Tag Archives: MMT

Scott Sumner Agrees that MMT Policy Proposals Are Not Inflationary

Posted on July 20, 2011 by Scott Fullwiler | 71 comments

By Scott Fullwiler
Scott Sumner sets out to debunk theories of the price level not based on a form of the quantity theory of money, and lumps MMT in with those approaches that “deny open market purchases are inflationary, because you are just exchanging one form of government debt for another.” While this is true, what’s interesting is that from within Sumner’s own paradigm, MMT-related proposals should not be inflationary. This is clear right off the bat when he lists his first “qualifier” or exception to the quantity theory:

If the new base money is interest-bearing reserves, I fully agree that OMOs may not be inflationary. That’s exchanging one type of debt for another.

And that is about all we need to hear. As we’ve said probably gazillions of times, you can’t have discretionary open market operations beyond that which is consistent with the Fed achieving its federal funds rate target unless an interest-bearing alternative to reserve balances is offered. Traditionally, this has been Treasury securities issued by the Treasury or sold by the Fed. The only way to leave all the reserve balances circulating and achieve a positive interest rate target at the same time would be to pay interest on reserve balances.
For instance, later, when Sumner writes, “Now suppose that in 2007 the US monetized the entire net debt, exchanging $6 trillion in non-interest bearing base money for T-securities,” hopefully he realizes that this is not operationally possible without paying interest at the target rate on the excess reserve balances created unless the Fed wanted to have a zero-rate target.

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Posted in Scott Fullwiler

Tagged Federal Reserve, inflation, MMT, Modern Monetary Theory

Coin Seigniorage: A Legal Alternative and Maybe the President’s Duty

Posted on July 18, 2011 by Joe Firestone | 36 comments

By Joe Firestone
(Cross-posted from Correntewire.com.)

(Author’s Note; Many thanks to lambert strether, beowulf, and Yves Smith for their reviews of this post)

Well, the debt limit crisis is upon us. Treasury Secretary Geithner says the US Government will not be able to meet all its obligations on August 3, unless the debt ceiling is increased by Congress. The Secretary says he is out of moves to extend this date. I don’t think that’s true. I think he can use proof platinum coin seigniorage to supply all the money needed to spend Congressional Appropriations. I do not know if the Administration knows about this idea yet. It may, and it may simply have been unwilling to mention it for its own reasons. But just in case it doesn’t know, and also for the sake of the rest of us, I’m making another attempt to state the case for using coin seigniorage, so that as many people as possible know that the President has an alternative to the “shock doctrine,” make a deal approach to cutting essential spending and services including the social safety net, in return for getting $2.6 Trillion more in debt issuance authority.

The idea of using coin seigniorage to remove the need for issuing debt, and so to always stay under the debt ceiling is due to a commenter (and occasional blogger) on economics and politics blogs whose screen name is beowulf. He first presented the idea in comments and then posted the seminal blog on coin seigniorage.

Throughout the next six months, a number of other posts appeared at various sites (See here for links) with increasing frequency as the debt limit problem received more attention.

In the last few days, as coin seigniorage itself climbed up the hierarchy of public awareness, Felix Salmon and Matt Yglesias, both well-respected, mainstream, and professional bloggers, have mentioned the proposal while taking issue with it for reasons I’ll analyze below. Before, I do that however, here’s what’s involved in proof platinum coin seigniorage,

Congress provided the authority, in legislation passed in 1996, for the US Mint to create platinum bullion or proof platinum coins with arbitrary fiat face value having no relationship to the value of the platinum used in these coins. These coins are legal tender. So, when the Mint deposits them in its Public Enterprise Fund account at the Fed, the Fed must credit that account with the face value of these coins. This difference between the Mint’s costs in producing the coins and the credit provided by the Fed is the US Mint’s profit. The US code also provides for the Treasury to periodically “sweep” the Mint’s account at the Federal Reserve Bank for profits earned from these coins. Coin seigniorage is just the profits from these coins, which are then booked as miscellaneous receipts (revenue) to the Treasury and go into the Treasury General Account (TGA), narrowing the revenue gap between spending and tax revenues. Platinum coins with huge face values e.g. $2 Trillion, could close the revenue gap entirely, and technically end deficit spending, while still retaining the gap between tax revenues and spending.

Recent Comments from the Mainstream

Here’s Felix Salmon’s treatment at Reuter’s:

Even if Treasury can still sell bonds, however, that doesn’t mean for a minute that breaching the debt ceiling is something which should be considered possible for the purposes of the current negotiation. Tools like the 14th Amendment or even crazier loopholes like coin seignorage would be signs of the utter failure of the US political system and civil society. And that alone could mean the loss of America’s status as a safe haven and a reserve currency. The present value of such a loss? Much bigger than $2 trillion. (Coin seignorage, if you’re wondering, is the right that Treasury has to mint a couple of one-ounce, $1 trillion coins and deposit those coins in its account at the New York Fed. It could then withdraw cash from that Fed account to make all the payments it wanted.)

Felix Salmon does give an acceptable one sentence overview of the proposal, but doesn’t make clear that there could be even a single coin (not a “couple of coins”) of arbitrary value produced by the US Mint. More importantly, he doesn’t make clear why using coin seigniorage would be a sign “. . . of the utter failure of the US political system and civil society,” or why using it would be “. . . breaching the debt ceiling.” He also doesn’t say why he lumps in a 14th Amendment challenge to the debt ceiling with coin seigniorage as crazy ideas.

Addressing these points one by one, first, it’s true that the Congress hasn’t been able to come to agreement on the debt ceiling, but it’s hard to see why this is a sign of “the utter failure” . . . “of civil society.” Even more, the US political system has provided the tool of coin seigniorage as a legal, if not customary, way of generating revenue in addition to taxing and borrowing. Why does this count as “crazier” idea or a failure of the political system? From my point of view the only failure here is the President’s in not using coin seigniorage, or perhaps not yet even knowing about it. But if this is a failure, I don’t see that it’s a systemic one as much as it is a failure of this Administration to look for alternative views that go beyond its own knowledge and imagination.

Second, it’s hard to see why using coin seigniorage would be “breaching the debt ceiling.” Certainly, challenging the Constitutionality of the debt ceiling and overturning the legislation mandating it might be described as “breaching” it. Also, just ignoring it on grounds that it is unconstitutional might be described in the same way. However, using proof platinum coin seigniorage with very high face value coins just spends Congressional appropriations, including paying down debt so that it’s way below the debt ceiling, or even completely eliminated, using perfectly legal means. It’s hard to see how this can be legitimately described as “breaching the debt ceiling.”

And, third, why does Felix Salmon think that using coin seigniorage “. . . could mean the loss of America’s status as a safe haven and a reserve currency. ” Why should a demonstration, using coin seigniorage, of the Treasury’s power to meet US obligations even when Congress is in deadlock, lead to a loss of confidence, making investment in the US look any more dangerous than it is at present, or disturbing the status of the US dollar as the reserve currency? Surely if Felix Salmon wants to make such a serious charge he should at least give readers his reasoning.

It is possible that if coin seigniorage were used on a continuing basis to close the gap between taxes and spending, then US Treasuries would no longer be a safe haven for investing USD reserves, simply because, if no more debt is issued, then no investment in Treasuries is possible. But even if that happened, a low level of interest paid by the Fed on USD reserves would still leave US dollar reserves as safe a haven for holding “risk-free” US financial assets as short-term Treasuries are right now.

It is also hard to see why coin seigniorage, if used, would interfere with the status of USD as the reserve currency. Why should it, since continuous use of seigniorage would result in gradually eliminating the national debt? And what other reserve currency would the world use? The UK pound? The Euro, with its great potential instability? The Yuan, which if it became the reserve currency would force China to give up its peg to the Dollar and to even acquire a bit of a disadvantage in trading with us? What about the Yen? Sounds OK to me, but the world seems convinced that Japan, with its 200% debt-to-GDP ratio might have runaway inflation anytime now. So, will the world take the Yen? Probably not.

What about a market basket of freely floating currencies? Well, that would be fine, but it’s hard to see how that would disadvantage us or cost us $2 Trillion. I also wonder where Felix Salmon got that estimate from. Also, is the $2Trillion an interest cost, a reduction in GDP? Is it over one year, or a decade? Isn’t it a fact, that being the reserve currency costs us exports and jobs? How does that get factored into Salmon’s $2 Trillion cost of not being the reserve currency?

Matt Yglesias is the second popular blogger mentioning coin seigniorage last week. Matt says:

This is an idea that’s circulating in Modern Monetary Theory circles, and I believe that it’s legally mistaken.

Perhaps it is. But don’t you owe it to readers to tell them why?

That said, conceptually it highlights a very accurate point. If you think of the United States government as a consolidated entity, it’s not possible for us to “run out of money” or “go bankrupt.” The government of Ireland owes euros, but it lacks the legal authority to create Euros. Governments of small developing countries often owe dollars, but lack the legal authority to create dollars. Under a gold standard, a government might owe gold and lack the physical capacity to create it. But the United States is owed dollars, and can create dollars, so it’s absurd to think that we might not be able to pay our bills.

Matt understands this very basic point of MMT, and that puts him miles ahead of most who pronounce on solvency. But it’s also important to emphasize that Governments like our own can become insolvent voluntarily. That is, if Congress fails to raise the debt ceiling, or if, in the event they fail, the President fails to use coin seigniorage or another Treasury tool to create a positive balance in the Treasury General Account (TGA) at the Fed, then we can become voluntarily insolvent – a self-inflicted wound caused by a collective failure to understand our fiat currency and monetary system.

Now what might happen is that people lose willingness to lend us dollars in the future. We also might have inflation. Money was lent in the past on the assumption that dollars would be able to purchase real goods and services. Monetization of debt would reduce the real purchasing power of dollars, and might call into question the wisdom of agreeing to lend dollars in the future. But these are different issues.

First, if, as Matt recognizes, we can’t “run out of money” then why do we need people to lend us our own currency in the future? Why can’t we use coin seigniorage indefinitely for “deficit spending?” (From a technical point of view continuous use of proof platinum coin seigniorage would end deficit spending because it would close the gap between spending and taxes with miscellaneous receipts, a class of revenue. However, the gap between taxes and spending would remain and that “deficit” represents a surplus for the non-Government sector.) If we did that we’d avoid, as time went on, most spending on interest costs projected by CBO over the next 10 years. Indeed, if we project out to 15 years based on CBO 10-year numbers, we’d avoid nearly $12 Trillion in projected interest costs. Why borrow our own money back at all? The answer is we don’t need to. So, we don’t really have to care whether people want to lend us back our own money, or not.

Second, why would coin seigniorage in itself cause inflation? Coin seigniorage creates money to spend Congressional appropriations. As long as those appropriations are not so great that they exceed the potential productive capacity of our economy — and right now our output gap is around 30%, and there is no sign of Congress deciding to spend enough to close that gap — there will be no demand-pull inflation.

Would there be cost-push inflation? Not from coin seigniorage. The coins would just go into a Fed vault forever, and again the spending will be only what Congress appropriates. Coin seignorage will add to aggregate demand whenever spending exceeds taxes; but it will not cause cost-push inflation. That is caused by suppliers or speculators who are distorting markets. And the remedy for that is criminal investigations, price controls, rationing, and a thoroughgoing belief that markets must be very closely regulated by independent adversarial enforcers if they are to remain free.

Third, “money was lent in the past on the assumption that dollars would be able to purchase goods and services in the future.” But, again, why should the simple fact of using coin seigniorage debase the currency? Matt needs to explain the transmission mechanism from using seigniorage to spend Congressional appropriations and pay down debt, to currency debasement. Saying that “we also might have inflation” is easy. But one really has to show that the likelihood of inflation is greater if we use coin seigniorage than it is if we issue more debt instead. My view is good luck with that, because there are very good reasons for thinking that coin seigniorage would actually be less inflationary than issuing debt to close the gap between taxes and spending would be.

Fourth, “monetization” is a term that is frequently thrown around whenever the Government wants to use its Constitutional power to deficit spend and create money in the process. But “monetization of debt” has a strict meaning in modern economies. It refers to the purchase of debt instruments by the Central Bank from the Treasury. That wouldn’t be happening here.

Here’s how coin seignorage works: Legal tender, money, in the form of proof platinum coins, not legally viewed as debt, is being exchanged for USD credits in the US Mint’s Public Enterprise Fund account. The money goes into the Fed vaults, the USD credits go into the Mint’s account. The profits from seigniorage go into the TGA. This is an asset swap, between the Fed and the US Mint, of money in the form of a coin, for money in the form of bank reserves. Both sides of the swap are money; so there is no “monetization of debt” involved.

[UPDATE] I now think this might be legal after all, provided the coin is made of palladium.

Palladium coins won’t do; we need coins that can be legally given an arbitrarily high face value. The palladium coins are specified by Congress at $25 in face value. The platinum coins being discussed in the coin seigniorage proposal are proof platinum coins. The face value of these coins is arbitrary and has nothing to with the value of the metal. Platinum proof coins are strictly fiat money, and they can have as a large a face value as the Mint likes. Just like the USD reserves the Fed creates for quantitative easing, or to increase the money supply.

So, after months of blogging, commenting, and tweeting about the coin seigniorage option, it seems that enough activity has been generated in the blogo- and twitter-spheres to have attracted at least the passing attention of well-respected bloggers such as Felix Salmon and Matt Yglesias. It’s pretty clear from my analysis, however, that both of them are offering conclusions about coin seigniorage that aren’t based on careful analysis of the literature that’s developed on the subject.

Put simply, they don’t seem to have thought things through, and they don’t seem to be in a position to guide their readers in learning about the coin seigniorage option. It’s good that they’ve recognized that coin seignorage is, at least, analytically sound enough to merit attempted refutation, and have opened the door to discussion of it in the wider discourse. Thanks to both of them for that, and especially to Matt for pointing out that involuntary solvency isn’t a problem for the US. Exposure for a policy proposal is always better than just continued burial in the non-visible portion of the blogosphere. Nevertheless, it would be so much better for all of us if well-known bloggers who take up a new proposal would investigate it with care before they pronounce a verdict on it.

What harm would have been done if Felix Salmon and Matt Yglesias had just mentioned coin seigniorage and admitted that they still had to research it before deciding on whether it would work, and that they were keeping an open mind pending that research? Certainly, the potential of coin seigniorage as a solution to our revenue problem merits that kind of consideration. How important is it?

The Importance of Coin Seigniorage to the President

I’ll end this post by showing how important it is through an examination of our present situation with respect to the debt ceiling and the potential obligation of the President to use coin seigniorage to cope with it.

1. Congress has appropriated Federal spending for FY 2011 which the Executive is mandated to spend.

2. These appropriations exceed the tax revenue the Government is collecting. This was expected at the time the appropriations were passed. So Congress appropriated deficit spending.

3. Congress has mandated that whenever the Government plans to deficit spend, it must first issue and sell debt instruments in an amount a least equal to the planned deficit spending. In this connection, the Treasury is prohibited from having an overdraft in its TGA at the Federal Reserve Bank.

4. Congress has mandated a debt limit such that the Administration must stop issuing debt when that limit is reached. (The limit was reached in early May). Given the Congressional requirement that deficit spending must be accompanied by debt issuance, the debt limit, in the absence of other countervailing factors puts a stop to deficit spending, until the limit is increased. There is a very important countervailing factor. But it is not recognized or used. So, for the moment, at least, the debt limit has stopped any further deficit spending

5. The 14th Amendment, section 4, requires that the validity of the “debts” (broadly construed) of the United States never be questioned, and since the President has sworn an oath to uphold the Constitution, he is obligated to do all he can to see to it that these “debts” are paid. In fact, he’s obligated to see to it that these debts aren’t even “questioned.” His suggestion that Social Security and other key payments won’t be made on August 3, isn’t living up to his obligations. Of course, he’s not alone in this, since many law makers have been warning about the likelihood of a default for many months now.

6. Congress has provided the authority, in legislation passed in 1996, for the US Mint to create platinum bullion or proof platinum coins with arbitrary fiat face value having no relationship to the value of the platinum used in these coins. The US code also provides for the Treasury periodically sweeping the Mint’s account at the Federal Reserve Bank for profits earned from coin seigniorage. These profits are then booked as miscellaneous receipts (revenue) to the Treasury and go into the TGA, narrowing the revenue gap between spending and tax revenues. Platinum coins with huge face values e.g. $2 Trillion, would close the revenue gap entirely, and technically end deficit spending, while still retaining the gap between tax revenues and spending.

7. If used routinely to close the revenue gap, such coin seigniorage would eventually reduce the national debt to zero, and remove it as an issue in US politics. In addition, the existence of platinum coin seigniorage as an option, removes the tension between the mandated debt ceiling and the 14th Amendment. It is the countervailing factor I mentioned earlier, because it provides a way to spend Congressional appropriations without issuing further debt.

8. The President has sworn to uphold both the Constitution, which prohibits a default, and also the laws of the United States including the mandates just mentioned.

9. These mandates, along with the platinum proof coin seigniorage authority, make using seigniorage, or another option like it that allows the Treasury to create revenue without either taxing or borrowing, the only viable options to: continue spending appropriations without violating the debt limit; fulfill all the other mandates, both legal and constitutional; and still be able to spend the money Congress has appropriated.

10. So, if no action by Congress raising the debt limit is forthcoming, it will be the President’s sworn DUTY AND OBLIGATION to either use platinum coin seigniorage, or some other revenue creating tool legislated by Congress in past years, to make the money necessary to avoid default, since his failure to use an available way of creating revenue for continuing to spend appropriations, which he is mandated to do, would be a violation of his oath of office.

So, coin seigniorage isn’t some crazy idea. Instead, it is a legal instrument that the President may, depending on how things work out, have to use in a bit more than two weeks to comply with his oath of office. It may be the only way for him to avoid breaching one of the laws which he is supposed to enforce. As such, it has to be taken seriously, and treated with more than just a few dismissive conclusions, accompanied by a lack of explanation.

Many writers on the current debt ceiling crisis have been taking the view that the 14th Amendment constitutional challenge route is the best thing for the President to do if there is no agreement on the debt ceiling. In e-mail communication yesterday, beowulf offered the following opinion on why this will not work, given the existence of coin seigniorage.

. . . No federal judge — Supreme Court justices included — will take the extraordinary step of enjoining an Act of Congress if the President who asks them to had an opportunity to sidestep the constitutional issue lawfully but neglected to do so. . . . .

. . . The moral of the story is if the Court thinks there is no alternative to breaching the debt ceiling, it probably would find it unconstitutional (or rather, it would decline to hear the case on Standing grounds, leaving the President’s decision to ignore the debt ceiling in place). On the other hand, if the Court thinks the President had a lawful alternative– like coin seigniorage– but neglected to use it, they’re not going to bail him out.

This argument is compelling to me given the history of the Court. The Court defers to the legislature if it possibly can, and prefers the President to avoid constitutional challenges if he has a means of doing so. In this case, he does, and the means is platinum coin seigniorage.

Appendix: The Coin Seigniorage Idea in the Blogosphere

The idea of using coin seigniorage, the profits made from minting proof platinum coins, depositing them at the Fed, and receiving electronic credits in return, to remove the need for issuing debt, and so to always stay under the debt ceiling is due to a commenter (and occasional blogger) on economics and politics blogs whose screen name is beowulf. The first comment of beowulf’s I noticed on coin seigniorage was at New Deal 2.0 http://www.newdeal20.org/2010/11/04/obama-faces-his-own-teachable-moment-25819/#comment-9831 and I mentioned his proposal in a post I did on a possible Government shutdown due to the debt ceiling a couple of weeks later. http://www.correntewire.com/constitutional_crisis_over_debt_ceiling_does_government_have_shut_down

Beowulf continued his work on the coin seigniorage proposal as the weeks went by in various comments made at blog sites such as this one at FDL. We also began to exchange messages on coin seigniorage. On January 3, 2011, he posted the seminal blog on coin seigniorage. I followed two days later, raising the question of whether President Obama would use it to forestall an attempt to use the debt ceiling to extract cuts in the social safety net or not.

These posts were noticed by Warren Mosler, one of the originators of the Modern Monetary Theory (MMT) approach to economics, who sponsored what turned out to be a wide-ranging and very high quality discussion of the coin seigniorage option at his site. Beowulf contributed extensively and very creatively to this discussion, which remains one of the most important resources on the coin seigniorage option.

Throughout the next six months, I pushed coin seigniorage in blog posts at Correntewire, FDL, and DailyKos from time-to-time and in comments at various sites. Then, in late June and July a spate of posts on seigniorage appeared beginning, I think, with wigwam’s at FDL and DailyKos. He’s followed up since with a number of other posts including this one with a variation on how coin seigniorage might be applied by buying $2 Trillion in debt from the Fed to create “head room” relative to the debt limit. Other important posts have appeared this month by Mahilena, DC Blogger, Cullen Roche, Scott Fullwiler, and Trader’s Crucible. Accompanying the last two are extensive discussions of coin seigniorage and constitutionality of the debt ceiling with contributions from beowulf. Scott’s post also received extensive discussion with beowulf contributing at Cullen’s site. In addition, I’ve added two of my own posts, another on the President’s obligation, if no agreement on the debt ceiling is forthcoming.

So, the proposal to use coin seigniorage to both comply with the debt ceiling and still spend Congressional appropriations has by now enjoyed the support of a growing number of bloggers. It has also received a great deal of discussion; receiving 246 comments at Warren Mosler’s site; 206 comments spread over two post’s at Cullen Roche’s site, and 89 comments at Naked Capitalism. Readers checking out these discussions can see that the coin seignorage proposal has stood up very well to some very aggressive and forthright criticism.

(Cross-posted from Correntewire.com.)

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Posted in Joe Firestone

Tagged 14th Amendment, beowulf, debt ceiling, debt-to-GDP ratio, deficit, Felix Salmon, jumbo coin seigniorage, Matt Yglesias, MMT, Modern Monetary Theory, national debt, Reuters, surpluses

QE3, Treasury Style—Go Around, Not Over the Debt Ceiling Limit

Posted on July 9, 2011 by Scott Fullwiler | 54 comments

By Scott Fullwiler

Cullen Roche’s excellent post at Pragmatic Capitalism explains—via comments from frequent MMT commentator Beowulf (see here) and several previous posts by fellow MMT blogger Joe Firestone (see the links at the end of Cullen’s post and also here and here)—that the debt ceiling debate could be ended right now given that the US Constitution bestows upon the US Treasury the authority to mint coins (particularly platinum coins). Further, this simple change would lift the veil on how current monetary operations work and thereby demonstrate clearly that a currency-issuing government under flexible exchange rates cannot be forced into default against its will and is not beholden to “vigilante” bond markets. As Beowulf explains in a later comment, “The anomaly it addresses is that the US Govt has a debt limit yet an agency of the US Govt (the Federal Reserve) does not have a debt limit. Clearly this is a structural defect.”

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Posted in Scott Fullwiler

Tagged MMT, Modern Monetary Theory

Modern Monetary Theory and Mr. Paul Krugman: a way forward

Posted on March 28, 2011 by Pavlina Tcherneva | 23 comments

By Pavlina Tcherneva

“There is nothing more deceptive than an obvious fact.”
— Arthur Conan Doyle (The Adventures of Sherlock Holmes)

The fact that the U.S. government is a monopoly issuer of the U.S. currency is an obvious fact. The fact that an issuer of a currency doesn’t need to borrow its own currency from anyone else in order to spend is also an obvious fact. So is the fact that a sovereign currency nation that issues two government liabilities—government bonds and central bank reserves—can always issue such liabilities and convert one into the other ad infinitum. And yet there is nothing more deceptive than the significance of these obvious facts.

Mr. Krugman in his Friday NYT blog engaged Modern Monetary Theory on these facts and received considerable flack from MMT economists and supporters for misrepresenting MMT’s assertions. Frankly, I was pleased to see Mr. Krugman address our work and was really not surprised by some of his objections. After all, he is making the same arguments we’ve been addressing for the last two decades, since the very early days of MMT. I am surprised, however, that he has relied on hearsay or critics of MMT, rather than our own writings to do them justice. Over those decades we have elucidated our position in great detail in various books, journal articles, blogs and papers (probably the most systematic responses to MMT critiques that are accessible to non-academic audiences can be found on this blog, Bill Mitchell’s, and Warren Mosler’s). Many more amazing and intellectually curious people have engaged with these ideas, and have started their own blogs (see links on this blog). There are plenty of primary sources on MMT not to mischaracterize it!

But this is an opportunity for dialogue because we are all on the same side here. We are all convinced that poor understanding of the economy leads to bad policy. For MMT, poor understanding of the monetary system leads to especially bad policies. So if we do anything together, Mr. Krugman, let’s build one bridge and let that be a bridge of understanding of what the possibilities are under sovereign currency regimes.

Here I want to make the simple point that it is not sufficient (although it is necessary) to just recognize these obvious facts; indeed we must have a framework for thinking about these facts to move economics and policy forward. Yes, you recognize that we are a sovereign currency nation, but nevertheless conclude in your second piece on MMT that we can (at some point) become insolvent. Your argument looks at bond vigilantes’ behavior to which I will turn in a second.

It is an obvious fact that the U.S. government’s liability is unlike those of the private sector, because only the government pays by using its own liability and there is no limit to which it can issue those. This has been an important point of departure for MMT, but it has been recognized by some of your saltwater colleagues as well. And yet, they have not been able to provide the intellectual leadership to move us forward.

Let’s take Mr. Woodford, for example — a saltwater star economist, who developed the Fiscal Theory of the Price Level (FTPL), which I must admit I have criticized considerably. Problems with FTPL and DSGE models, notwithstanding, Woodford has recognized the obvious fact that sovereign currency nations cannot default on their obligations:

“A subtler question is whether it makes sense to suppose that actual market institutions do not actually impose a constraint … upon governments (whether logically necessary or not), given that we believe that they impose such borrowing limits upon households and firms. The best answer to this question, I believe, is to note that a government that issues debt denominated in its own currency is in a different situation than from that of private borrowers, in that its debt is a promise only to deliver more of its own liabilities. (A Treasury bond is simply a promise to pay dollars at various future dates, but these dollars are simply additional government liabilities, that happen to be non-interest-earning.) There is thus no possible doubt about the government’s technical ability to deliver what it has promised…” (Woodford 2000, p. 32)

Even more surprisingly, Woodford has used this logic to make the point that:

“it is possible for a government to finance transfers to an initial old generation by issuing debt that it then ‘rolls over’ forever, without ever raising taxes” (2000, p. 30).

In other words, programs like Social Security are forever sustainable! Some may wonder why an economist of Mr. Woodford’s standing would make such a claim and yet remain silent at a time when Social Security, the most popular American social safety-net, is under attack by deficit hawks. The reason is because recognizing a simple and obvious fact does not provide the tools for intellectual leadership.

Does the recognition that sovereign governments like the U.S. (he calls these Non-Ricardian Regimes) cannot possibly default on their obligations tell us anything about what fiscal policy should look like? NO, it does not. Does it give guidance on what stabilization policy must look like? Absolutely not. There is nothing in this work of use for economic policy. The reason is that the recognition of this obvious fact has been coupled with a whole series of flawed assumptions, problematic models, and dubious transmission mechanisms, which lead him to conclude that government spending is inherently inflationary.

You too made this logical leap and argued that in normal circumstances when:

“we’re no longer in a liquidity trap, running large deficits without access to bond markets is a recipe for very high inflation, perhaps even hyperinflation”. (NYT, March 25, 2011)

There is a problem with this claim. As MMT has demonstrated through the use of double-entry book-keeping, in reality, the government always spends by crediting bank accounts, i.e., by creating ‘money’. Yet, considering the inflation data, we’d be hard pressed to make the case that government spending in the postwar era has set unsustainable inflationary processes in motion, much less hyperinflation. Inflation is not a function of too many liabilities in circulation. But both you and Mr. Woodford are assuming that this is the case.

There is another problem with your arguments. You are saying that because government spending has to be financed by the private sector, it can be held hostage by the bond vigilantes. In other words, you argue, the government still needs someone to buy its debt before it can spend. This is not the case as we have explained in detail in our blogs. But even if we assume for a moment that this were the case, how are these bond vigilantes going to finance the government debt? What will they use to buy these bonds? The answer, of course, is reserves. The next logical question would be: how did these reserves get into the hands of the vigilantes in the first place? And since we know that reserves come from one place only – the government – they have to be spent into existence first before they can be used to buy bonds. In other words, government spending is financed through reserve creation by the Fed, not through borrowing from the private sector. We know of course that the Fed cannot force reserves on the banking system (Post Keynesians have made this point for decades, but mainstream economists have come around to understand this too). When the federal government spends, however, be that on military aircraft, Collateralized Debt Obligations, or Social Security, the Fed clears all government spending by crediting the bank accounts of Boeing, Goldman Sachs, or grandma (or anyone else for that matter who gets payments from the government, be they in the form of contracts, bailouts, or income assistance). This is how government spending creates reserves. Bond sales only drain any excess reserves from the system, to allow the Fed to hit its interest rate target, sales which are no longer needed since the Fed started paying interest on reserves (see here).

Now, many saltwater economists use Woodford’s idea that if the government injected bonds into the hands of the population without committing to raising taxes in the future to ‘repay’ these bonds, this bond injection will create net wealth in the hands of the private sector that would produce a wealth effect to stimulate the economy. The logic of this argument is completely upside down. There are two main problems: 1) ‘A bond injection’ does not increase net wealth, because households/investors give up reserves in order to buy Treasuries. Their net wealth position remains unchanged since they lose one asset (reserves) and gain another (a Treasury)—both of which are liabilities and a monopoly of the government. 2) It is a huge leap of faith to argue that more reserves or bond holdings would create a wealth effect. It might, but the transmission mechanism is highly problematic—the banking sector is bursting with reserves as we speak, yet bank lending to consumers and investors continues to be sluggish. The textbook money multiplier is completely wrongheaded and the transmission mechanism from reserves to deposits is fundamentally flawed. Putting aside Milton Friedman’s famous mea culpa and admission that the Central Bank cannot control the money aggregates (Financial Times, June 9, 2003), MMT has always said that it is loans which create deposits, and loan creation is never reserve constrained. Bank lending is based on the credit worthiness of borrowers, bank liquidity preference, capital requirements, regulation, but not on the availability of reserves. Reserves are provided by an accommodating Central Bank after the banking sector has made its loans, which have created the deposits that are subject to reserve requirements.

Note, however, that when a commercial bank makes a loan and creates a deposit, it can get reserves from the Fed (in order to meet its reserve requirement) in two ways: 1) it can borrow them (either at the discount window or through repos, i.e., through temporary OMOs) or 2) it can sell securities outright to the Fed (permanent OMOs) in exchange for reserves. When commercial banks borrow, they acquire an asset (the reserves) and a liability (borrowing from the Fed) so the net wealth position of the private sector does not change! When they sell securities to the Fed to get reserves, they lose one asset (a Treasury security) and gain another (reserves). Again the net wealth position remains unchanged.

Fed direct lending and temporary or permanent OMOs do not change the net financial wealth of the private sector. However, government spending does! When the government spends, private agents get reserves in their bank accounts. The banking sector will then convert these excess reserves into interest bearing assets—Treasuries. Bond sales are only undertaken by the Fed to drain reserves from the banking system and hit its interest rate target. Reserves come first and borrowing comes later. It is government spending that adds net new financial assets to the private sector. If you prefer to use Friedman’s analogy, helicopter drops of money are fiscal operations.

Another saltwater economist seems to get this. That is Mr. Bernanke who knows that the Fed cannot rain reserves unilaterally on the population or that the government cannot technically go broke. But he too has not provided much intellectual leadership even though he has a unique responsibility to do so.

Now, Mr. Krugman, you argue in your blog that “the rapid growth in monetary base since 2007 has taken place because the Fed is trying to rescue the economy, not because it’s trying to finance the government.” This statement is not quite correct because the Fed cannot adequately rescue the economy without financing its government’s purchases, like those of toxic financial assets. Note, the Fed has been lending to the private sector too, but this does not increase the net financial assets (NFA) in the hands of the private sector (a requirement for the saltwater economists’ presumed wealth effect). But according to Bernanke, a wealth effect can be generated, when the Fed finances government spending, (which as MMT’ers have been saying, it always does).

As I have explained in detail elsewhere Bernanke’s recipe for fighting crises and deflationary forces depends on fiscal policy (forthcoming in the Journal of Post Keynesian Economics, Spring 2011). Bernanke clearly recognizes that the Fed cannot increase the holdings of net financial assets (NFA) of the population without the Treasury. Only when monetary policy finances government spending are NFA created into existence. This is what he calls the fiscal components of monetary policy. When the Fed buys toxic financial assets from private banks, it buys worthless (or almost worthless) private sector assets on behalf of the Treasury and replaces them with reserves. Because a private sector asset is also a private sector liability, there is no net wealth created by the private sector as a whole when, for example, one private sector entity issues a CDO and another one buys it. But when the government (or the Fed on behalf of the Treasury) buys the CDO, it provides an asset – a reserve (in exchange for the nonperforming asset), while the issuer of the CDO is no longer liable for his payment. In other words a private sector liability has been extinguished whereas the toxic asset has been replaced by a default risk free asset—the government’s liability. Some private sector entity doesn’t have to pay up anymore, because the Treasury just did. So NFA in the private sector as a whole have indeed increased.

Also, when the government sends everyone a check in the mail (think of the Clinton or Bush Jr. tax cuts), the Fed clears them and creates what Bernanke has called ‘money financed tax cuts’. Bernanke has clearly stated that there is no limit to which the government can finance these.

“Under a fiat (that is, paper) money system, a government (in practice, the central bank in cooperation with other agencies) should always be able to generate increased nominal spending and inflation, even when the short-term nominal interest rate is at zero… The U.S. government has a technology, called a printing press (or, today, its electronic equivalent) that allows it to produce as many U.S. dollars as it wishes at essentially no cost.” (Bernanke 2002)

In fact, Bernanke prefers money financed tax cuts to any other type of ‘alternative monetary policy measure’ (see Bernanke 1999). He prefers fiscal policy as a stabilization policy (or to use his vernacular he prefers these types of fiscal components, see here for details). Bernanke has also stated that we are not using taxpayer money to finance these fiscal components, just like we are not using taxpayer money when we lend to banks. The way the government spends or lends is by crediting bank accounts to private agents.

Scott Pelley: “Is that tax money that the Fed is spending?”

Chairman Bernanke: “It’s not tax money. The banks have accounts with the Fed, much the same way that you have an account in a commercial bank. So, to lend to a bank, we simply use the computer to mark up the size of the account that they have with the Fed.”

(60 minutes interview, June 7, 2009)

Why then is the Chairman appearing before Congress arguing that we have a long-term deficit problem and that Social Security and Medicare must be scaled back? Where is the intellectual leadership from this saltwater economist on issues of policy?

Mr. Krugman, you have also made this claim, namely that the government will eventually run into difficulty meeting its long-term obligations. My question is, if the Fed can clear any tax cut check that we get in the mail today, it can certainly clear the social security checks we will get in the future. If the government faced no technical limits to buying toxic financial assets, it clearly can pay for grandma’s social security today and mine in the future. More than that, the government can buy the labor of the unemployed today and put them to work on useful projects. The important question is what can we buy with these checks? MMT has always argued that we have to get past the illusion of financial constraints to start asking the meaningful questions of what the real resource constraints of our economy are and how to employ the idle resources to overcome these constraints in order to provide for the young, poor, unemployed and elderly and to increase the standard of living for all.

There are many economists who still don’t ‘get’ these obvious facts, but a number of saltwater economists do. Yet, ‘getting’ these obvious facts is not enough. We have to, indeed we must, engage in a conversation about the kind of spending we should be financing. Clearly we can finance any kind, but different types of spending will produce different real outcomes. Spending on anything politicians want without limit is absolutely the wrong conclusion to draw from recognizing the obvious fact that sovereign governments do not go bankrupt without self imposed political constraints (e.g., debt limits). Instead, we must ask the question: should the government be buying the junk of the financial sector or should it be buying the productive services of the unemployed? What type of government spending would pose greater risk of inflation than others, when would that happen, and in which sectors?

I’ve already argued that the mainstream cannot offer intellectual leadership on this last question because it assumes inflationary effects from government spending, all evidence to the contrary. MMT can and does fill this intellectual void. We have explained the problems with the traditional view of inflation and have ourselves offered policies for price stability. This work has also been concerned with true inflation beyond full employment and has offered a recipe to address it. We are worried about hyperinflation, and have carefully explained why Zimbabwe and Weimar Germany are extreme and unlikely special cases. From inception, we have been concerned with real economic problems like unemployment, and have argued that we can and must put the unemployed resources to work. We have objected to the inhumane notion economists hold that we can use unemployment to fight inflation and have provided alternatives. We have spelled out the key ingredients of what responsible fiscal policy would look like. We have offered specific policy proposals for addressing this crisis and our long term real economic challenges – policies, such as a payroll tax holiday and the job guarantee. We have argued that Social Security is not broken and that we can always make payments to the retired, but we have been very concerned with what the elderly can buy with these payments. We have always focused on the real productive capacity of the economy and whether it can generate the goods and services that the elderly will need. We have worried about the environment and have suggested specific policies for environmental renewal and sustainability. And on and on and on…..

So Mr. Krugman, let’s get past the obvious fact that sovereign currency nations are not financially constrained in their spending and start thinking about the genuine economic possibilities such systems can provide. Only then can we engage in the dialogue that we so desperately need. As I have argued before if we keep confusing solvency with sustainability, we will remain hostage to dated notions of insolvency, and will never get to ask the meaningful questions of what the government should do and how it should do it? But if we start this dialogue, I am sure that we will find a lot of common ground—and you will see that MMT has very specific proposals to prevent the government from running amuck and spending irresponsibly. We can and indeed we must challenge the current state of economic thinking and propel a new generation of economists forward—economists of the real world, not of the archaic textbooks.

23 Comments

Posted in Pavlina R. Tcherneva

Tagged MMT, Modern Monetary Theory

Yes, Deficit Spending Adds to Private Sector Assets Even With Bond Sales

Posted on November 17, 2010 by Stephanie Kelton | 49 comments

By Stephanie Kelton

In a recent blog post, I explained that government deficits increase the private sector’s holding of net financial assets. And this led to the following question from one reader:

“How does a chartalist respond to the idea that gov’t spending does not actually add $ to the private economy because of debt issuance?”

And to the following command from another:

“stop insisting that gov’t deficits add wealth to the private sector (they don’t if the gov’t sells debt).”

Apparently, both readers believe that budget deficits could, in theory, increase the private sector’s holding of net financial assets, but that, in practice, they do not because, the sale of bonds “pulls dollars out of the private economy,” leaving the private sector with no net addition to their holding of financial assets.

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49 Comments

Posted in Stephanie Kelton

Tagged MMT, Modern Monetary Theory

Keep the Deficit. Ditch the Doves.

Posted on November 15, 2010 by Stephanie Kelton | 25 comments

By Stephanie Kelton

I just read another disappointing piece dealing with the preliminary recommendations from President Obama’s fiscal commission, this time from a contributor at The Huffington Post. Like any good deficit “dove,” he concedes the existence of the crisis, which he says any idiot with a third-grade education could recognize: