Tag Archives: L. Randall Wray

Rationalization and Obligation, Part III: Premium Bonds, and Asset Sales

By Joe Firestone

In Part I of this six-part series I presented the President’s explanation of why he can’t use alternative options for coping with the default threat arising out of refusal to raise the debt ceiling, a summary of the kinds of difficulties characterizing it, and discussed two of seven options, selective default, and the exploding option, the President has to deal with it, apart from the way he seems to have chosen. In Part II I discussed the next three options, platinum coins, 14th amendment, and consols, and commented on the legal issues related to them. Here, in Part III, I’ll cover two options which have started getting attention most recently.

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Mine’s Bigger than Yours: Notes on Optimal Size of Govt.

By L. Randall Wray

For most of my career—going on 30 years–I’ve been accused of advocating Big Government. That is mostly because I adopted Hyman Minsky’s views—which I won’t go through here. Of course, those claims came from the right. I’ve always been proud of it, to some extent, even if I’ve always been critical of what my government actually does with its spending. And if I don’t piss-off at least one person every day, I’ve failed.

For the past 20 years as we developed the MMT approach and the JG/ELR proposal, we’ve faced all manner of ridiculous accusations: we advocate slavery (offering a job to someone who wants to work is no different from chaining him and whipping him and forcing him to pick cotton in the hot sun from sunrise to sunset) or communism (proposing full employment as a policy goal is the same thing as forcing everyone to share their undergarments) or fascism (noting that taxes-drive-money is equated to herding Jews into gas chambers).

Of course, those claims came mostly from the left—indeed, all three were proclaimed in the same sentence by a prominent Post Keynesian, and repeated at every opportunity by him and all his followers.

And now there is a whole website devoted to an “alternative” modern money view (called MMR—which I’ve not been able to decipher; it either stands for Measles, Mumps, and Rubella, or Monetarily Mentally Retarded—neither is very PC as an identity, I must say) insisting that the MMT approach embraces Nazi authoritarianism, since as we all know, no democratic government would ever impose taxes, much less use them to drive money (nay, according to MMR everyone would sit around leaderless campfires and barter with seashells whilst singing Kumbaya).

Oh and then there is the guilt by association: some financial markets people as well as Austrians agree with some of MMT, thus, MMT has to be an evil plan developed by Goldman Sachs to take over the world. This is the view of both right and left critics.

And now we find ourselves accused of advocating Small Government. The ultimate insult!
In a bizarre twist, the critics have been able to combine the guilt-by-association (some MMTers actually are willing to discuss Austrians views! Oh my, what has the world come to?), ad hominem attacks (a hedge fund manager must be against government!), and faulty logic (explaining how a JG is an automatic stabilizer must mean you are against discretionary fiscal stimulus!) to come up with yet another attack—and, again by Progressives (obviously—since Austerians want smaller government, so presumably they welcome us to the Small Government fold!).

I don’t think either our Austerian friends or our Progressives have the foggiest notion how big the federal government now is, what it spends on, and how much greater spending would need to be to fund all the programs Progressives want (and that Austrians fear).

I don’t know if this is going to make me more of a Big Government type or enhance my newly found Small Government reputation. But let’s see what the Federal government actually spends, using 2010 data (latest more-or-less actual data from the 2012 Economic Report of the President). The total is $3.5 Trillion, which is 24% of GDP that reached $14.66 Trillion.

Note that this is unusually high compared to trends due to the “big spending Democrats in the White House”.
No, actually it is big because GDP was depressed by the deep recession while government spending rose mostly automatically to deal with unemployment, poverty, and medical problems brought on by the crash.
But let’s take 24% of GDP as a rough approximation of the size of our “Big Government”. Note I am not including state and local governments—these are users, not issuers of the currency. Their spending is “paid for” by taxes, fees, fines, and some funding from Washington. I can see arguments either way for including them in our measure of the size of “Big Government” but I think that from the MMT perspective it makes more sense to leave them to the side.

I have added in parentheses the percent of GDP for the biggest items: defense (5%), Education and so on (1%), Health (2.5%), Medicare (3%), Income Security (4%), and Social Security (5%). Nothing else really matters much individually. Note there are well-known problems with the defense number—the reported figure significantly understates actual spending because a lot of “defense” activities are secret; some of the spending is hidden in other categories. Some is probably not reported anywhere.

Total: On-budget and off-budget …………………………………. 3,456,213    (24%)
National defense …………………………………………………………….. 693,586     (5%)
International affairs ……………………………………………………….. …45,195
General science, space and technology ………………………… ….31,047
Energy ………………………………………………………………………. ……..11,613
Natural resources and environment ……………………………… ….43,662
Agriculture ………………………………………………………………… …….21,356
Commerce and housing credit ……………………………………  ….–82,298
Transportation ………………………………………………………………… 91,972
Community and regional development …………………………. …23,804
Education, training, employment, and social services ……..127,710      (1%)
Health ………………………………………………………………………. ……369,054      (2.5%)
Medicare ………………………………………………………………….. ……451,636      (3%)
Income security ……………………………………………………………….622,210      (4%)
Social security …………………………………………………………… …..706,737      (5%)
Veterans benefits and services …………………………………….. .108,384
Administration of justice …………………………………………….. ….53,436
General government …………………………………………………… ……23,031
Net interest ………………………………………………………………….. ..196,194
Undistributed offsetting receipts ……………………………………–82,116
OK for our conservative and Austrian Austerians, a government that is almost 25% of our economy is far too big. For our progressive friends it is far too small. Let’s focus on the big things.
At least a fifth of all government spending goes to “defense”—and the actual figure is probably double that (say, 10% of GDP). Judging from libertarian support for Ron Paul and from the traditional progressive opposition to US imperialism abroad, I suspect we can agree that “defense” spending is far too big. Personally, I have opposed all US invasions of other nations with the exception of our participation in WWII. I’d bring all troops home, close all foreign bases, and prohibit further military adventures abroad; as our Republican friends say, “starve the beast” by cutting all military spending down to what is necessary to maintain a purely defensive force within our borders. The only foreign intervention I would support would be to air drop food and medical supplies wherever they are needed.
I know I won’t get my way. I would not call this a Big Government or Small Government preference—it is anti-war. But let us presume we scale back “defense” spending to a scale that makes it hard to mount sustained invasions abroad—to, say, 2% of GDP. (That should be sufficient to put a tank into the hands of every gun-loving and motherland-protecting patriot to ward-off attack.) We’ve thereby reduced the reported size of government by 3% of GDP (and perhaps actual size by 8% of GDP—but we will ignore that in calculations below). So, a 3% reduction of Big Government.
MMTers want a universal Job Guarantee program at a living wage. Various calculations have put that at about 1% of GDP, with net cost close to zero (due to savings on anti-poverty programs, unemployment compensation, and so on). Let’s say that is off by an order of a three hundred percent—true cost turns out to be 3% of GDP. That just replaces the reduction of defense spending, getting us back to 24% of GDP.
Now it is unreasonable to presume there is absolutely no reduction of “welfare” spending—in the form of “income security” that is 4% of GDP. We’ll offer a job to all who want to work, creating somewhere between 10 million and 30 million new jobs at a living wage (note that not all of the new jobs will be in the JG program—that depends on “multiplier” job creation in the private sector, but those jobs will also pay living wages or otherwise workers cannot be recruited out of the JG). Unemployment compensation, food stamps, and even some “tax expenditures” on the earned income tax credit will all decline.
Stephanie Kelton and I have replicated earlier work done by Hyman Minsky showing that a JG program will eliminate most poverty (defined as those below the official poverty line) just by providing one minimum wage job per household. At a higher wage, and by offering more than one job to households that want more work, the JG would raise most families well above the poverty line. Let us say that income security spending falls by a couple of percentage points (2% reduction). That offsets two-thirds of the JG program spending.
Note also there will be a bit of saving in the “education, training, employment, and social services” category that currently prepares workers for jobs that do not exist. But let’s keep the 1% devoted to that spending but instead prepare workers for jobs that will exist. So I won’t count any reduction here.
So we are down to 22% of GDP. Now let’s replace our failing US healthcare system with a universal and free, federally paid-for program that offers the range of services that are provided in the average rich nation. That will run about 7-8% of GDP. We already devote an amount equal to 5.5% of GDP to “health” and “Medicare”. Then there’s another 10% of GDP spent by consumers either out-of-pocket, through their state and local governments (“taxpayers”) and through private insurers. So we can cut total spending if we ramped up federal spending by a couple of percentage points. We’ll presume that extraordinary health spending (vanity nose jobs, anatomical augmentation, hair transplants from hairy backs to shiny scalps, etc) is taken care of by the private sector, while all the important stuff is covered by the federal government.
Let’s leave the savings to the nongovernment sector spending to the side and focus on the government’s portion: we go from 5.5% of GDP to, say, 8% of GDP for an increase of federal spending equal to 2.5% of GDP.
The remaining big category is Social Security—about three-quarters of which goes to retirees. That is the main income support for the majority of our seniors. Progressives believe benefits are too small—especially for retirees who had low earnings, and also for many who receive disabilities as well as for dependents and spouses of workers who die. Let’s ramp that up by 2% of GDP.
Note that with the JG program discussed above, that offers a living wage to all who want to work, seniors and their dependents will already have the option of earning more income from work. We should let them “double dip”—no reduction in work opportunity due to retirement onto Social Security benefits, nor in Social Security benefits should they choose to work. Living standards should be significantly higher with the boost to benefits plus the enhanced jobs prospects.
Our net impact on federal government spending so far: net increase of 2.5% of GDP. We’ve gone from a Big Government of 24% to 26.5%.
But we aren’t done yet. Let’s look to our progressive wish list for more. Public infrastructure is deficient—a point made by President Obama, and by our society of engineers that finds a deficit in our public infrastructure amounting to trillions of dollars. Yes we need bullet trains, cleaner water, better airports, bridges and hiways, and more dependable sewage treatment. And we need to join the developed world in getting our darned electrical wires safely underground so that power isn’t knocked out in every ice storm.
How much? Let’s look to the estimates provided by the progressive PERI report. They found that the rate of growth of public infrastructure spending fell by about half over the past decades; they project a needed “baseline” annual increase of $87 billion to make up for the shortfall, of which $54 billion would come from all levels of government.
Their “wish list” high end estimate would be for the public sector to spend even more, an additional $93 billion annually. However our state and local governments are broke—so let’s put the full burden on the federal government, and ramp up its spending by 1% of GDP (make it a nice round $150 billion per year). That is well above the PERI dreams—which will go beyond traditional projects and make a dent in our sustainability problems with insulation retrofitting and so on. (There is a nice synergy here as our JG workers will be doing these sorts of projects.)
So we add another percentage point to government spending.
Our Big Government is now 27.5% of GDP. We’ve got true full employment at a living wage. We’ve got universal and free healthcare. We’ve got a more generous retirement system, and better care for survivors and those with disabilities. We’ve got bullet trains and bridges that don’t fall into rivers. And we’re reducing our foreign entanglements.
All for 3.5% of GDP additional spending.
And we’ve avoided “dynamic budgeting”—we have not counted potential savings in terms of reduced incarceration for the young jobless males who turn to a life of crime. We haven’t counted health benefits; we didn’t reduce spending very significantly on income support that will face fewer demands. We didn’t count multiplier effects on private sector spending—that would reduce government spending in some areas. And so on.
All of us, progressives and Austrians alike, know we can “afford it” because a sovereign government cannot run out of its own currency. Three point five percent.
I do not know if that will comfort our Austerians, who think 24% is already far too big. Nor do I know if it will comfort our Progressives, who are now sure that MMTers have become advocates for Small Government.
To be sure, I can add some more items to the list above: more federal funding for education, federal support for sustainable agriculture (but less support for corporate farming—so that probably balances), more foreign aid, and good wine flowing from every water fountain in America.
All that might add one or two or three more percent—and get us to a 30% government. Will that horrify our Austrians, and still dissatisfy our Progressives?
Probably. Both.
What should government do?
I think reasonable people can disagree when it comes to what government ought to do. I think it is worth discussing. Lay it out on the table. Forget the silly arguments about deficits and hyperinflations and taxation by dictatorships and JG slavery and bankrupting our grandkids and associating with Austerians and Hedge Fundarians.
And about arbitrary government-to-GDP ratios. We don’t need to argue about whose is bigger. What matters is what you do with government.
What should government do? It’s a mostly political question. A 24% government (US) can do most of what most people seem to want government to do. And more than what others want. And so can a 50% government (France). The jury is still out on a 15% government (Mexico)—it would be hard to point to Mexico as either a case of a successful government doing what people want it to do, or as an Austrian Austerian utopian Small Government.
What do you want government to do? 

Today’s Modern Money Primer

Complications and private preferences. There are often two objections to the claim that government spending effectively takes place by simultaneously crediting the recipient’s bank account as well as the bank’s reserves: a) it must be more complicated than this; and b) what if the private sector’s spending and portfolio preferences do not match the government’s budget outcome?
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Today’s Modern Money Primer

Check out the latest in the Modern Money Primer series:  The Effect of Sovereign Budget Deficits on Saving, Reserves and Interest Rates.

Fiscal and Monetary Policy in a Sovereign Nation: Responses to Blog #18

By L. Randall Wray

Thanks for comments. Let me provide a dozen responses, by topic.

Q: What about interest on reserves?

A: Chairman Bernanke moved to pay interest on reserves a couple of years ago, joining other countries (like Canada) that do so. Does that make any difference? Yes and no. First it simplifies operations and renders Treasury bond sales superfluous. Since the purpose of bond sales is to provide an interest-earning alternative to non-interest paying reserves, once you pay interest on reserves that is effectively the same thing as a bond. Ergo, you can stop selling bonds.

Now, why do you sell bonds when reserves don’t pay interest? Because excess reserves in the system drive overnight rates below the central bank’s target. It then sells bonds to offer the alternative.

But the easiest way to hit a target interest rate is to charge—say—50 basis points (100 bp = one percentage point) on loans at the discount window then to pay 25 bp on reserves held at the central bank. The overnight market rate on interbank lending (fed funds in the US) cannot deviate from the 25 to 50 bp range. (These are the ceilings and floors—you can do the same thing with sheep wool: government pays $25 to buy wool and sells at $50 so wool never rises above $50 nor falls below $25). The narrower that range, the smaller the flux of overnight rates.

Now as we know the US (and Canada) still sells bonds. This mostly has to do with the maturity structure: reserves are close substitutes for very short term bonds (ie: 30 day bills), and the central bank normally stays at the very short end.

Not that Treasuries understand any of this: when rates on 30 year maturity bonds are low, they issue lots of those thinking they’ll save on interest payments. But any Central bank with a floating rate can set the overnight rate anywhere it wants, and then just pay interest on reserves—no need to ever issue long maturity debt. Call your Treasury official and explain this. Stop issuing bonds = never run up against debt limits = never have kindergarten level debates in congress about debt limits.

Q2: In real terms, do government deficits take away “real saving”?

A: At full employment, government deficits move resources away from other uses to the public purpose. That might be good; it might be bad. With fewer resources available for private use, private investment might be lower. In that sense, “private real saving” is less. Fewer shopping malls, more schools and museums. Less investment in producing social life-altering underarm sprays, and more investment in bridges that do not collapse into rivers. I don’t know which to choose. But I’ve been flying a lot, avoiding bridges but sitting next to passengers who could use the spray.

Judge that for yourself. In nominal terms, however, government deficits create equivalent private savings—dollar for dollar. (Full disclosure, some can leak out to imports from Mars, etc.)

Q3: How does the central bank (CB) affect interest rates? Using open market operations (OMO)? Does it use the fed funds rate or discount rate? Is the 10 year bond rate set by the CB or by the market?

A: From above, we know CBs target overnight interest rates, and can use the ceilings and floors approach: lend at the discount window at 50bp and pay 25bp on reserve balances. In which case the “market rate” will flux between the two. Is this done through OMO? Not really. If the CB announces it will move its target rate from the range of 25-50bp to 50-75bp it does not need to engage in any OMO. All it does is to increase its rate paid on reserves to 50, and increase its discount rate charged to 75. And then “presto-change-o” market rates move. So you can see it uses both the fed funds rate (target) and the discount rate (rate charged), as well as the “support rate” paid on reserves.

What about longer maturities like the 10 year? It could do the same in that maturity—offer to buy at an interest rate equivalent of 200 bp and to sell at 150bp and you can bet your bottom dollar that the 10 year will trade in that range. But normally central banks do not do that. (QE tried a backassward way to do it: using quantity rather than price to try to get long rates down. Didn’t work—but who says Bernanke knows what he’s doing?)

Q4: What is endogenous vs exogenous?

A: It is somewhat arbitrary; and these terms are used in different senses (for the truly wonky: statistical, theoretical, or control senses). To keep it simple, most people use these to refer to the policy sense: does the government control the variable? For example, does the CB control the “money supply” or the “interest rate”. Well, it clearly cannot control the money supply—however measured except in the sense that it can do a Bernanke and fill banks full of excess reserves (that cannot get out). But it clearly can set overnight interest rates—all of them do—so that is called “exogenous” control of interest rates.

Q5: If the deficit gets bigger and bigger, doesn’t it have to get repaid later out of savings?

A: No. The US government debt was only “repaid” once in our nation’s history: 1837. That will never happen again. Bet on it.

Q6: In a fixed exchange rate system does govt really “choose” to spend less (or raise its interest rate target) to protect currency?

A: Yes. In the sense that it can “choose” not to do so, and then deal with the consequences. You can “choose” not to drive on the right (or left) side of the road. You might not enjoy the outcome. I’ve done it. You probably have, too. You might even “choose” to drive above the speed limit, too. There are consequences, and we all deal with them.

Q7: Does it matter if govt spends money into existence for interest payments rather than wages (as in ELR program)?

A: Yes. It can also spend money into existence to support fat cat Wall Street fraudsters. Good idea? Maybe not. Will it run out of funds? No.

Q8: Use GDP income measure rather than GDP expenditure measure.

A: Well, by identity they are identical. But, yes, it does matter that the wage share in the US has dropped toward third world status (about 50% of national income; vs 25% in Mexico). And so for consumption to grow Americans had to borrow heavily. Bad idea.

Q9: MMT has an unwarranted fixation on nominal vs real.

A: Give me a break, Neil. I guess you slept all through last week (see Blog 17). If anyone suffers from a fixation it is our Austrian brethren who are so fixated on “real” that they cannot understand that we live in a monetary economy.

 Thanks, Eric and Calgacus.

Q10: Can the CB compel banks to support higher reserve levels; can the CB control interest rates without issuing reserves?

A: CB can raise required reserve ratios, and banks (magically!) will hold more! That acts like a tax on banks, increasing their cost of doing business as reserves pay very little, ie 25 bp. Banks are less profitable. Not sure why we want that. In the Canadian system, bank holdings are right about zero—since the Bank of Canada requires zero and operates with a ceiling and floor interest rate as described above. Nice system. Sometimes those Canadians surprise you with how clever they can be! So, yes, they hit their interest rate targets even as banks essentially hold no reserves. But they do use them for clearing—which is all that matters.

Q11: How are government bonds issued?

A: By Treasury, to special banks, that use reserves to buy them. The CB supplies the reserves the banks need. We’ll do more of this later.

Q12: I go to a bank and it creates a loan; does it create money out of thin air? Is this disreputable?

A: Yes. And No. It takes your IOU, and creates its own IOU (your demand deposit). Out of a keystroke to a computer tape. Sounds a bit sexy but not at all pornographic. It is the bank’s IOU. It gets your IOU (“loan”) and goes into debt (demand deposit). It does not “get something for nothing”. If it eventually earns profits on the deal, that is a reward for “underwriting”: determining that you are no scumbag deadbeat borrower who will default.

I think that’s the nicest thing I’ve ever said about a banker. Made her sound almost like Jimmy Stewart. On that note I should stop.

Today’s Modern Money Primer

By L. Randall Wray

This week we will begin to examine our next topic: government spending, taxing, interest rate setting, and bond issue. We will examine fiscal and monetary policy formation by a government that issues its own currency. We will bear in mind that the exchange rate regime chosen does have implications for the operation of domestic policy. We will distinguish between operational procedures and constraints that apply to all currency-issuing governments and those that apply only to governments that allow their currency to float. Over the previous 17 (!) weeks we have touched on much of this, but now it is time to get down to “brass tacks” to look at some of the nitty-gritty.
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MMP Blog #18: Fiscal and Monetary Policy Operations in a Nation that Issues its Own Currency

By L. Randall Wray

This week we will begin to examine our next topic: government spending, taxing, interest rate setting, and bond issue. We will examine fiscal and monetary policy formation by a government that issues its own currency. We will bear in mind that the exchange rate regime chosen does have implications for the operation of domestic policy. We will distinguish between operational procedures and constraints that apply to all currency-issuing governments and those that apply only to governments that allow their currency to float. Over the previous 17 (!) weeks we have touched on much of this, but now it is time to get down to “brass tacks” to look at some of the nitty-gritty. As always, we are trying to stay true to the purposes of a “Primer”—a fairly general analysis that can be applied to all nations that issue their own currency. We will note where the results only apply to specific exchange rate regimes. And we will get into some of the procedures adopted that effectively “tie shoelaces together”—self-imposed constraints. This week we will provide a quick overview of general principles.

Statements that do not apply to a currency-issuer. Let us begin with some common beliefs that actually are false—that is to say, the following statements do NOT apply to a currency-issuing government.

  1. Governments have a budget constraint (like households and firms) and have to raise funds through taxing or borrowing 
  2. Budget deficits are evil, a burden on the economy except under some circumstances
  3. Government deficits drive interest rates up, crowd out the private sector…and necessarily lead to inflation
  4. Government deficits leave debt for future generations: government needs to cut spending or tax more today to diminish this burden 
  5. Government deficits take away savings that could be used for investment 
  6. We need savings to finance investment and the government’s deficit 
  7. Higher government deficits today imply higher taxes tomorrow, to pay interest and principle on the debt that results from deficits

While these statements are consistent with the conventional wisdom, and while they are more-or-less accurate if applied to the case of a government that does not issue its own currency, they do not apply to a currency issuer.

Principles that apply to a currency issuer. Let us replace these false statements with propositions that are true of any currency issuing government, even one that operates with a fixed exchange rate regime

  • The government names a unit of account and issues a currency denominated in that unit;
  • the government ensures a demand for its currency by imposing a tax liability that can be fulfilled by payment of its currency;
  • government spends by crediting bank reserves and taxes by debiting bank reserves; 
  • in this manner, banks act as intermediaries between government and the nongovernment sector, crediting depositor’s accounts as government spends and debiting them when taxes are paid; 
  • government deficits mean net credits to banking system reserves and also to nongovernment deposits at banks;
  • the central bank sets the overnight interest rate target; it adds/drains reserves as needed to hit its target rate; 
  • the overnight interest rate target is “exogenous”, set by the central bank; the quantity of reserves is “endogenous” determined by the needs and desires of private banks; and the “deposit multiplier” is simply an ex post ratio of reserves to deposits—it is best to think of deposits as expanding endogenously as they “leverage” reserves, but with no predetermined leverage ratio; 
  • the treasury cooperates with the central bank, providing new bond issues to drain excess reserves, or retiring bonds when banks are short of reserves; 
  • for this reason, bond sales are not a borrowing operation used by the sovereign government, instead they are a “reserve maintenance” tool that helps the central bank to hit interest rate targets; 
  • the treasury can always “afford” anything for sale in its own currency, although government always imposes constraints on its spending; and 
  • lending by the central bank is not constrained except through constraints imposed by government (including operational constraints adopted by the central bank itself). 

Some of these statements will seem cryptic at this point. We will clarify further in the following weeks. Here we are setting out the general principles that will be discussed later in order to contrast them with the “conventional wisdom” that likens a government’s budget to a household budget.

Let us be careful to acknowledge that these principles do not imply that government ought to spend without constraint. Nor does the statement that government can “afford” anything for sale in its own currency imply that government should buy everything for sale in its currency. Obviously, if things are for sale only in a foreign currency, then government cannot buy them directly using its own currency.

These principles also do not deny that too much spending by government would be inflationary. Further, there can be exchange rate implications: if government spends too much, or if it sets its interest rate target too low, this might set off pressure to depreciate the currency. This means that the government’s interest-setting policy as well as its budget policy will be mindful of possible impacts on exchange rates and/or inflation rates; in that sense, interest-setting and fiscal policy are “constrained” by government’s desire to control the exchange rate or the inflation rate.

This brings us to the exchange rate regime: while the principles above do apply to governments that peg their exchange rates, they must operate fiscal and monetary policy with a view to maintaining the peg. For this reason, while these governments can “afford” to spend more, they might be choose to spend less to protect their exchange rates. And while government can “exogenously” lower its interest rate target, this might conflict with its exchange rate target. For that reason, it might choose to keep its interest rate target high if it is pegging its exchange rate.

Next week we will begin to examine in more detail the government’s budget when it is the issuer of the currency.

Real vs. Financial Accounting: Responses to Blog #17

Ok this week we are detailing the difference between real and financial—both flows and stocks. Let me provide answers on seven points, and (sorry) postpone for a couple of days an answer to the eighth (which I have not had time to go through).

Q1 (Neil): What about a reserve currency? What about insufficient real investment—especially to deal with the extra demand of ELR?

A: All the real and financial accounting applies to any nation, any currency. No difference. But, OK, might be worthwhile to have a blog devoted to the international reserve currency. Will do.

On adopting ELR and capacity. Look, my belief is that capitalists are not (too) stupid. If there is demand, they will try to meet it. There can be bottlenecks, but those are temporary. We do not need to prod them to invest. If there are sales prospects they will add capacity. On ELR (a topic we have not covered yet), we increase employment and probably demand for consumer goods. By Okun’s law, reducing the unemployment rate by one percentage point raises output by three percentage points (GDP). The ratio could be considerably less for ELR. Note that conventional estimates of a universal ELR program are that wages and other costs would be about 1% of GDP, so by Okun’s law, reducing unemployment by 10 percentage points or so the extra output generated would be far more than enough (up to 30 percentage points of GDP, although probably less) to satisfy the demand. But—we’ll do this later.

Q2: (Tom): Doesn’t childcare (etc) increase value added as women (etc) are released to higher value work? And Austrians argue only real assets, not financial assets, constitute “the economy”.

A: Agreed on the first point, but “efficiency” is vastly overrated—see below. The second, Austrian, point might be OK as a prescription, but certainly not as a description of the real world (a point Dave makes, too). This is a “monetary production economy” where satisfying consumer demand (providing “utils”, raising living standards, reproducing labor power—whatever you want to call it) occurs only by coincidence. What matters is monetary profits. All the more important when Wall Street runs the economy.

Q3: (Geerussell): Does government need to tax all activity, including production for own use?

A: No. We need a broad-based tax that is hard to avoid. Cubic foot of dwelling space, or perhaps cubic inches of cranial space, will do it. (Everyone needs shelter and a brain.)That will drive money, allowing government to move resources to the public purpose.

Q4: (Rvm) Does MMT apply to communist society?

A: In theory, socialist society still uses money to motivate production, hence to move resources to public purpose. So, yes, taxes drive money and money motivates labor. From each according to ability to each according to contribution. In communist society, in theory, you no longer need money to motivate activity. From each according to ability to each according to need. No taxes, no money.

Q5: (Dave): Is drop-out hippiedom the future?

A: Well, a lot of people thought that back in 1965. We’re still waiting. Note, I do think that “slow” and “local” food is a good thing, with proper caveats.

Q6: (Forrest) Again, a question on efficiency vs independent food production.

A: Briefly, efficiency is vastly overrated as an overriding goal, and it often (maybe always) conflicts with sustainability. Without getting overly tree-huggy about this, if using a few more workers in agriculture instead of poisonous petrochemicals can help to save the globe, let’s give up some efficiency. It is not like we’ve run out of labor. And if we go a bit wonky, the economic definition of efficiency is only well-defined in a general equilibrium model with continuous full employment. That ain’t our real world. Most of the time we have massive amounts of unemployed resources, so putting them to work increases output without sacrificing any efficiency, no matter how inefficient the production process.

Q7: (Joe & Larry—I sure wish it had been Moe&Larry!): Money is the way to shift real production; money is not real stuff, but moves it.

A: Mostly agreed—from the perspective of government. Government creates a money of account, issues IOUs denominated in it, and imposes a tax to move real resources to the public sector to accomplish the public purpose (as it sees it). Unfortunately, in a capitalist economy, the captains of industry that control a huge portion of production do not see it that way. All they really care about is money.

Q8: (Mattay): Accounting example.

A: Sorry—will try to answer soon.

Today’s Modern Money Primer

Last week we received a well-thought-out query, which is pasted below in its entirety (although I removed the author’s name to respect privacy). I think the author raises points that are sufficiently important that we should take another unplanned diversion this week. This is the great thing about running the Primer this way as I can see where I’ve failed to adequately explain something. I had thought the distinction between real and financial (nominal) was clear—but obviously it was not.

At this point you might want to skip down to the bottom of this post to read the query. I will summarize the main point later, but I expect that many of you would agree with the author—so go ahead and read it first. Then we’ll get to the response.

Ok, let me try to explain this as clearly as possible.

Today’s Modern Money Primer

In the next series of blogs we will look in more detail at fiscal and monetary operations of a nation with a sovereign currency. Before we do that, let us briefly examine the case of the Euro. There is no way the system as designed could possibly survive a significant financial crisis. And a crisis began in 2007. Due to flaws in the set-up, it was obvious (at least to those who adopted MMT) that the original arrangement was not sustainable. Read more…