debt service growing unbounded. The obligations are in nominal terms. Consider the case with the interest rate below the growth rate–which has been the case on average for the past 70 years in the US. There, the govt must run primary deficits forever or the debt ratio will actually fall. Where is the obligation "in real terms" there?Best,Scott Fullwiler