Daily Archives: February 12, 2012

MMP Blog #36 What Government Ought to Do: An Introduction

By L. Randall Wray

In the nextseries of blogs we will turn to whatgovernment ought to do. This serieswill specifically treat only sovereign government—one that issues its owncurrency. From the earlier blogs, that will make it clear that we areaddressing only a government that does not face an affordability constraint.

In theseupcoming blogs we will examine alternative views about the proper role forgovernment—given that it can “afford” anything for sale in its own currency. Wefirst look at four reasons why government spending ought to be constrained. Wethen compare and contrast a typical “conservative” versus “liberal” view aboutthe scope of government. (These terms are used in the American sense—that are somewhatidiosyncratic. In America, conservative is closer to what is called “liberal”or “neoliberal” abroad. Liberal in America is closer to “social democratic” orto “labor party” abroad.)

We willwork toward developing an example of a government program that is consistentwith the MMT view of sovereign money—one that uses the principles we haveestablished in previous chapters to resolve the problem of unemployment in amanner that is consistent with both the liberal and the conservative views.That is the employer of last resort or job guarantee approach. I will concludethis series with my own view on whether MMT must include the ELR/JG proposal.

Warning:when we address views on whatgovernment ought to do, we have moved beyond description. My views of what government ought to do need not beaccepted by others, even those who fully understand MMT. I will be makingpolicy recommendations that are consistent with MMT. You do not have to likemine; you can come up with your own. I will devote a blog to an Austrianapproach to policy-making, and its goals will be different from my own.

Just Because Government Can Afford to Spend, Does Not MeanGovernment Ought to Spend. Understanding how government spends leads to the conclusion that affordability is not really theissue—government can always affordthe “keystrokes” necessary to make expenditures as desired. But that does notmean it should. We can list severallegitimate reasons for constraining government spending:
  • too much spending can causeinflation
  • too much spending couldpressure the exchange rate
  • too much spending by government might leave too few resources forprivate interests
  • government should not do everything—impactson incentives could be perverse
  • budgeting provides a lever to manage and evaluate government projects

Forexample, suppose government decides to newly hire 1000 rocket scientists for anexpedition to Pluto. Our first consideration is whether there are 1000 rocket scientists available forhire with the necessary skills. Even if government can afford its desired spending plan that does not mean it canaccomplish its mission if the resources are not available. In other words, thegovernment always faces a “real resource” constraint: do the resources exist,and are they for sale or hire? Related to this consideration: are the existinginfrastructure, technology, and knowledge up to the task of achieving programgoals. That, of course, is an important question. Let us presume that theseconditions are met.

The secondconsideration, then, concerns competition with alternative uses of theresources, what is called the “opportunity cost”. If those 1000 rocketscientists would otherwise be unemployed, then the opportunity cost of hiringthem for the Pluto mission is low or zero. (We might find, for example, that ifthey were not employed they would take care of their children at home so thenon-zero opportunity cost of employing them is the value of the foregonechildcare services. You get the picture—it is not likely that opportunity costsare zero, but for unemployed laborthey are probably low relative to benefits of employment in appropriate jobs.)

Moreimportantly, it is likely that many or most of them are already working, eitherin the private sector or on other government projects. Since sovereigngovernment does not face an affordability constraint, it can win a bidding waragainst the private sector if it chooses to do so. In that case, it will pushup the wages of rocket scientists so high that the private sector gives up andhires workers with other credentials. The impacts on the private sector couldbe complex—likely leading to higher wages, higher product costs, and even lessoutput in those sectors that use rocket scientists and other skilled workerswho can substitute to some degree for rocket scientists (perhaps for somepurposes, other types of engineers are almost as good, so firms bid up theirwages). At the very least, the Pluto mission could lead to“bottlenecks”—relative shortages of key resources—and some (perhaps limited)price hikes. In that case, public policy must consider the much greateropportunity cost of hiring rocket scientists away from other employment.

Inaddition, other wages and prices might be increased through spill-over effectsif a new government program is so big that it sets off a general bidding warfor labor and other resources. For example, during a major war like WWII,government not only conscripts workers into the military but it also redirectsresources to production for the war effort. Without rationing and wage andprice controls, it is relatively easy for this to lead to a general price andwage inflation. Note that it does not take a major war for this to happen. Ifgovernment spending pushes the economy to, and beyond, full employment it islikely that inflation will result even in the absence of a major war. At thesame time, high domestic employment and income can—under somecircumstances—lead to a trade deficit (as domestic demand for imports risesrelative to foreign demand for exports—discussed in the previous section). Thismight then pressure exchange rates (although the correlation between tradedeficits and exchange rate depreciation is far from certain).

Hence,while government can afford to spend more, it must weigh the consequences interms of withdrawing resources from other (perhaps more desirable) uses, aswell as possible impacts on prices and exchange rates.

There aremany other reasons to constrain government spending. For example, conservativesoften argue that spending on “welfare” affects incentives. A strong socialsafety net might send the signal that individuals do not really need to workbecause they can always live well enough on government hand-outs. Or,government bail-outs of business might encourage management to take excessiverisks on the belief that no matter what happens, government will cover thefirm’s losses.

Further, acorrupt government might spend on programs that help friends, but refuse to doanything to assist more deserving groups—what is often called “cronycapitalism”.  So, there could be complexand even unintended consequences of government programs.

All of thatmust be considered when undertaking government spending programs—and negativeconsequences raise legitimate concerns about the size of government spending,not due to the (im)possibility of insolvency but rather to undesired (andunknown) effects of government programs.

Finally,governments should, and do, use budgets, which are a form of self-imposedconstraint. Typically, the elected representatives will allocate a sum to bespent on a particular project. Program managers are then held accountable forfinishing the project within the budgeted amount. Over-running the budget canbe used as an indication of mismanagement. The budgeting process also helps toreduce the incentive for “mission creep”, expanding the project to enhance themanager’s power and prestige. In other words, budgeting by sovereign governmentprovides a useful mechanism for project control and evaluation.

We concludethis section by observing that absence of an “affordability” constraint doesnot imply that government ought tospend without constraint. As we discuss in the next blog, its spending ought tobe aimed toward achieving the “public purpose”. 

Response to Comments on Blog #35: Thirlwall’s Law

By L. Randall Wray

Sorry for being late. There were really only two issuesraised (ignoring the comment about MMR vs MMT—which I’m not going to addresshere).
The first concerned the orthodox belief that trade dependson comparative advantage: Italy specializes in wine because of its climate andsoil. In the case of agriculture in the old days, there isn’t too much doubtabout that—it was hard to grow grapes at the North Pole, so Santa tradeddelivery services for products made in southern climes. But once we move beyondagriculture, and after we’ve invented greenhouses and the like, there is muchless truth in this. In manufacturing, a factory can be set up anywhere in theworld, often in a few weeks, and it takes a couple more weeks to train theworkers. And out in the real world what we find is that much of the trade infinished goods is actually between “equals”: Italy sends Fiats to Germany andGermany sends VWs to Italy. Tastes or preferences, styles, desire to be different,brand loyalty, and all that matters much more.
The second is more important and concerns the belief thateconomic growth is balance-of-payments constrained, as described by TonyThirwall’s “Law”. As Neil “Ramanan” Wilson Jargued: “There have been some suggestions that Thirlwall’s law stops thegovernment expanding domestic policy and will cause ‘twin deficits’ problems(increased government and external deficits). But why would that apply togovernment and not private expansion? Thirlwall’s law appears to have a fairamount of empirical data behind it, but is that curve fitting? In other wordsdoes the Law appear true because nobody dare do the domestic expansion in thecorrect fashion necessary to test the underlying assumptions on which it is based.”
To simplify and summarize: A country like the US that has ahigh propensity to import will tend to run a trade deficit if we grow fasterthan our neighbors who have low propensities to import. We will then run out offoreign reserves quickly so will be constrained to the extent that ourneighbors won’t take our currency in exchange. Thus, our growth will beconstrained—it needs to be slower than that of our neighbors.
To be sure, Thirlwall would throw in lots of caveats thatare usually ignored by those who wave his “Law” about. Not all growth has thesame implications for the trade balance. Income distribution matters forimports—so it depends on who benefits from the growth. We could target ourgrowth to areas that make us more competitive internationally—increasingexports. If we do grow faster than our neighbors, their demand for our currency(to invest in the US, for example, to share in the bounteous growth) might growas fast as our current account surplus. If we float the currency, theconstraint is softened since a trade deficit might cause the exchange rate tofall and thereby increase exports and reduce imports. And we can change policyto encourage exports and restrict imports, or to encourage “capital” inflows(demand for our currency to buy assets). So for all these reasons, there is nosimple “Law”.
Neil also raises an important point usually overlooked bythose who advocate the “Law”: the evidence in favor of a constraint probablyhas more to do with policy overreaction than to any real constraint.Governments react to a current account deficit by tightening the fiscal andmonetary policy screws, trying to raise unemployment and slow growth. That is apolicy choice. Except for those nations that choose to peg their currencies (oradopt foreign currencies—as Greece did), it is almost always going to be a badpolicy. Indeed, pegging the exchange rate is a bad policy because it usuallyforces government to give up policy space. Unemployment is the normal price ofpegging—and it is pegging and the reaction to a current account deficit that thenmakes Thirlwall’s Law “bite”.
Let us say that a country does not impose the “Law” onitself, refusing to adopt austerity when a trade deficit appears. What happens?At a constant (but not pegged—this is a little mental experiment) exchangerate, for its current account to increase, there must be a demand for itscurrency so that its capital account surplus rises by the same amount. In otherwords, there are two sides to the coin, and as foreigners demand the currency,a capital account surplus is created, and as the domestic population demandsthe imports, a current account deficit is created. We cannot split the coin inhalf to blame one side or the other.
Let us say that the rest of the world (ROW) will not allowthat to happen—the ROW will accept the currency only if it depreciates. OK,then, the currency falls in value to find holders of the currency given acurrent account deficit. And as the currency falls, exports might rise a bit,and imports fall a bit. But let us say that this will not restore trade“balance” (recall from my earlier blog however that “balance” is a misleadingword—the balances always balance!). As the currency depreciates, the terms oftrade turn against the country. In other words, it gives up more currency toget the same basket of imports.
(Yet in real terms as a current account deficit is created,the country gives fewer exports to get imports! How ironic: the real terms oftrade move in the favor of a trade deficit nation. Exports are the cost,imports are the benefit.)
If you are an OZ that imports oil and finished manufactures,a depreciating A$ raises the A$ cost of much of what you buy. And as BillMitchell argues, the swings of the A$ are historically large and do lead to verylarge fluctuations of the domestic purchasing power. But so long as Australiakept its commitment to full employment, it tolerated these swings withoutimposing austerity. Policymakers preferred to use their domestic policy spaceto maintain growth with (nearly) full employment. So Oz consumers would remainemployed and would substitute out of expensive imports as best they could. Andthey’d probably have to reduce overall consumption when the Oz Dollar fell. Thosewho follow MMT and Functional Finance believe that is the best policy.
Should a nation like Oz adopt other policy in response to atrade deficit? Bill often uses the example of auto manufacture. Oz might havetried to keep out Japanese autos in order to promote Oz auto production. Billhas argued this makes little sense, and would cost Australian consumersdearly—both in terms of loss of choice but also in terms of a policy ofdevoting substantial real resources to produce autos at what might be a scalefar too small to achieve economies of scale. I have no dog in this hunt and noparticular opinion on the issue of Oz auto production. But Bill’s argumentmakes sense to me as a general statement. It is also related to the comparativeadvantage argument briefly discussed above. If you can import high quality andlow cost products from abroad, it may not make sense to use government policyto block the imports and to subsidies domestic production. Remember: importsare a benefit, exports a cost, in real terms. Of course that is only true ifyou have a commitment to full employment. So if auto jobs are lost governmentmust ensure alternative employment.
The immediate response always is: “but auto jobs are good;nonmanufacturing jobs are bad”. Only one who has never worked in a factorycould literally believe this. (Full disclosure: I worked in a soup factory andwhile I liked the pay, I hated the work.) What most mean is that factory jobspay well, many service sector jobs don’t.
The solution—of course!—is to make the service sector paymore. I am always amazed at the lengths to which people will go to offer“crazily improbable” (in Keynes’s words) solutions rather than looking to theobvious.
To be clear, I have nothing against using domestic policy ina strategic manner—to target areas for expansion. All economies area alwaysplanned. The questions are: by whom and for whom. But responding to a tradedeficit by imposing austerity simply imposes a “Thirlwall’s Law” growthconstraint unnecessarily.
There are many other issues related to imports, exports, andexchange rates—we’ll return to some of them in the remainder of the Primer.

A Dimon Repeatedly in the Rough who Demands Winter Rules (aka Preferred Lies)

By William K. Black
(Cross-posted from Benzinga.com)

Golf is one of the sports associated with the CEOs of big banks, so it is not surprising that Jamie Dimon is expert at seeking to invoke Winter Rules whenever JPMorganChase (NYSE: JPM) finds that its actions have placed it in an unfavorable lie.

Golfers know that they cannot unilaterally invoke Winter Rules – only the folks in charge of the course can put Winter Rules in effect. When Winter Rules are put in effect the golfer can improve his lies by placing his ball in a preferred lie.

A New York Times investigation by Edward Wyatt documented the depth of the rot at the SEC in a February 3, 2012 article entitled “S.E.C. is Avoiding Tough Sanctions for Large Banks.”

“JPMorganChase, for example, has settled six fraud cases in the last 13 years, including one with a $228 million settlement last summer, but it has obtained at least 22 waivers, in part by arguing that it has “a strong record of compliance with securities laws.””

SEC investigations have found that JPMorganChase is a serial violator of the securities laws. The bank gets caught, promises to clean up its act, gets fined, signs a typically useless consent decree that has no admissions, creates no precedent, and undercuts deterrence, and gets waived out of the few detriments there are to banks with records of serial SEC staff findings of violations.

JPMorganChase exemplifies this pattern of the SEC winking at serial fraud by the systemically dangerous institutions (SDIs). The SEC routinely allows the SDIs to operate under Winter Rules and the SDIs routinely and repeatedly employ preferred lies.

But the metaphor is inexact for three reasons. First, Winter Rules are not supposed to be routinely available. They are reserved for unusual circumstances where the course is unusually unplayable due to weather. Second, Winter Rules are available due to problems with the course not caused by the player. Third, when Winter Rules are invoked by the golf course the course posts that information publicly and Winter Rules are available to all players rather than to a subset, i.e., the wealthiest players.

Consider what the world would be like if we had a “three strikes law” for corporations. Assume that the corporations were only assessed a “strike” if the violations were attributable to the actions of a senior officer. Assume further that the SEC and the Department of Justice (DOJ) actually brought actions against the SDIs and required admissions of violations of the law in settlements and pleas. The SDIs would have been dissolved (the equivalent of being sent away for life) decades ago.

Consider the chutzpah of JPMorganChase claiming “a strong record of compliance with securities laws” after SEC staff investigations found six violations in 13 years. But that kind of arrogance and indifference to complying with the law is inevitable under an SEC regime that allows the SDIs to play by Winter Rules. “Improved lies” captures perfectly the perverse incentives that the SEC has created.

The CEOs of SDIs who know that they can commit fraud with effective impunity (the SEC fines are typically chump change from the SDIs’ standpoint) develop a belief in their divine right to transcend the law and conventional morality. Jamie Dimon captures the mindset that Nietzche celebrated for the Superman. Dimon extends the logic of transcendence to its ultimate, absurd, extreme. He is enraged that the CEOs running the SDIs have been criticized. It turns out that the SDIs’ CEOs are sensitive types. Nobody exemplifies this Rich White Whine motif better than Dimon.

“I’ve disagreed right from the beginning of this blanket blame of all banks,” Dimon said in an interview with Charlie Gasparino of the Fox Business Network Tuesday. “I don’t like that. I think that’s just a form of discrimination that should be stopped.”

The interview was taped shortly before Dimon left for the World Economic Forum summit in Davos, Switzerland, where Dimon said he will be speaking with other attendees about financial regulation. At last year’s Davos summit, Dimon made similar remarks pushing back against the vilification of the banking industry, calling it “a really unproductive and unfair way of treating people.”

No serious critic has a “blanket blame of all banks.” The blame is focused on SDIs, particularly SDIs like JPMorganChase that investigations find engaged in recurrent fraud, yet were treated to Winter Rules because they were SDIs. These SDIs are not only the bane of the world economy; they are the bane of honest banks.

Dimon has also reached the logical, albeit absurd, conclusion about the legitimacy of investigating JPMorganChase. He is tired of the investigations finding fraud, so he has decided, in the context of the settlement negotiations of the widespread foreclosure fraud by five large mortgage servicers including JPMorganChase, to offer a settlement in return for prohibiting the government from investigating his banks’ mortgage origination and foreclosure fraud.

When news reports claimed that the federal government was reducing its disgraceful offer of widespread impunity from investigation and prosecution, Dimon responded that it was likely that JPMorganChase would not enter into a settlement that did not have a broad prohibition on investigating JPMorganChase’s frauds.

“The new unit “has a pretty good chance of derailing it,” JPMorgan Chase CEO Jamie Dimon told CNBC on Thursday, referring to the settlement. JPMorgan is one of the five banks involved in those negotiations.”

Dimon is the face and mindset of crony capitalism. It is long past time for the SEC to end selective Winter Rules and Preferred Lies for the SDIs.

Bill Black is the author of The Best Way to Rob a Bank is to Own One and is an associate professor of economics and law at the University of Missouri-Kansas City. He spent years working on regulatory policy and fraud prevention as Executive Director of the Institute for Fraud Prevention, Litigation Director of the Federal Home Loan Bank Board and Deputy Director of the National Commission on Financial Institution Reform, Recovery and Enforcement, among other positions.

Bill writes a column for Benzinga every Monday. His other academic articles, congressional testimony, and musings about the financial crisis can be found at his Social Science Research Network author page and at the blog

Follow him on Twitter: @WilliamKBlack