MMP BLOG # 3 RESPONSES

Thank you for comments and questions. Let me divide the responses into several different issues.

1. “Sustainability Conditions” for Government Deficits

I said: “If you want to take a guess at what our “mirror image” in the graph above will look like after economic recovery, I would guess that we will return close to our long-run average: a private sector surplus of 2% of GDP, a current account deficit of 3% of GDP and a government deficit of 5% of GDP. In our simple equation it will look like this:

Private Balance (+2) + Government Balance (-5) + Foreign Balance (+3) = 0.

And so we are back to the concept of zero!”

Now I want to be clear, I said nothing to imply these particular sectoral balances would continue on through infinity to the sweet hereafter. What I gave was a contingent statement (what the balances would look like AFTER recovery and if we return to LONG-RUN AVERAGES—that is to say, average stances over the past 30 years or so, taking into account trends—essentially just eye-balling the 3 sectors graph provided in the blog). I have made no projection that we actually WILL recover, and it is certainly possible that even after recovery our private sector balance will remain in high surplus. Let us say it remains at 6% (which would be higher than average but consistent with an attempt to delever debt—that is, to keep consumption low in order to pay down debt). In that case, and again assuming the foreign balance remains a positive 3% (that is, our current account deficit is 3%) then the government will remain in deficit of 9% (more or less where it is now). I will not place probabilities on these two outcomes—I think the original statement is more likely—because my main point is simply that taking balances of each of the 3 sectors, the overall balance must be 0.

For those who would like to balance the government budget, the burden is on them to tell me what the implied outcome for the private and foreign sectors will be. If we are not going to return to the disastrous “Goldilocks” outcome with the private sector running deficits, then a huge adjustment will be necessary in the foreign balance in order to have a balanced government budget with a private sector surplus. Virtually none of the deficit hawks consider this. But, again, I would like to hear their explanation for how we will get the current account into surplus.

On to the sustainability conditions. It has become trendy among economist wonks to look at government budget stances to determine whether they could continue forever. Many objections could be raised to such purely mental exercises. An obvious one is that no government has ever lasted forever—and so any such exercise is a waste of time. Ok that one is not something we want to contemplate. Economist Herb Stein quipped that unsustainable processes will not be sustained. Something will change. That gets us somewhat closer to the problem with such approaches. And finally, if we are dealing with sovereign budget deficits we must first understand WHAT is not sustainable, and what is. That requires that we need to do sensible exercises. The one that the deficit hysterians propose is not sensible.

Let us first look at a somewhat simpler unsustainable process. Suppose that some guy—we’ll use the name Ramanan—decides to replicate the “Supersize me” experiment (based on the 2004 documentary by Morgan Spurlock). His caloric intake is 5000 calories a day, and he burns 2000 daily. The excess 3000 calories lets him gain one pound of body weight each day. If he weighed 200 pounds on January 1, by the end of the year he weighs 565 pounds. After 100 years he’s up to 36,700 pounds—a bit on the pudgy side. But we don’t stop there. After 100,000 years he weighs 36,700,000 pounds, and after a few million years, he’s heavy enough to affect the earth’s spin on its axis and its revolutions about the sun. But, according to our policy wonks, that still is not a long enough period—we’ve got to carry this out to infinity, at which point, Ramanan is infinite sized, like the universe, and if he is growing faster than the expansion of the universe, the entire rest of the universe will eventually be infinitesimally smaller than Ramanan. I guess he’s become the black hole of the universe (but I’m no physicist or biologist). So, yes this is unsustainable. Aren’t we all clever?

But would the process actually work that way? Of course not. First, Ramanan is not going to live an infinite number of years; second, he’s either going to blow up (literally) or go on a diet; and third, and most important, his body is going to adjust. As his body mass increases, he will burn more than 2000 calories a day—perhaps he’ll get up to a 5000 calorie a day burn-rate—and his body will use the food in a less efficient manner. So he will stop gaining weight long before he becomes the universe’s black hole. Herb Stein was right.

Our little mental exercise was fundamentally flawed. It assumed a fixed caloric input (flow) and a fixed caloric burn-rate (consumption flow) with the difference between the two accumulating as a stock (weight gain) at a fixed rate (essentially, “savings”). No adjustments to behavior or metabolism are allowed. And then the whole absurd set-up is carried to the ultimate absurdity by the use of infinite horizon projections. Anything carried to a logical absurdity is unsustainable. As you will see, this is the rigged game used by deficit warriors to “prove” the US Federal budget deficit is unsustainable.

The trick used by deficit warriors is similar but with the inputs and outputs reversed. Rather than caloric inputs, we have GDP growth as the input; rather than burning calories, we pay interest; and rather than weight gain as the output we have budget deficits accumulating to government debt outstanding. To rig the little model to ensure it is not sustainable, we have the interest rate higher than the growth rate—just as we had Ramanan’s caloric input at 5000 calories and his burn rate at only 2000—and this will ensure that the debt ratio grows (just as we ensured that Ramanan’s waistline grew without limit). Let us see how this works.

We will start with a simple example similar to the one used in our blog and response last week. Let us have two sectors, government and private. Our government follows the Goldilocks model, spending less than its income (tax revenue); the private sector by identity runs a deficit (spends more than its income). We know this means the private sector is running up debt, held by the government as its asset (surpluses are realized in the form of private sector IOUs). The private sector must service the debt by paying interest; that of course adds to its deficit (interest is additional spending it must make out of its income). In comparison to our Supersizing Ramanan, the sustainability conditions will be determined by the interest rate paid, the growth rate of income (or GDP), and the deficit of the private sector.

Jamie Galbraith laid out the typical model used to evaluate sustainability of deficit spending as follows:

The key formula is:

Δd = –s + d * [(r – g)/(1 + g)]

Here, d is the starting ratio of debt to GDP, s is the “primary surplus” or budget surplus after deducting net interest payments (as shares of GDP), r is the real interest rate, and g is the real rate of GDP growth. (http://www.levyinstitute.org/publications/?docid=1379)

Now, this is wonky but the key idea is that (given a relation between the primary surplus and starting debt–both as ratios to GDP) so long as the interest rate (r) is above the growth rate (g) the debt ratio is going to grow. (Jamie has put these key terms in “real”—that is inflation adjusted—terms but that really does not matter; we can keep it all in nominal terms since “deflation” by the inflation rate merely reduces all terms by the inflation rate). Note that the starting debt ratio (d) as well as the primary surplus (what the private sector’s budget would be if it did not have to pay interest) also play a role. (Galbraith proves that the starting debt ratio does not matter much—just as Ramanan’s initial weight will not matter since in any case he will grow to an infinite size.) But we do not need to get too hung up in math to see that all things equal if the interest rate is above the growth rate, we get a rising debt ratio. If we carry this through eternity, that ratio gets big. Really big. Ok that sounds bad. And it is. Remember, that is a big part of the reason that the GFC hit—overindebted private sector. The GFC is the equivalent to an explosion of Ramanan that would prevent him from growing to an infinite size. (A debt diet would have been far preferable, but Greenspan and Bernanke opposed “interfering” with Wall Street lender fraud.)

Now let us change all this around. Let us say that the government runs a continuous budget deficit while the private sector runs a surplus. We can obtain the same equation. It appears that a continuous government budget deficit implies a continuously rising debt to GDP ratio and surely that is unsustainable. (See the appendix below for more complex math.)

But wait a minute. Is such a mental exercise sensible? We already saw that our supersizing Ramanan is going to adjust: he will diet, explode, increase his metabolism, and reduce the efficiency of his absorption of calories. If he does not explode, he will reach some “equilibrium” in which his intake of calories will equal his burn-rate so that his waistline will stop growing. What about our supersizing government? Here are the possible consequences of a persistent deficit that implies rising interest payments and debt ratios:

  1. Inflation: this tends to increase tax revenues so that they grow faster than government spending, thus lowering deficits. (Many, including Galbraith, would point to the tendency to generate “negative” interest rates.) In other words the growth rate will rise above the interest rate, and reverse the dynamics so that the debt ratio stops growing. (That is equivalent to an increase of Ramanan’s caloric burn rate—so he stops growing.)
  2. Austerity: government can try to adjust its fiscal stance (increasing taxes and reducing spending to lower its defict). Of course, it takes “two to tango”—raising tax rates might not change the government’s balance. It could lower growth rates, and thereby actually increase the rate of growth of the debt ratio.
  3. The private sector will adjust its flows (spending and saving) in response to the government’s stance. If government continually spends more than its income, it will be adding net wealth to the private sector; and its interest payments will add to private sector income. It is not plausible to believe that as the government’s debt ratio goes toward infinity (which means that the private sector’s net wealth ratio goes to infinity) there is no induced spending in the private sector. That is usually called the “wealth effect”. In other words, government debt is private wealth and as private wealth grows without limit this will eventually cause spending to rise relative to private sector income—reducing government deficits. In addition, private sector income includes government interest payments, so rising government interest payments on its debt could induce consumption. When all is said and done, the private sector will not be happy consuming less than its income flow—given its rising wealth—and will adjust its saving behavior. If the private sector tries to reduce its surpluses, this can be done only by reducing the government sector’s deficits. It takes two to tango and the likely result is that tax revenues and consumption will rise, the government’s deficit will fall, and the private sector’s surplus will fall.
  4. Government deficit spending and interest payments could increase the growth rate; it can be pushed above the interest rate. This changes the dynamics and can stop the growth of the debt ratio.
  5. The interest rate is a policy variable (as will be discussed in subsequent weeks). Ignoring all the dynamics discussed in the previous points, to avoid an exploding debt ratio, all the government needs to do is to lower the interest rate below the economic growth rate. End of story, sustainability achieved.

Finally, and this is the most contentious point. Suppose none of the dynamics just discussed come into play, so the government’s debt ratio rises on trend. Will a sovereign government be forced to miss an interest payment—no matter how big that becomes? The answer is a simple “no”. It will take weeks of explication of MMT to explain why. But let us put this in the simple terms that Chairman Bernanke used to explain all the Fed spending to bail-out Wall Street: government spends using keystrokes, or, electronic entries on balance sheets. There is no technical or operational limit to its ability to do that. So long as there are keyboard keys to stroke, government can stroke them to produce interest payments credited to balance sheets.

And that finally gets us to the difference between perpetual private sector deficit spending versus perpetual government sector deficits: the first really is unsustainable while the second is not. Now, I want to be clear. We have argued that persistent government budget deficits that increase government debt ratios and thus private wealth ratios will lead to behavioral changes. They could lead to inflation. They could lead to policy changes. Hence, they are not likely to last “forever”. So when I say they are “sustainable” I merely mean in the sense that sovereign government can continue to make all payments as they come due—including interest payments—no matter how big those payments become. It might choose not to make those payments. And the mere act of making those payments will likely cause changes in growth rates and budget deficits and growth of debt rations.

2. “Sustainability” of Current Account ratios:

In the quote at the top of this response there was also a contingent statement about US current account deficits. To be more clear (and thus to respond to comments), the current account includes the balance of trade (and, more broadly, the balance between exports and imports) plus some other items including “factor payments” (interest and profits paid and received). For the US, we obviously run a trade deficit (and exports are less than imports), but the factor payments are in our favor (we receive more in profits and interest from abroad than we pay to foreign creditors and owners). In any event, our negative current account balance is offset by a positive capital account balance. To put it simply—there is a “flow” of dollars abroad due to the current account deficit that is matched by the “flow” of dollars back to the US due to our capital account surplus. This is often (misleadingly) presented as US “borrowing” of dollars to “pay for” our trade deficit. We could just as well put it this way: the US imports more than it exports because the rest of the world wants to accumulate savings in dollar-denominated assets. I do not want to go into that in detail since it is the subject of later blogs.

But here’s the question. Is a continuous current account deficit possible? A simple answer is yes, so long as “two want to tango”: if the rest of the world wants dollar assets and Americans want rest of world exports (imported to the US), this will continue. But, hold it, say the worriers. As the rest of the world accumulates dollar claims on the US, they also receive interest payments. That is a factor payment that increases our current account deficit. You can see the relation to the point above about government deficits and interest payments. The world will be flooded with dollars twice over: once from our excessive propensity to import and once from our interest payments on debt.

But here is the interesting point: even though the US is the “biggest debtor on earth”, those factor payments flow in our favor. We pay extremely low interest rates and profit rates to foreigners, and earn much higher interest rates and profits on our holdings of foreign investments and debt. Why is that? Because the US is the safest investment on earth. Anytime there is a financial crisis anywhere in the world, where do international investors run? To the US dollar. Ironically, that happens even when the crisis begins in the US! Why? The US has a sovereign government with a sovereign currency. Its interest rate is set by the Fed, which can always set the rate below the US growth rate (and, indeed, as Galbraith points out, the inflation-adjusted interest rate is often below the “real” growth rate). In spite of the deficit hysteria whipped up by hedge fund billionaire Pete Peterson, no investor in her right mind believes there is any default risk on US Treasury debt. So when global fears rise, investors run to the dollar. This could change, but not in your lifetime.

In short, I make no projection about continued US current account deficits but I believe they will continue far longer than anyone imagines. They are sustainable. They will be sustained until the rest of the world decides not to accumulate more dollars and Americans decide they really do not want the cheap junk and environment-destroying oil produced by the rest of the world. When that will happen, I do not know. It is nothing to lose sleep over. Yes we can calculate “sustainability conditions” but it would just be an exercise in mental masturbation. We’ve already done enough of that. I suppose it is titillating but ultimately unsatisfying.

3. Briefly there were several other points raised.

There were some about maldistribution of income as a contributing cause of the private sector deficit. Agreed. There were some questions about stocks and relations to flows. Some of that is treated above but much more will come in the next series of blogs. There were points made about need to regulate Wall Street. Yes! There were questions about QE and the difference between helicopter drops and fiscal policy. Put it this way: Treasury SPENDS money things into existence, the Fed LENDS money things into existence. The first adds income and net wealth, the second only transforms balance sheets. This will be explained in more detail later.

Appendix:

Government debt outstanding (D) follows the following law of motion:

That is, every year, assuming the debt never matures, the outstanding debt increases by the size of the deficit. The deficit is the difference between government spending (G), taxes (T) plus interest payments on outstanding debt (iD)

Let us assume to simplify that G = T so: therefore

The gross domestic product (Y) grows at a rate g and so follows the following law of motion:

Let us find the limit of this ratio:

Following the same logic for Y we get (noting d the debt to gdp ratio)

It is pretty clear that if i > g then the ratio tends toward infinity when n tends toward infinity; and toward zero otherwise. If g = i then dt = d0 for all t.

The complication of the deficit to GDP ratio at 5% would mean:

Without going too far into the implications we have:

Therefore by doing a recursive calculation we get:

As n tends toward infinity dt also does. Note that a given deficit to gdp ratio means that deficit has to explode as gdp increases.

Thanks: to James Galbraith and Eric Tymoigne.

35 responses to “MMP BLOG # 3 RESPONSES

  1. "These blogs begin with the basics; no previous knowledge of MMT—or even of economics—is required"

  2. ^ Yes, but I think that applies to the primer blog entries. If people with advanced understanding ask complex questions and Dr. Wray has offered to respond, he has to respond in kind- although as you imply that risks alienating those without advanced understanding and introducing assertions he hasn't yet had the chance to defend.That said- Dr. Wray also has answered the more basic questions. So pick and choose what you read in the response blog entries and wait for future blogs that bring things back down to the basics.It's a tough balance for Dr. Wray to strike but I appreciate his time and thoroughness.

  3. Not sure my points get across so easily.The debt-sustainability equations as usually presented Δd = –s + d * [(r – g)/(1 + g)] does not imply that if r < g, debt is sustainable. As in it does not guarantee that "d" does not rise without limit. This is because, such an analysis says nothing about the first term.r < g is neither a necessary nor a sufficient condition for d to rise without limit. For example I can construct a model in which g > r and d does not rise without limit, even when the government is not making discretionary attempts to reach a surplus. This was done by Godley&Lavoie.Now you can present analogies where some individual rises in size, does dieting etc … doesn't help in the case of an open economy.For the case r<g, the unsustainability may arise due to the primary balance term – the first term in the right hand side of the equation I quoted from the blog post.For example, a rising current account leads to a rising DEF due to the "three balances" approachNAFA=DEF+CABIt does not matter if r<g, in the case when CAB is growing (in the reverse direction, as in CAD is growing). For, example for NAFA to be positive, DEF would have to grow as well. If NAFA does not grow and turns negative, then the private sector debt keeps increasing and will go bust sometime.Now you have assumed that US pays low interest to foreigners etc. So lets say that the US international investment position goes to -500% of GDP. Between now (-25%) and -500%, the factor income paid to foreigners will surely turn negative because even though the effective interest rate is lower than what US residents get from abroad, effective interest rate times liabilities to foreigners will be huge.You can argue that it such process can still continue etc, but hardly an argument that the stock/flow ratios converge.Plus there is a quibble among Neochartalists that a nation with negative net asset position should not be considered a debtor nation because foreigners "do not create the dollars". Or that "we do not borrow from foreigners". And I can quote many papers by the Neochartalists which claim that the US government promises to pay only in dollars. This is misleading and untrue. This claim is also crucial in the analysis.One should just refer to Article VIII, Section 4 of the IMF articles of agreement. http://www-bcc.imf.org/external/pubs/ft/aa/aa08.htm#4 on convertibility of foreign balances. Plus I have seen similar arguments made for Mexico, Turkey etc… their currencies collapsed during the 2008 crisis!Fiscal policy is powerful, it alone cannot do the trick. It is my central contention that the Chartalists are chasing a mirage.

  4. Professor Wray:Here are two questions that I don't feel I can answer competently or confidently.This all with the basic assumption that the only limit on government spending is inflation. The underlying assumption to that is that there is some point (high single digits?) where inflation becomes a problem, where it can spiral out of control and destroy the stability that's necessary for prosperity and growth. Are these fair statements of MMTer's beliefs?1. MMT/functional finance seem to suggest that money *flows* from government (deficit spending including interest payments) are what can cause inflation. Basically goosing aggregate demand beyond what a fully engaged economy can supply.But can an excessively large *stock* of money in the private sector (in our current bond-based arrangement, equal to total government debt) cause runaway inflation? (If yes, it seems like it would be deucedly hard to control/roll back.) That characterizes the fear out there, I think, and I think the question would be worth addressing explicitly. Aside: "money supply" is a confusing term because it suggests a flow, even though it's referring to a stock. Should be called the stock of money, no? 2. Steve Keen and Dirk Bezemer, among others, are damned cogent in their discussions of banks (etc.) creating money, and the effects of that money creation on economies. The sectoral balance model seems to ignore that money creation. (Throwing out the money multiplier model does not mean throwing out money creation by banks, does it? Yes, it's not about multiplying reserves, but banks certainly create money in return for IOUs…) Would much appreciate hearing thoughts on how private credit issuance relates to the sectoral model.Thanks for listening…Steve

  5. Steve: bank money (thing) creation will be discussed in coming MMP blogs.Yes government spending will likely fuel inflation beyond full employment (note that is true whether or not there is a budget deficit); and depending on what government spends for, it can be inflationary long before full employment.A "money stock" or even "money flow" is not by itself inflationary. I could have $50trillion in cash safely buried under my house. How can that cause inflation? Depends on what I do with it.Ramanan: You've missed the whole point, and gone off on another wayward mental exercise.Yes the balances will balance; causation is much harder to identify. How did the external claims on US dollars get to 500% of GDP and what impact does that have on the behaviors that will determine the sectoral balances? These sustainability mental masturbations do not tell us as they blindly carry the math to infinity and the sweet hereafter. Look, I know you are opposed to MMT. Maybe you can find another way to entertain yourself? Just asking….Anon: Yes, thanks; I try to answer all serious questions, and sometimes those serious questions are about complex matters. But I think the Supersizing Ramanan ought to be understandable for most readers–if not, they should rent the video!!! LRWray

  6. Ramanan- what are you implying Re: the IMF thing? What does this change?Also- MMTers don't say fiscal policy is a panacea, so not sure where you are getting that from. Dr. Wray has already recognized the value of the private economy and laws and regulation.

  7. No, I haven't gone far. Because it seems according to the logic, a nation can run any external deficit – 17%, 20%, 30%, and fiscal policy shouldn't worry about it. The truth is that nations are "balance of payments constrained". Current account deficits (even "small" such as 2-3%) lead to a hemorrhage in the circular flow of national income. It is not necessary to go to 500%. The rhetoric "imports are benefits, exports costs" is not true because imports drain demand and reduce employment. Plus it is a ruthless application of accounting. Since the US's Net International Investment Position is negative, it is a debtor nation.

  8. Regarding other avenues of entertainment: well, I should state upfront that the debates have been useful for me to clarify my own thoughts – especially some commenters trying to take me to task. I am making an attempt to get across what I believe I earlier got wrong in the first place and how. The overkill does not work in open economies. Cheers!

  9. Perpetuity models are just lazy exercises period. They might have been a useful shortcut in the days before calculators but now all they do is deliver flawed results. We need to move on from this sort of stuff in economics and finance:http://seekingalpha.com/instablog/486073-wildebeest/65043-planet-economics-vs-planet-earth

  10. "I am making an attempt to get across what I believe I earlier got wrong in the first place and how."no, you just say the same things over and over.

  11. RamananYou are obviously a clever chap and have the respect of the MMT core developers judging by their responses.If we disregard the academic finer points just for a moment, I'm intrigued to know what you think about the various governments austerity drives knowing what you know.Does it make you angry ?

  12. Anonymous @ June 24, 2011 1:31 AM If you are the Anon I interact with … I have this to say .. you have mentioned this to me several times that I keep repeating this over and over again … so I am guessing its you. you have *supreme* understanding of the banking system. So you would appreciate the fact that there must be a means in which banks can settle their debts. In some periods, they settled in Gold and now in "Central Bank Money". In a similar way nations need a means to settle their debts and in briefs periods it was via Gold the the original version of Article VIII, Section 4 of the Bretton Woods Agreement. It was amended to exclude Gold in various amendments but the convertibility of currencies remains. But the Chartalists will keep repeating over and over again (in spite of my having pointed them out in blogs) that governments do not promise to convert their currencies. And such things are crucial to their analysis and concept of money. More generally, in Chartalists' theory, international trade is not "settled". Maybe they should IMF's Joseph Gold. Their concept of money has issues. .. but they will keep claiming that "This leads to the second dimension: convertibility. Most modern governments donot promise to convert their IOUs to anything, having long ago abandoned the goldstandard. (To be sure, many governments, especially in the developing world, do promiseconversion to a foreign currency such as the US dollar. In that case, we can think of theUS dollar as the apex of the pyramid.)"http://www.levyinstitute.org/pubs/wp_656.pdf which is completely inconsistent with Article VIII, Section 4 of the IMF Articles of Agreement. Anonymous @ June 24, 2011 11:24 AM,Thanks for calling me clever. Keynesian/Lernerian principles cannot resolve this crisis. Only coordinated efforts at fiscal expansion will work. Governments actually came together to coordinate policies in a G-20 meet in November 2008 or maybe April 2009: http://www.imf.org/external/np/speeches/2011/062111.htmHowever, unsure as to how economies work, they haven't done much after than that. Recently they have taken a U-turn and have been going into austerity unfortunately. On the other hand, they understand the "balance of payments constraint" and hence you see talks of protectionism and currency depreciation. The world will not be able to achieve balanced growth and full employment unless institutions responsible in running economies in a completely different way. And that involves placing more importance to fiscal policy but at the same time also reversing the global imbalances.

  13. Anonymous @ June 24, 2011 11:24 AM,Check this book on Google Books on International Policy Coordination. http://goo.gl/hHJdISearch "game theory" inside the book. IMO, nations have chosen to play a non-cooperative game which hurts everyone. Or maybe they have cooperated to choose fiscal austerity whereas there is a solution which is good for everyone. Simple fiscal expansion will put a nation in an unsustainable path because it worsens the balance of payments.

  14. I would like to remind readers/commentators of the purpose of the MMP posted on Monday and as well of the comments/responses posted each Thursday. We are presenting and improving the MMP. This is not a general discussion group. It is not a place to try to promote some other approach to economics. Ramanan, especially, has come to see this page as a place to push his apparently single-minded view of balance of payments constrained growth. That approach is indeed a legitimate approach. It is, I think, wrong. But whether right or wrong, it is not the MMT. Further, the issue of floating versus pegged exchange rates is not a topic we have yet covered. Ramanan raised the issue of sustainability and I showed why I think that anyone who takes a 3 balances approach (as do MMT advocates) will reject it as too simplistic to be of any use. The substance of the rest of his approaches as well as of some who have responded to him, are not the topics of interest this week. Who cares what the IMF articles allow? Where in the previous 3 blogs was the IMF discussed? Or the G20? So, please, try to stick to the purposes of the MMP on these pages. Thank you. LRWray

  15. Something that struck me — although I'm not 100% I fully understand the argument (sorry, Dr. Wray, I agree we should stick with MMP, but better to get it out of the way now…).If I can understand this at all — and I'd appreciate if Wray could confirm as I think this would help other people as well — it appears to me that Ramanan's model is static. What I mean by that is it assumes a world which, in essence, only moves in one direction (toward equilibrium, if I were to hazard a guess).In this world the variables don't have any effect upon one another other than the one's that were established at the very beginning. So there is essentially no interactive changes and everything only follows a singular linear path.Again, if I understand correctly this model is assumed by certain economists to keep in line with their obsessions over equilibrium (which is a sort of conceptual stasis).If this is the case than I think Ramanan is probably following a very outmoded approach — but one that is very popular among economists.Again, I'd appreciate if Wray could confirm this as I think the language I've used will be familiar to people in most disciplines and should clear this up rather well.

  16. Anon: yes you are on the right track. The whole goal of the "sustainability" approach is to assume some fixed parameters (think of Ramanan with his fixed caloric intake and absorption) and then carry it all to absdurdity, then determine if it is sustainable. It is all too silly to really contemplate seriously. As Herb Stein says, things will adjust. I ensure you that Ramanan will diet before his mass exceeds that of the sun–no matter how hard he tries to deny that he would do so. It is mental masturbation, with one–unachievable–goal in mind. LRWray

  17. whoopsassurenotensure

  18. "The whole goal of the "sustainability" approach is to assume some fixed parameters (think of Ramanan with his fixed caloric intake and absorption) and then carry it all to absdurdity,"Ha! But you continue to argue that r<g leads to sustainability! I think they should teach mathematics of sequences and series in Economics. " appears to me that Ramanan's model is static. What I mean by that is it assumes a world which, in essence, only moves in one direction (toward equilibrium, if I were to hazard a guess)."Not at all. In fact I wrote the original comment because whether the author realizes it or not, his mental model was an equilibrium model. "I ensure you that Ramanan will diet before his mass exceeds that of the sun–no matter how hard he tries to deny that he would do so."Exactly, the adjustment happens in real world policy via austerity and unemployment. Remember Geithner called fiscal stimulus "sugar" recently ?

  19. Okay, that makes a lot more sense. I can see exactly where he goes wrong now. He thinks in terms of equilibrium and assumes that everyone else does the same (very few people do outside neoclassicism these days, but that's beside the point).Ramanan writes:"In fact I wrote the original comment because whether the author realizes it or not, his mental model was an equilibrium model."I can tell you for a fact that MMTers do not rely on equilibrium. It is one of the reasons why their approach attracted me in the first place. I really think it is you relying on static/equilibrium models and then projecting them onto others and then not being able to understand their criticisms because they don't fit with your conceptions.I think the relevant Keynesian quote for the type of projections you are trying to make in your head is the one Keynes is best known for:'The long run is a misleading guide to current affairs. In the long run we are all dead.'One of the central tenets behind dynamic analyses of any kind is that long-term predictions are useless and misleading because there are too many variables involved. The butterfly and the tornado comes to mind. Since you make VERY long-term predictions I think that it can safely be assumed that you have misunderstood some aspect of dynamic theorising. So, even if you think in broadly Keynesian terms, the shadow of equilibrium/static analysis will always be in the background infecting your understanding.

  20. Anonymous, Not sure how many Anonymous' I am talking to but let me summarize the situation. Ramanan: Sure about the three financial balances. Can't last long. Blog: Supersizing Ramanan, blah blah. r<g leads to sustainabilityRamanan: Here is a situation where r<g and still debt/gdp ratios are increasing forever. Blog: That mental masturbation. Ramanan: Then why claim r<g leads to xyz in the first place ? Blog: supersizing Ramanan will diet at some pointRamanan: Yes closed economy analogies for open economy. The post analyzes sustainability issues via some analogies which can get a consolation prize in a sense of humor contest, no doubt, but with the backdrop of a closed economy. Then it moves to an open economy and claims sustainability. —Incidentally Mental Masturbation Theory also abbreviates to MMT :-)No need to do so much theorizing. Its claimed in this post "even though the US is the “biggest debtor on earth”, those factor payments flow in our favor. We pay extremely low interest rates and profit rates to foreigners, and earn much higher interest rates and profits on our holdings of foreign investments and debt."Now, that is a mix-up of interest rate paid to interest rate times stock of liabilities. So it seems only p is considered instead of pq. Also forgetting q keeps growing. Here is a simple thing to do. Take the US Net International Position and do some calculation with some assumptions such as as trade deficit = $500B every year. Take the assets and liabilities position from the BEA and keep adding to the liabilities. NO need to go to infinite horizon just 5 years!Assuming a few non-controversial things, find out how much effect this has on the current account of balance of payments. To complicate add growth, growth of the rest of the world etc. You will really start seeing things. Of course, you can say assumptions are simple etc, but provide a mechanism where debt/gdp doesn't keep rising forever. Australia's factor income paid to foreigners is already negative. So "We pay extremely low interest rates" hardly is a mechanism for preventing factor income from turning negative. More importantly, one can continue to argue that these processes can continue and its true I can't tell you till when they will continue, but Australia itself has had issues. In the financial crisis, the banks' foreign funding pressures were eased through the Federal Reserve's swap lines with the Reserve Bank of Australia. More recently, positive net exports have been helping in preventing rising current account deficits. More importantly, the arguments presented here seems to suggest the world can move in so many different directions, but misses the point that policy makers need to make decisions and need to be aware of this. Do the math and you will see what I talking of.

  21. @ RamananDo you not think the most likely situation is that the trade deficit will close very gradually — starting in a few years time — when the rest of the world (especially China) finds new markets for its goods?Until then it seems logical for them to continue accepting US$ in exchange for goods to float domestic employment policies as best they can (China seriously worry about unemployment due to fear of social unrest).==========================On another point. You seem particularly worried about the current account adding to the deficit. But the addition the capital account is adding to the deficit is actually DOWN significantly since the Bush years. It seems to me that this will likely stay down as long as private savings rates stay up (i.e. as long as the private sector continue to deleverage — which will be a rather long time, if you ask me).Oversimplifying a bit, but look what actually happened in the past few decades:http://bit.ly/mC7eeUDo you see that it was when the private sector were leveraging themselves up to the hilt (i.e. borrowing) that the trade deficit really kicked into gear. This should be intuitively obvious because when people borrow and spend a lot they'll be seeking to purchase a lot of goods — foreign or otherwise.But if history is anything to go by — and intuitive logic — if the private sector are saving/deleveraging, they'll be buying a lot less stuff and this will close the deficit.Hence, if I understand correctly, Wray's prediction that the trade deficit will tend toward the long run average as shown in the sectoral balances chart above.

  22. Anonymous @June 25, 2011 8:05 AMForeigners can sell to both the US and other nations. Just because they can and might gain market in other nations doesn't mean they will reduce exports to the US. As far as the link between saving and imports is concerned, the general mainstream talk is that if saving rate improves, imports reduce. This is based on the three financial balances identityS-I = G-T+X-M and without going into any dynamics. However, looked at it from a dynamic perspective, while if the saving rate increases, imports will go down but this comes via a recessionary bias created in the economy and quite possibly less employment. Of course, that is under the assumption that the fiscal stance stays the same. But in general questions have to be framed right. Yes, I agree with you that when the domestic private sector is borrowing heavily, the trade deficit widens. This is of course due to the demand-led dynamics of economies. Deficit spending units create demand and higher demand leads to higher imports. But asking people to save more in order to reduce the trade deficit is not a solution.

  23. Anonymous @June 25, 2011 8:05 AM,From an old Godley paper at Levy:Refuting the “Saving is Too Low” Argument It is sometimes held that, in the words of the Economist (May 27. 1995, p. 18), “America’s current account deficit is enormous because its citizens save so little and its government spends too much.” The basis for this proposition is the accounting identity that says that the private sector’s surplus of saving over investment is always equal to the government’s deficit plus (or minus) the current account surplus (or deficit). As this relationship invariably holds by the laws of logic, it can be said with certainty that if private saving were to increase given the budget deficit or if the budget deficit were to be reduced given private saving, the current account balance would be found to have improved by an exactly equal amount. But an accounting identity, though useful as a basis for consistent thinking about the problem can tell us nothing about why anything happens. In my view, while it is true by the laws of logic that the current balance of payments always equals the public deficit less the private financial surplus, the only causal relationship linking the balances (given trade propensities) operates through changes in the level of output at home and abroad. Thus a spontaneous increase in household saving or a spontaneous reduction in the budget deficit (say, as a result of cuts in public expenditure) would bring about an improvement in the external deficit only because either would induce a fall in total demand and output, with lower imports as a consequence.

  24. "Deficit spending units create demand and higher demand leads to higher imports."Look at the sectoral balances chart. There is no historical evidence for that. In the late-80s and early-90s the deficits were significant but the trade deficits less so. This appears to be because the private sector was saving and NOT borrowing.History indicates — and logic follows — that private sector saving in the US in the latter half of the 20th century leads to lower trade deficits (this is confirmed post-08, so the dynamic has not changed). While private sector deficits lead to high trade deficits."But asking people to save more in order to reduce the trade deficit is not a solution."The only entity 'asking' people to save is History — with a capital 'H'.It's not a case of 'asking' people to save. If the MMTers are clear on one point it is that people generally don't simply 'decide' how much they're going to save. That's simply a neoclassical myth with NO historical precedent (I would add: NO logical grounding).People are saving at the moment because they need to take on the debt they accumulated in the Clinton years. These debts were essentially forced on the populace by the government's desire to run surpluses. This opened the trade deficit massively as people went into debt to buy foreign goods.After the stock bubble burst the clever goons in the financial sector continued to allow people to borrow through derivative instruments and the like. Since they were borrowing less, but remained on the same 'buying binge' it was necessary that the Bush administration open up government deficits to fill the gap.Now we're at a point where all the chickens are coming home to roost at once — Wray's 'perfect fiscal storm'. People are rapidly deleveraging and buying less goods from the foreign sector. The deleveraging is so great that the government has had to run MASSIVE deficits — and yet the capital account shrinks still BECAUSE the deleveraging is so great. This isn't FORCED saving — the 'savings police' aren't calling to people's doors and ensuring that they're not spending too much. It is necessary paying down of the debt that was incurred through bad economic policy.What you see here is a DYNAMIC economy at work. Not a model that unfolds teleologically. But one responsive to all sorts of changes — political, economic and social. It won't fit your models. It's too complex.

  25. Godley: "But an accounting identity, though useful as a basis for consistent thinking about the problem can tell us nothing about why anything happens."No, and that was what Wray's 'perfect fiscal storm' argument sought to do — and my above post. Show the political policies that led to the current problems… and why these policies no longer have room to operate in our brave new world and so, inevitably, must be discontinued.(Sorry for posting Anon for so long, I realise it's very annoying. Couldn't get my profile to work)

  26. "Look at the sectoral balances chart. There is no historical evidence for that. In the late-80s and early-90s the deficits were significant but the trade deficits less so"As I said, one needs to ask the right question. Yes too many things happening such as the import propensity of the US increasing due to competitiveness of foreigners versus domestic producers etc. "It's not a case of 'asking' people to save. If the MMTers are clear on one point it is that people generally don't simply 'decide' how much they're going to save. "Not sure on that one. The private sector has a propensity to save and the government has no choice but to accommodate this if it wants to aim full employment. Of course, the government may not relax its fiscal stance fully, and these two are interrelated. At present, the US household saving is not due to the government. It is due to the private sector increasing its propensity to save. The US government wants a lower budget deficit. But I guess you are saying that as well. "What you see here is a DYNAMIC economy at work. Not a model that unfolds teleologically. But one responsive to all sorts of changes — political, economic and social. It won't fit your models. It's too complex."Not sure if I ever said somebody is forcing people to save. I am talking of situations where people may be induced to save or they decide to increase their propensity to save. Really not sure what point you are trying to make. Yes, government policies are bad, where did I disagree ?Don't really know why you think I am saying that somebody external is FORCING to save.

  27. ""Deficit spending units create demand and higher demand leads to higher imports."Look at the sectoral balances chart. There is no historical evidence for that. "Have you ever studied international economics 101 ? Do you know what income elasticity of imports is ?

  28. Ramanan: "Yes too many things happening such as the import propensity of the US increasing due to competitiveness of foreigners versus domestic producers etc."That's part of it, I'm sure. But a macroeconomist would only be able to point in what direction the government should direct their fiscal position in order to prevent this. All else aside, running up private sector deficits (i.e. trying to run government surpluses) is the wrong way to counteract this.My main point — and one that you didn't address — is that the government can NO LONGER RUN THIS POLICY OPTION.For better of for worse, the 'perfect storm' HAS hit and this is going to constrain imports (and, since the dollar has devalued, promote exports). Hence Wray's estimate that the trade gap will return to historical levels and your doomsday scenario is extremely short-sighted.THIS is my key point and I want to highlight it because everything else that follows is just padding the original argument.Ramanan: "Don't really know why you think I am saying that somebody external is FORCING to save."You claimed above that people are being 'asked to save' to reduce the trade balance. They're not. They're paying down the debt that was incurred in the boom years. To say that they are being 'asked to save' is to imply a policy consciously geared toward private sector saving with the goal of reducing the trade deficit.That's simply not happening. True, policies in the past have led to this circumstance, but to say that people are being 'asked' to save implies some sort of agent doing the 'asking'. Not the case. Simple as.Increased private sector saving WILL reduce the trade deficit (together with other semi-autonomous factors, such as the devalued dollar), but this is not 'asking' people to save. It's simply the overarching logic ironing itself out."Do you know what income elasticity of imports is?"That when people's income rises their demand for imports rises, presumably…That seems to greatly oversimplify things as far as I can see. For example, if income rises due to government deficits, then they may use this income to pay down debt if they are highly leveraged (i.e. save).Also, over a period of reduced imports (and increased exports) many things can happen. People can move their shopping basket away from imported goods. New industries might spring up to replace imports and increase exports. Etc. etc.Once again, you cannot predict the future with your models. And any attempt to do so comes across to me — and many others — as quackery of the highest order.

  29. "You claimed above that people are being 'asked to save' to reduce the trade balance. They're not."I did _not_ claim that. Its the policy makers' view that if people can be made to save, the trade deficit would reduce. As in… if policy makers are looking to ask people to save in order to reduce trade deficit, the trick wouldn't work. Imports would reduce but so would employment. "All else aside, running up private sector deficits (i.e. trying to run government surpluses) is the wrong way to counteract this.My main point — and one that you didn't address — is that the government can NO LONGER RUN THIS POLICY OPTION."Neither did I say that the US government needs to go into surplus, nor did I say that it will be good if the US private sector goes into deficit. "For better of for worse, the 'perfect storm' HAS hit and this is going to constrain imports (and, since the dollar has devalued, promote exports)"Yes exports can go up due to the depreciation of the dollar, but that isn't sufficient enough to increase exports. Policy is needed to promote exports in addition to relying on depreciation. "That when people's income rises their demand for imports rises, presumably…That seems to greatly oversimplify things as far as I can see."Well yes and no. Because exports depend on demand abroad the foreigners' import elasticity but depends on whether you want to call it a crude approach or not. "Also, over a period of reduced imports (and increased exports) many things can happen. People can move their shopping basket away from imported goods. New industries might spring up to replace imports and increase exports. Etc. etc."Yes, but that requires policy. No people won't simply move their shopping basket away from imported goods. The relation of imports to national income is not so erratic that it can be considered so random. "Once again, you cannot predict the future with your models. And any attempt to do so comes across to me — and many others — as quackery of the highest order."Yes, true but policy makers need to know what the consequences of their policies are going to be. "For example, if income rises due to government deficits, then they may use this income to pay down debt if they are highly leveraged (i.e. save)."Yes, the deleveraging is already happening but attempts to reach to full employment would come only via relaxing fiscal policy even higher and hence more demand but that would mean higher imports. You can partly see this happening. When demand collapsed, international trade shrank but now as the US economy is improving, imports have increased.

  30. Ramanan: "As in… if policy makers are looking to ask people to save in order to reduce trade deficit, the trick wouldn't work." You're missing the point about saving here. The saving is not really saving — it's DELEVERAGING. Think Irving Fisher, not JM Keynes. This greatly changes the whole discussion.Okay, look at where this leads you:Ramanan: "Imports would reduce but so would employment"That's not necessarily the case. Look at Japan. The private sector has been 'saving' (read: 'deleveraging') for years. Governments have offset this by deficits. But household saving has fallen. At the same time, unemployment has been kept at a low level (apart from during the austerity drive in the late-90s, but that's besides the point).You cannot understand what is going on here unless you understand how debt deflations actually work. To do that you need to take off your rose-tinted neoclassical glasses."You can partly see this happening. When demand collapsed, international trade shrank but now as the US economy is improving, imports have increased."Prediction I: they will not reach the levels they reached in the boom years — probably ever again.Prediction II: the US economy will not improve for much longer and will suffer double-dip before imports reach anything near their previous highs.Prediction III: the US will increase its exports in the coming years.Prediction IV: China's housing bubble will collapse, greatly altering their economic position.Prediction V: the Eurozone will increasingly lag in the coming years which will also significantly alter worldwide dynamics.Conclusion: The world is a bloody complicated place and we shouldn't really take any predictions seriously. Keynes was right: in the long run we really are all dead — or at least it will always appear that way to crystal-ball gazers and mental masturbators.==================Apart from that, we're just talking in circles. You're coming at this from a different perspective. I know what your perspective is, but I don't think you fully understand mine. Or, at least, you haven't integrated it into your approach properly. So, one minute you're talking about increased income leading to increased imports, the next you're talking about deleveraging.Your approach appears to me confused and messy. Although, mine may appear that way to you — I don't know.All in all, I think Wray was right above. Either take on the MMT perspective or keep your own. Don't try to negotiate the two; it's apples and oranges. When you think you're making a fresh point to the MMTers, you're not. But the point you're making rests on different assumptions — one's that the MMTers think are fundamentally wrong.

  31. "You're missing the point about saving here. The saving is not really saving — it's DELEVERAGING. Think Irving Fisher, not JM Keynes. This greatly changes the whole discussion."I think you are just attempting to find some error. Sorry you can't. "That's not necessarily the case. Look at Japan. The private sector has been 'saving' (read: 'deleveraging') for years"No, again you didn't read me right. I did not mean reduction of imports leads to loss of employment. Ceteris Paribus, an increase in the propensity to import, leads to a higher unemployment. I said, if the US household sector suddenly increasing its propensity to save, imports reduce as well and so do imports due to a fall in demand and output. Now, when ceteris is not paribus, i.e., the government relaxes the fiscal stance, perhaps such as Japan, then of course, you have lesser unemployment. "You cannot understand what is going on here unless you understand how debt deflations actually work. To do that you need to take off your rose-tinted neoclassical glasses."Again, you don't see where I am coming from. I am quite an avid reader of PKE. Just goes to prove, you are just trying to find some error. "Conclusion: The world is a bloody complicated place and we shouldn't really take any predictions seriously."Yes and no. Its important for policy makers to understand what the result of their policy is going to be. So one needs to create "what if" scenarios. "Your approach appears to me confused and messy. Although, mine may appear that way to you — I don't know"No you are simply trying to find some error in reasoning. " the next you're talking about deleveraging."You brought that hence I am talking about it. " I know what your perspective is"and what is my perspective ?

  32. "I said, if the US household sector suddenly increasing its propensity to save, imports reduce as well and so do imports due to a fall in demand and output. "Oops meant …I said, if the US household sector suddenly increasing its propensity to save, imports reduce as well and so does employment due to a fall in demand and output.

  33. "I think you are just attempting to find some error. Sorry you can't."I'm not. Look I'm going to quote you directly from over you last four posts.You said: "But asking people to save more in order to reduce the trade deficit is not a solution."I said: Policymakers aren't 'asking' people to save. People are deleveraging. There's a difference. People have to deleverage, it has nothing to do with what policymakers ASK.Look at what you said. Look at what I said. I'm not looking for errors. I'm pointing one out.You said: "As in… if policy makers are looking to ask people to save in order to reduce trade deficit, the trick wouldn't work."Same erroneous assumption as above. Namely that policymakers 'ask' people to save. People are not being 'asked' to save — politely or otherwise — they are being forced by historical circumstance.But in the middle of all that you said: "At present, the US household saving is not due to the government. It is due to the private sector increasing its propensity to save."But that doesn't add up with what you said at other times about governments 'asking' people to save to reduce trade deficits.Here's my central point: The government is not 'asking' people to save. You argument — and I've quoted you above (and not out of context as far as I can tell) — oscillates between these two points.This appears to me messy and confused and I think you're going between a 'what if' and current reality because you've got the two mixed up in your head. Once again, you can deny all you want that you're confused, but I'll let others be the judge. I've laid out the evidence.So, what I'm saying is (I'm oversimplifying, but its necessary to deal with this central point): (1) No one is asking anyone to save. That's the first point. So we need not even consider that. (2) People are saving in response to the debt they ran up during the boom years. This is a necessity. The moon comes out at night — people need to deleverage after a debt binge.(3) The massive private sector debt binge was largely to blame for the extreme trade deficits the US government ran during that era. We went through this with reference to the sectoral balances sheet.(4) Now that this binge is over and unlikely to occur again the deficit is going to (and has) close to a large degree. This is in part due to (a) reduced consumption of imports, but also (b) a devalued dollar and hence (c) a rise in exports. (Nominal export rise quite significant, see: http://bit.ly/jqSrDv).(5) These trends will likely cause the US to enter a new phase of growth (or lack thereof) where, due to a devalued dollar and a temporary (or not so temporary) giving up of imports, they will become more self-sufficient.Conclusion I: The Great Recession will return the US closer to historical average levels of trade deficit. This will happen regardless of unemployment levels. If people remain unemployed they will buy less. But even if they don't, a weaker dollar and a temporary break from imports will help them become more self-sufficient. Conclusion II: This has nothing to do with 'asking' people to save. It is a historical dynamic that was completely inevitable given the growth path of the 1990s and early-mid 2000s. If this dynamic had not occurred, the trade deficit probably wouldn't have risen so high in the first place. Given that it did occur this is now correcting itself.Phew! Okay, I'm actually done with this now. Let posterity be my judge.

  34. Sometimes we are asked to save, like when money market accounts first became popular and were offering high interest rates, but maybe that was just moving money around.