Stephanie Kelton recently sat down with Dara McHugh, Co-Ordinator of Dublin-based Smart Taxes, to discuss Ireland’s debt problems and the economic prospects for the Irish economy. The interview appears in the June-August issue of Ireland’s Village Magazine.
Dara McHugh (DM): Can you discuss the fundamental features – and the fundamental flaws – of the design of the Euro system?
Stephanie Kelton (SK): The Euro is premised on a philosophy that is best characterized by the slogan, “One Market, One Money.” At the core of the Euro system is the European Central Bank, an institution that was given a limited but ostensibly critical role: keep a tight lid on inflation by strictly controlling the supply of euros. Because they could not conceive of an event that would trigger a breakdown in the payments system itself, the authors of the Maastricht Treaty did not give the ECB the statutory mandate to act as a ‘Lender of Last Resort’ in times of crisis. And, because a group largely composed of bankers (the Delors Committee) had written the blueprint for the Euro, it contained no systematic framework for regulating and supervising Europe’s financial institutions. Instead, the ECB was given a sole mandate: maintain price stability. These are significant departures from the customary modus operandi for a central bank.
Because they assumed that a sharp decline in output and employment would be rectified through emigration or a depreciation of the euro, the authors of the Maastricht Treaty saw no reason to create a fiscal analogue to the ECB, an institution that would bear responsibility for promoting growth and employment in the Eurozone. Instead, the political intention of the Treaty was to subordinate the role of fiscal policy, leaving it to the individual member nations to cope with a downturn by permitting only a modest increase in their deficits.
The problem, as everyone now observes, is that an individual member nation can find it impossible to engineer a recovery on its own.
During a recession, the private sector retrenches, preferring to save or pay down existing debts rather than parting with cash or borrowing to finance new purchases. Without an offsetting increase in demand – from the public or foreign sector – unemployment will rise and GDP will decline. The Maastricht Treaty assumed that a small increase in the deficit, together with some emigration, would be sufficient to bring about a recovery. That was wrong.
The bottom line is this: the Euro system contains a serious design flaw. It failed to recognize that it was designing a system that would cause its members to become more like Alaska, California or Utah than Australia, Canada or the US. That is, it was stripping them of their capacity to use their budgets to stabilise their own economies.
DM: What are the key differences between the Euro and another currency, such as the US Dollar?
SK: The primary difference is that the Euro can only be created by the ECB – it is the ISSUER of the currency. The governments of Ireland, Greece, Spain, Germany, etc. are the USERS of the currency. The implications of this distinction cannot be overstated.
Members of the Eurozone are like individual states in the US. Like California, Ireland must go out and ‘get’ the currency – either by taxing or borrowing – before it can spend. It must pay whatever financial markets demand, and it can be priced out of the market. It can become insolvent, and it can be forced to default on its debt.
In contrast, the Federal Reserve is the government’s bank. The government does not need to ‘get’ dollars before it can spend because it is the ISSUER of the currency. It simply spends by crediting bank accounts. It does not need to sell bonds in order to run a deficit, and it does not have to pay market rates. It can never become insolvent, and it can never be forced to default on its obligations.
DM: How do these differences affect the response to the Euro-zone debt crisis?
SK: The US has a monetary system that remains “wedded” to its fiscal system. The Euro system created a “divorce” between the fiscal and monetary institutions within each member nation. Because of this, members of the Eurozone cannot sustain the kind of deficits that can be run in the US. When rising interest rates and declining tax revenues force countries like Ireland and Greece into a substantial deficit position, they respond the same way Illinois and Georgia do – with massive spending cuts and tax increases to try to reduce the deficit.
DM: What is your opinion about the current response adopted by the peripheral economies and supported by the ECB?
SK: It is difficult to blame the peripheral economies for their response to the crisis (save Ireland’s bone-headed decision to add to its debt problems by bailing out foreign creditors). They are doing what they believe they must in order to avoid default and live up to the promises they made when they adopted the Euro.
As it stands, Greece, Ireland and Portugal have no choice but to try to meet the terms of the EU/IMF bailouts by driving through massive austerity programs. It is a policy response that could only have been engineered by a group of economists who lack even a basic understanding of first principles, and it is already yielding disastrous and perverse effects across the periphery.
Indeed, the European Commission has just reported that Greece’s deficit has failed to come down as expected. Any decent economist understands why. Pay cuts, layoffs, tax increases and the like will only reduce private sector incomes, dragging sales and tax revenues down along the way. Unfortunately, the EC has insisted that the government must push through even deeper cuts in order to satisfy the EU-IMF inspection team. This is the definition of economic malpractice.
DM: Do you see any better solutions to the debt crisis?
SK: First, let us be clear. What is currently in place is not a “solution.” The EU/IMF extortion program will not resolve the debt crisis – it will only prolong the ultimate demise of the Euro project.
In order to preserve the “Union,” the ECB must recognize that the member governments are neither responsible for the debt crisis nor capable of resolving it. The ECB must recognize the design flaw in the Euro system and, like Toyota, inform its users that it will take corrective measures to fix it. My good friend Warren Mosler – an expert in financial markets – has pointed out that it took 10 years for most analysts to discover the flaw in the Euro system but that it would take the ECB only 10 minutes to correct it.
The fundamental problem is that member nations have no safe funding mechanism under the existing system. To fix the problem, the ECB should create the euros that its member governments, as USERS of the currency, cannot. It would do this simply by crediting bank accounts, just like the Federal Reserve does when it transfers money to cash-strapped states in the wake of a national disaster. The funds could go directly into the member governments’ accounts, or they could be routed through the European Parliament, which could distribute them on a per-capita basis to all seventeen members of the Eurozone. Because these are transfer payments – not loans – the ECB would not seek repayment. A back-of-the-envelope calculation suggests that an annual distribution of about 10 percent of Euroland GDP would be sufficient to eliminate the funding risk, reduce borrowing costs, permit the repayment of debt and help to restore growth.
If the ECB refuses to create a safe funding mechanism for its member nations, then there may be no alternative but to abandon the euro and return to the more conventional “One Nation, One Money” arrangement.
DM: Why is currency sovereignty so important?
SK: Because without it you are merely the USER of the currency, no different from an individual state in the US. You have no independent monetary policy and very little control over your budget. You are at the mercy of financial markets, and your only hope is that some other source of demand will emerge and drag you out of the trenches.
Couple of suggestions. First "Euroland" is loaded language and undermines your credibility. Secondly, Eurozone members countries are not like US states, they are separate nations with different identities, very different income levels and there is very little appetite for fiscal transfers, therefore, suggestions like per capita money transfers are dead in the water I would think. Same sum of money is much more for, say, Estonia, Slovakia, Slovenia than for France and Germany. So please, can we get realistic here? No-one is going to accept proposals like that.
X Anonymous realistic solution?One Nation one money.
She is SUCH a good communicator!
re Anonymous @ 4:50pm:1) the comparison of European Nations within the EMU to US States is restricted to an analogy of their fiscal setup. This means: just like US states, European NAtions within the EMU "must go out and ‘get the currency – either by taxing or borrowing – before [they] can spend". That is the difference between the USER and the ISSUER of a currency. OF COURSE "Eurozone member countries are (…) separate nations with different identities, very different income levels"…..2) Per Capita Money transfers are not "Same sum of money" for each nation. As a matter of fact the exact opposite is true…3) PLEASE do name one proposal that is more "realistic", I'd be very interested in hearing it. Beware though, don't let the mainstream fool you, what is currently in place or other options being discussed are merely disguised as solutions but do not address the core of the problem…
Member countries are not like US states, because they have "different identities and very different income levels". Are you serious? Did you SEE the footage from Katrina? Have you been to the south? Trust me, we have VERY different identities and income levels (across states). But that doesn't prevent us from acting like a "union" when one of our own is in trouble. Out of curiosity, what is the difference between "Euroland" and the "Eurozone". i have used them interchangeably in many academic publications. They are both — in my usage — terms to refer to the geographic region that uses the euro. What's the secret meaning?
Is there is any political or popular control over the ECB? I ask that because to have the safe funding mechanism, wouldn't there need to be a political entity directly accountable to the public, something like a financial ombudsman?
I've long found the argument that this sort of proposal — i.e. Stephanie's — would be 'politically unrealistic' to be completely laughable.What does this mean?Does it means that certain segments of the Euroland (sorry, Eurozone) population would dislike fiscal transfers? Well, I'm sure they would. But the Eurocrats have long circumvented popular opinion in order to ensure the European project goes ahead (see: Lisbon, Nice etc).So, when people say 'politically unrealistic' what they really mean is that European leaders currently don't want to push such a proposal through. Well, that's a losing strategy and reflects the poor leadership that now characterises the European project.
"In contrast, the Federal Reserve is the government’s bank. The government does not need to ‘get’ dollars before it can spend because it is the ISSUER of the currency. It simply spends by crediting bank accounts. It does not need to sell bonds in order to run a deficit, and it does not have to pay market rates."I agree that is possible. I don't believe that is the way the system is set up now. The currency/demand deposits (medium of exchange) with no loan/bond attached is not allowed because it has been turned over to the fed. The fed enforces that all new medium of exchange has to be the demand deposits from debt. Even if that were to change, I don't believe that is the best way to get more currency/demand deposits (medium of exchange) with no loan/bond attached into circulation.IMO, crediting bank accounts and crediting reserve accounts with no loan/bond attached is the same as printing currency with no loan/bond attached. If the currency printing entity sends me $100,000 in currency with no loan/bond attached then I deposit it in the bank, won't the accounting end up the same? Selling the bond, debits the reserve accounts 1 to 1 so the fed funds rate is the same.And, "It can never become insolvent, and it can never be forced to default on its obligations."IMO, that depends on definitions. It can "never" become insolvent because the currency printing entity would be expected to make the bondholders whole (they get their currency/demand deposit back). Most investors and rating agencies would consider that a default. If that happened, investors would probably start saving in hard assets driving up their price, foreigners might not want to ship us goods, and there would be fewer buyers of the bonds meaning higher price inflation and higher interest rates.
@ 12.37PMThere's an awful lot wrong with what you just said, but this stood out:"…and there would be fewer buyers of the bonds meaning higher price inflation and higher interest rates."Didn't you just argue two paragraphs before that crediting accounts sans bond issue would affect the Fed funds rate? You're correct in that — it would drive the funds rate DOWN because there would be an excess of reserves that could be lent on the interbank market at a lower-rate.So, if your reasoning is correct, there would be LOWER, not HIGHER interest-rates.Tip of the iceberg, though.
Anonymous @12:55, sorry not specific enough.The overnight fed funds rate would probably be lower unless people started withdrawing currency and/or more debt started being created.I was referring to longer term interest rates.
"I was referring to longer term interest rates."Being higher, right?Well, QE1 and QE2 come to mind here. There we had a real world example of reserve issuance without bond issuance (indeed, the idea was, in part, to buy up bonds). This drove the interest-rates right down to the support rate (0.25% in the US) and this doesn't look like its going to change anytime soon.And, to ensure that we have the causality right (i.e. that this is QE at work), we turn to the other country that initiated QE: Britain. There the interest rate has stayed at the support rate (which is 0.50% in Britain).Here is the relevant data for the US (too lazy to dig up the UK). Interest rate:http://bit.ly/e5rTayProbable cause:http://bit.ly/iN9xf7
EDIT: "and/or more debt started being created."TO: "and/or more private debt started being created."
It is a simple argument, which the UMKC is always repeating. However, debts are remainig to be debts. Of course the Fed can create money as much as it wants, but when it creates more money or debts than the increase of the productivity of labour inflation will be the outcome. It is too simple to define sovereign money as the deus ex machina. This theory has asignificant lack: It has no theory of value.
And you, I'm afraid, have a theory with no empirical, real-world support. What is your model? How fast does your model predict that inflation will rise when the money supply (which measure?) grows faster than productivity? The Fed creates money every time it makes a purchase. A trillion dollar increase in the money supply has no impact whatsoever on the inflation rate. It merely results in a credit to a bank's bank account at the Fed.
Unless and until something more takes place, which is what I'm waiting to hear from you. Model, please.
"I was referring to longer term interest rates."Being higher, right?Well, QE1 and QE2 come to mind here. There we had a real world example of reserve issuance without bond issuance (indeed, the idea was, in part, to buy up bonds)."Central bank reserves aren't a medium of exchange in the real economy."This drove the interest-rates right down to the support rate (0.25% in the US) and this doesn't look like its going to change anytime soon."By interest-rates, do you mean the overnight fed funds rate?Here is billy blog's quiz for June 11, 2011:http://bilbo.economicoutlook.net/blog/?p=14869Check out Q2 and the Q2 chart. Plus, near the end of the explanation for Q2."The answer to the question is thus False because the simple act of paying interest on reserves does not necessarily eliminate the need for open market operations. It all depends on where the support rate is set. Only if it set equal to the policy rate will there be no need for the central bank to manage liquidity via open market operations."If so, I agree with that.
Eh, I think you misunderstood my comment."Central bank reserves aren't a medium of exchange in the real economy."That's not relevant, we're talking about interest-rates."By interest-rates, do you mean the overnight fed funds rate?"Is there any real difference? I think most people refer to the interest-rate as the Fed funds rate over the course of the year. So, to 'set the interest-rate' is 'to set the Fed funds rate'.
Anonymous @ 3:52I'm referring to the fed attempting to use the overnight fed funds rate to influence the amount of medium of exchange and its velocity. That is relevant to the economy.IMO, there is a difference between the interest rate (overnight fed funds rate) and interest rates (meaning other rates).By longer term interest rates, I mean things like a 5 year treasury or a 10 year treasury. It is possible the fed could lower the fed funds rate and interest rates on 5 year treasuries and/or 10 year treasuries could go up.
Nice to hear someone having the same simple idea I had to get out of this dead end road. Just giving each government new money to pay off it's sovereign debt on a per capita basis. This, until the lowest ranking governments are out of their negative spiral. After that new rules could be implemented to avoid big deficits.
Il me semble que l'Europe c'est pas "l'hopital qui ce fou de la charité". C'est à dire et particulièrement en ireland qui bénéficie de taxe sur les sociétés avantageuse, l'Europe à essayé de répartir d'une certaine façon les aides par rapport aux besoins de chacun et aussi à leur compétence. L'europe n'est pas en danger, elle est en travaux. Son devoir c'est trouver es solutions que pour l'instant elle assume. L'euro garantie la paix en europe et malgré les antagonismes politiques qui opposent les eurosceptique (parfois europhobe) et les pragmatiques, l'Europe fonctionne. Elle doit sortir renforcer de cette crise unie dans un contexte de monté du protectionnisme. L'Irlande souffre il est vrais que son taux de chomage touche 14% de sa population active. En 1995 celui-ci était de + de 15%. Il est vrai que par rapport aux 10% de la zone euro, l'Eire est un des parents pauvre de l'Europe et je ne crois pas que celle-ci l'oublie. PS : Scuse for my french langage.http://ericlemiere.blogspot.com/
2001 the Greek public debt was 127% relative to GDP. I assume most of that was in the local Greek currency that could be created by fiat in Greece. Overnight it was converted to a "foreign" currency the Euro that was controlled by a foreign body, the ECB.What did they think, did they think at all?Credits to Greece private sector went from about 45% of GDP to 95%. Greek trade was on a rising trend from 1994 to 2000 (42%/GDP to 63%) during the Euro period it declined to 48% 2009. And with a sharply deteriorating Current Account balance.Greece of course have its problems with a bad organized and inefficient society but overall the growth in the “piigs” was probably basically sound with a modest expansionary economics, it was the rest with financial “austerity” and mercantilist policies that slowed growth overall in Europe. The “freed” financial institutions couldn’t find borrowers at home they had to seek them in the growth areas of EU creating a real estate bubble in some parts.But expansionary economics that promote domestic growth require the countries to be sovereign in their own currency to be able to parry increased imports.A few Geek charts from WB data“Europe is "a monument to the vanity of intellectuals, a programme whose inevitable destiny is failure: only the scale of the final damage is in doubt"”Margaret Thatcher
hi Stephanie, there's something that i don't understand. I understand the difference between users and issuers but technically I miss a point. If banks in USA (for example) buy securities from the government and so, reserves to purchase these securities come from the FED (like Scott, you and others say), and so every deficit spending is in HPM, what's the difference in Europe?States sells bond to primary dealers, but reserve to buy securities come from ECB, no? what's the difference?