I recently returned from conference in Brazil jointly sponsored by the Levy Economics Institute, the Ford Foundation, and the Brazilian research group MINDS. It is part of a bigger project to take Hyman P. Minsky global. In my view, Minsky was hands-down the greatest economist of the second half of the twentieth century and he deserves the attention he’s getting. Watch for an upcoming film by Monty Python’s Terry Jones that will feature Minsky and his work. Minsky will even make an appearance—or, more accurately, a bigger-than-life Minsky puppet will be in the film. (Steve Keen and I were also interviewed.)
Minsky the puppet had to travel from England to NY for filming. Question: how do you transport a huge puppet across the Big Pond? Well, you buy him a seat, of course! It would have been worth the price of airfare to be on that flight, buying Minsky a drink.
In any event, I’m going to focus my comments around the conference’s kick-off presentation by the always entertaining Paul McCulley, formerly the brains behind PIMCO. I was sitting with Paul right before his talk, during which he apparently put the whole thing together. He asked for three fundamental principles to structure his presentation. In a matter of minutes he came up with three, fleshed them out, and then gave the kind of performance that only Paul can give. Herewith follows my recollection of his points along with my comments on each.
Principle 1: Microeconomics and Macroeconomics are inherently different disciplines. Macro is demand-side; micro is supply-side. For any practical time horizon, demand always drives supply.
For those who have been trained in economics, and then had to suffer through the mainstream preoccupation with the supposed “micro foundations of macro”, or even with the heterodox arguments for “macro foundations of micro”, Paul brilliantly cut to the chase: the twain do not meet in any way that matters. They are different disciplines and trying to uncover which of the two is really foundational would be like trying to determine whether poetry rests on the foundations of structural engineering, or versa vice.
Further, and this is more important, demand drives supply—at least for any real world relevant situation. Your typical Keynesian argues that demand draws forth supply in the short run, but wants to concede to Neoclassicals the truth of Say’s Law that in the long run supply governs demand. (Exhibit A is the Solow growth model.) But as Keynes insisted, in the long run we’re all dead. Forget-about-it. Paul rightly says that what matters in the short, medium and practical long run is demand.
That leads to point two:
Principle 2: Monetary and fiscal policy are not inherently independent instruments. Both are macro policies in the policy-maker’s toolkit, and both work on the demand side. The Sovereign Fiscal Power is the ability to impose a tax; the Sovereign Monetary Power is the ability to name what can be accepted in tax payment. The goal is to use these two tools to achieve the maximum possible full employment position.
That, in a nutshell, is MMT. MMT, of course, also emphasizes that the Sovereign issuer of the currency imposes a tax liability in the Sovereign’s money of account, issues currency in the same unit, and requires payment in that currency (broadly defined to include central bank reserves). MMT also embraces the view that Sovereign Government should pursue true full employment, defined as a job offer to anyone ready and willing to work at a basic compensation. Further, like Paul, MMT rejects the notion that fiscal and monetary policy are (or should be) independent. (A caveat will be discussed below—Paul insists that there can be instances where it is pragmatic to keep monetary and fiscal policy separate.) Indeed, MMT has emphasized the necessary coordination between monetary and fiscal policy: if the central bank wants to target overnight interest rates, its actions cannot be independent since it must coordinate operations with the fiscal authority (the Treasury).
Paul was agreeing with MMT against various critics who attack us for “consolidation” of the central bank and treasury when we explain in simple terms “how a government really spends”: it chooses a money of account, spends its currency into the economy, and then receives its own currency in tax payment. The consolidation is not supposed to be a detailed description of today’s operations, but rather a statement of the logic of the way a sovereign currency “works”. I’ll return to this at the bottom.
Principle 3: Banking is inherently a joint venture between the public and private sector. Why? Because of Principle 1: the effective demand problem. Banks promise what they cannot deliver, which is a positive sum game for society so long as banking is a going concern. The problem is that the ex ante demand for liquidity is (almost) always greater than the ex post demand. So banking must be a joint enterprise because only government can ensure that the ex ante demand = the ex post demand. We need a marriage of banks and government. The problem is that today’s global finance needs marriage therapy.
Let me translate. You will recall from Econ 101 that the propensity to spend is generally less than one, meaning that income recipients generally want to save some fraction of their incomes. This is Keynes’s “demand gap” that needs to be filled. Banks can help fill that gap by financing spending by those willing to spend more than current income, most beneficially when it is based on the expectation that this will increase future income.
As Paul put it, government needs bankers because bankers do not need to use democracy to determine who gets that credit. Bankers (are supposed to) lend in a very undemocratic way—to those most likely to repay. (Well, that was the ideal, anyway, before Wall Street decided it could earn far more by making loans to those who have zero chance of repaying!) Government cannot operate that way—its provision of credit is either democratic or allocated on the basis of cronyism—neither of which is desirable.
So bankers are supposed to do their duty, using underwriting to selectively lend to the credit worthy, helping to raise aggregate demand. They do this by issuing their own highly liquid IOUs to borrowers. The problem is that the liquidity of these IOUs ex ante is greater than it is ex post. In the crunch, only the real thing—currency (or what I called TWINTOPT—that which is necessary to pay taxes—in my 1998 book)—will do. Suddenly no one wants those bank IOUs; as Paul put it, the ex post demand for this kind of liquidity is less than the ex ante demand was that got the banks to provide it. The government needs to partner with the banks to supply the currency that bank depositors prefer ex post.
In today’s world the problem is not really with the banks—since they’ve got the Big Bank (Fed) and Big Government (Treasury) standing behind them. Now it is the shadow banks (Paul coined the term) that suffer the run when their short term liabilities suddenly fall out of favor. I think that what Paul means by the need for marriage therapy is that policy needs to address the massive build-up of shadow bank liabilities in good times (ex ante liquidity) and the crisis of confidence in bad times (ex post liquidity). Unfortunately, that’s not happening.
Leonardo Burlamaqui of the Ford Foundation began the conference with a reference to governance by lobbyists and regulation by the shadow banking system. The idea is that we cannot reign-in global finance because it has bought and paid for our “elected” representatives. Paul came back to that at the end of his talk, when he referred to lobbying as a legal twilight—legislation made in the dark. The solution, he declared is transparency: “Sunshine is a great disinfectant.”
Returning to the aforementioned caveat on fiscal and monetary policy independence, Paul warned me that MMT goes too far. He echoed a position taken by the other Paul (Krugman, that is) that when we are in a slump, we need an alignment of fiscal and monetary policy. Because we’ve reached the zero bound on interest rates, monetary policy has become impotent. Hence, we also need fiscal stimulus. However, a time will come when we might need to delink the two. If after recovery we are still running a budget deficit, we might need monetary constraint to hold down inflation; or, if the budget is too tight the Fed can relax.
I was puzzled. I told Paul that so far as I know, no MMT proponent has ever argued that monetary policy and fiscal policy must march lock-step in the same direction. He insisted we’ve never explained that as our position. So there you go, Paul and Paul, I’ve said it: YES, THERE CAN BE TIMES WHEN MONETARY AND FISCAL POLICY MIGHT PUSH OR PULL IN OPPOSITE DIRECTIONS.
Now, for my own two caveats on that. (Note that not all MMTers necessarily agree with these—I’m more skeptical than most on the potency of interest rate changes.)
- Monetary policy is not just impotent in a slump, it is also impotent in the boom. When a speculative fever takes hold—say, in stocks or gold or housing—raising interest rates a few hundred basis points is not going to cool the spirits. And the investment channel—which is how interest rates are supposed to work according to all the textbooks—is far too weak. So, while monetary policy can and most likely will tighten when fiscal policy is thought to be too loose, that will not do much. My own view is that monetary policy tightening mostly works by causing massive insolvency and widespread defaults. Witness the Volcker experiment of the early 1980s (the target was raised above 20%) and the Bernanke rate hikes after 2004 (while rates weren’t raised much, ARMs were structured such that rates exploded, ensuring instant insolvency). There isn’t any nice smooth relationship between rising rates and slowing growth of aggregate demand. If you want to use monetary policy to slow a boom, you’ve got to cause a significant financial crisis. I think that is bad policy, but it is a choice.
- Within the normal ranges of interest rate hikes, monetary policy can even work in the opposite direction. If you’ve got a lot of federal government debt and not too much private sector debt, then raising rates can actually stimulate the economy. The reason is that it increases government spending servicing debt, which increases private sector income. In my view this is not just a theoretical point. Japan’s situation just before the GFC was like that. After two decades of huge government budget deficits and no private sector borrowing, raising rates actually was stimulating the economy and bringing Japan out of a slump. But when the GFC hit, Japan reversed course, lowering rates and adding to the global headwinds. (The USA was in the opposite situation, with massive private sector debt and a relatively small government debt so that rate hikes killed the private sector.)
But more importantly, I think the two Pauls misunderstood the point MMT was making. Our argument is that the monetary and fiscal branches of government can NEVER be operationally independent. The central bank is the treasury’s bank. Virtually all payments made by and received by national government run through the central bank. Fiscal operations (spending and taxing) necessarily impact bank reserves. Since the Fed targets the overnight interbank lending rate (fed funds rate), the Fed must offset these fiscal operations. That is the sense in which we say that monetary and fiscal policy cannot be independent.
Put it this way. If Washington ever gets its act together to let government start paying its bills again, the Fed will not bounce Treasury checks.
But, yes, MMT agrees with the two Pauls that the central bank can squeeze when fiscal policy inflates, and vice versa.