DTM, zer da berri? (3)

1 Ikus http://bilbo.economicoutlook.net/blog/?p=34214.

2 Ingelesez: “(…) Today’s blog considers another section of the paper – the dynamics of fiscal deficits and public debt. We consider the difference between deficit doves, who consider fiscal deficits are appropriate under some conditions but should be balanced over some definable economic cycle, which we argue has been the standard Post Keynesian position, and the MMT approach to deficits, which considers the desirable deficit outcome at any point in time to be a function of the state of non-government spending and the utilisation of the productive capacity of the economy. We argue that fiscal rules expressed in terms of some rigid balance to GDP target are not only meaningless but dangerous. Fiscal rules in MMT are only meaningful if related to the state of non-government spending and the utilisation of the productive capacity of the economy. This body of MMT work is clearly novel and improves on the extant Post Keynesian literature in the subject which was either silent or lame on these topics.”

3 Ingelesez: “MMT says that a sovereign government is never revenue constrained because it is the monopoly issuer of the currency.

A sovereign government in MMT is one that issues its own currency, floats it on international markets, sets its own interest rate and never accumulates liabilities in foreign currencies.

Never revenue constrained means that such a government is not financially constrained and can spend whatever it likes without recourse to ‘funding’, unlike a household (a user of the currency), which has to finance all its spending from income earned, prior savings, asset sales and/or borrowing.

(…)

MMT authors have never claimed that they were the first to understand that point. The language that these authors use is clearly different to the way that mainstream or other Post Keynesian macroeconomists discuss this point.

And their understanding of the options that follow from that are very different.

(…)

Once again, MMT does not consider that the government deficit is restrained in any way by tax revenue or bond sales. The ability to earn income or have access to credit is important to a household or business firm, which uses the currency.

But to a sovereign government the role of taxes or bond sales is not akin to any experience that a household or business firm would know.

The accounting structure (…) is, in fact, a trivial exercise in adding and subtracting.

Does it provide any clue to the real constraints facing a sovereign government intent on creating full employment? Answer: Absolutely not.

And it is here that MMT has provided significant new insights.”

4 Ingelesez: “For example, if taxes are not necessary to fund government spending then what role do they play at the macroeconomic level (and here I ignore taxes designed to alter resource allocations – such as carbon or tobacco imposts)?

(…)

By linking taxation to real resource usage in the non-government sector, MMT brings to the fore the insight that taxation functions to promote offers from private individuals to government of goods and services in return for the necessary funds to extinguish the tax liabilities.

The orthodox conception is that taxation provides revenue to the government which it requires in order to spend. In fact, the reverse is the truth. Government spending provides revenue to the non-government sector which then allows them to extinguish their taxation liabilities.

This insight allows us to see another dimension of taxation which is lost in mainstream and extant Post Keynesian analysis, (…).

Given that the non-government sector requires fiat currency to pay its taxation liabilities, in the first instance, the imposition of taxes (without a concomitant injection of public spending) by design creates unemployment (people seeking paid work) in the non-government sector.”

5 Ingelesez: “The unemployed or idle non-government resources can then be utilised through demand injections via government spending, which amounts to a transfer of real goods and services from the non-government to the government sector.

In turn, this transfer facilitates the government’s socioeconomic program.

While real resources are transferred from the non-government sector in the form of goods and services that are purchased by government, the motivation to supply these resources is sourced back to the need to acquire fiat currency to extinguish the tax liabilities.

Further, while real resources are transferred, the taxation provides no additional financial capacity to the government of issue. Conceptualising the relationship between the government and non-government sectors in this way makes it clear that it is government spending that provides the paid work which eliminates the unemployment created by the taxes.”

6 Ingelesez: “That perspective is not found in the non-MMT literature. It is true that way back Abba Lerner’s Functional Finance approach recognised that (Lerner, 1943: 39):

The central idea is that government fiscal policy, its spending and taxing, its borrowing and repayment of loans, its issue of new money and its withdrawal of money, shall all be undertaken with an eye only to the results of these actions on the economy and not to any established traditional doctrine about what is sound and what is unsound. This principle of judging only by effects has been applied in many other fields of human activity, where it is known as the method of science opposed to scholasticism. The principle of judging fiscal measures by the way they work or function in the economy we may call Functional Finance …

Government should adjust its rates of expenditure and taxation such that total spending in the economy is neither more nor less than that which is sufficient to purchase the full employment level of output at current prices. If this means there is a deficit, greater borrowing, “printing money,” etc., then these things in themselves are neither good nor bad, they are simply the means to the desired ends of full employment and price stability …

Taxation thus drains non-government purchasing power.”

7 Ingelesez: “Palley (…) thinks it is a body blow against MMT to point out that “it is easy to show that budget surpluses destroy high-powered money balances and lower the privately held high-powered money supply”.

But that trivial accounting fact was at the heart of Lerner’s observation and no MMT author claims any originality for building it into the monetary framework they use.

The more important point, which is not at the forefront of Lerner’s representation, and certainly not apparent in the trivial accounting relationship that links the monetary flows, is that the MMT literature directly links taxation to the real constraints that governments have to deal with to achieve socio-economic goals.”

8 Ingelesez: “This brings out into relief – in a clear way – why mass unemployment arises.

It is the introduction of State Money (which we define as government taxing and spending) into a non-monetary economics that raises the spectre of involuntary unemployment.

As a matter of accounting, for aggregate output to be sold, total spending must equal total income (whether actual income generated in production is fully spent or not each period).

Involuntary unemployment is idle labour offered for sale with no buyers at current prices (wages). Unemployment occurs when the private sector, in aggregate, desires to earn the monetary unit of account through the offer of labour but doesn’t desire to spend all it earns, other things equal.

As a result, involuntary inventory accumulation among sellers of goods and services translates into decreased output and employment. In this situation, nominal (or real) wage cuts per se do not clear the labour market, unless those cuts somehow eliminate the private sector desire to net save, and thereby increase spending.

So the purpose of State Money is to facilitate the movement of real goods and services from the non-government (largely private) sector to the government (public) domain.

Government achieves this transfer by first levying a tax, which creates a notional demand for its currency of issue. To obtain funds needed to pay taxes and net save, non-government agents offer real goods and services for sale in exchange for the needed units of the currency.

This includes, of-course, the offer of labour by the unemployed. The obvious conclusion is that unemployment occurs when net government spending is too low to accommodate the need to pay taxes and the desire to net save.”

9 Ingelesez: “This analysis also sets the limits on government spending.

It is clear that government spending has to be sufficient to allow taxes to be paid. In addition, net government spending is required to meet the private desire to save (accumulate net financial assets).

From the previous points, it is also clear that if the Government doesn’t spend enough to cover taxes and the non-government sector’s desire to save the manifestation of this deficiency will be unemployment.

Keynesians have used the term demand-deficient unemployment. In our conception, the basis of this deficiency is at all times inadequate net government spending, given the private spending (saving) decisions in force at any particular time.

That type of construction is clearly an innovation introduced by MMT authors.”

10 Ingelesez: “Fiscal policy and the economic cycle

There is also misunderstandings in the Post Keynesian literature about the role that fiscal deficits should play over the economic cycle.

(…)

There is no question that if nominal spending continues to grow at a rate that outstrips the capacity of the productive sector to meet that spending with real output then firms will move to price-adjustment and inflation will result.

MMT puts that generally accepted observation at front and centre of its analysis – but has never claimed to have introduced it into the literature.

In part, it helps us to understand the previous discussion over the role of taxes. For there to be real space in the economy for the government to spend, the non-government sector has to be deprived of its capacity to utilise the real resources the government seeks to command.

(…)

…MMT authors have moved away from the ‘deficit dove’ position to properly articulate the role of deficit spending in the monetary economy.

In this blog – The full employment fiscal deficit condition – I outlined what I called the full employment fiscal deficit condition, which is the only fiscal rule that is important, despite the plethora of rules proposed by the mainstream (deficit to GDP ratios etc) and Post Keynesians (balanced budgets over the cycle).

Tymoigne and Wray (2013) are correct to say that at full employment there is no necessity for the fiscal balance to be zero. Under some conditions, a fiscal surplus might be appropriate. In other situations, which will be more often encountered by nations, continuous fiscal deficits will be required.

That is a central insight provided by MMT authors and you will struggle to find it in the mainstream or Post Keynesian literature.

But is it correct?”

11 Ingelesez: “In an open economy, if there was no government spending or taxation (so a fiscal balance of zero) the level of economic activity (output) will be determined by private domestic spending (consumption plus investment) and net external spending (exports minus imports). If one or more of those spending sources declines, then activity will decline.

A spending gap is defined as the spending required to create demand sufficient to elicit output levels which at current productivity levels will provide enough jobs (measured in working hours) for all the workers who desire to work.

A zero spending gap occurs when there is full employment. From a functional finance perspective the role of government fiscal policy is obvious – to ensure there is no spending gap.

It becomes obvious (and incontestable) that if the non-government spending sources decline from a given position of full employment, the only way that the spending gap can be filled is via a fiscal intervention – direct government spending and/or a tax cut (to increase private disposable income and stimulate subsequent private spending).

That is standard Keynesian thinking and certainly not newly introduced by MMT.”

12 Ingelesez: “What about the maintenance of full employment?

The fiscal position (deficit or surplus) must fill the gap between the savings minus investment minus the gap between exports minus imports (with net income transfers included).

But that relationship can be easily satisfied at levels of economic activity that are associated with persistently high levels of unemployment. Keynes’ General Theory was important in history because it showed how market economies could get stuck in these sort of high unemployment steady-states.

To maintain a full employment level of national income, which is generated when all resources are fully utilised according to the preferences of workers and owners of land and capital etc, the fiscal deficit has to be sufficient to offset the saving and imports that occurs at that level of income, less the sum of private capital formation and export revenue that is forthcoming at that level of income.

I could have written that in algebra (along Palley’s lines) to get a ‘model’ if I chose::

Full-employment fiscal deficit condition: (G – T) = S(Yf) + M(Yf) – I(Yf) – X

Where Yf is the full employment level of income and the sum of the terms S(Yf) and M(Yf) represent drains on aggregate demand when the economy is at full employment and the sum of the terms I(Yf) and X represents spending injections at full employment.

Either way, the point is clear:

If the drains outweigh the injections then for national income to remain stable, there has to be a fiscal deficit (G – T) sufficient to offset that gap in aggregate demand.

If the fiscal deficit is not sufficient, then national income will fall and full employment will be lost. If the government tries to expand the fiscal deficit beyond the full employment limit (G – T)(Yf) then nominal spending will outstrip the capacity of the economy to respond by increasing real output and while income will rise it will be all due to price effects (that is, inflation would occur).

In this sense, MMT specifies a strict discipline on fiscal policy. It is not a free-for-all. If the goal is full employment and price stability then the Full-employment fiscal deficit condition has to be met.

But also note that the full-employment fiscal deficit condition does not necesarily (or usually given history) solve to zero on the right-hand side (more algebra talk!).

If it did, then at full employment, the appropriate fiscal position would be a balance.

But there is nothing necessary for that to happen and as history tells us, it usually will not happen.

Making this deficit condition explicit is novel in MMT and has not been articulated in the extant Post Keynesian literature, which has become trapped into thinking that deficits in downturns must be offset by surpluses in upturns to stabilise public debt.

MMT breaks with that Post Keynesian tradition because it places no particular importance on any specific public debt ratio. It also recommends breaking the nexus between deficit spending and debt-issuance per se, by advocating Overt Monetary Finance, which Post Keynesians have typically rejected because they have bought the mainstream line that it would be inflationary.

(…)

In the real world, capital formation is rarely constrained to equal depreciation. In other words, the capital stock typically grows and, with it, the productive capacity of the supply side. (…)”

13 Ingelesez: “Fiscal policy and banking

Finally, it is without doubt that the MMT authors have introduced new insights in the relationship between fiscal policy and the banking system which overturn much of the conventional wisdom found in the macroeconomics literature.”

14 Ingelesez: “One of the enduring myths that are to be found in the mainstream macroeconomics literature relates to the so-called ‘financial crowding out’ assertion.

The financial crowding out assertion is a central plank in the mainstream economics attack on government fiscal intervention. At the heart of this conception is the theory of loanable funds, which is a aggregate construction of the way financial markets are meant to work in mainstream macroeconomic thinking.

The original conception was designed to explain how aggregate demand could never fall short of aggregate supply because interest rate adjustments would always bring investment and saving into equality.

At the heart of this erroneous hypothesis is a flawed viewed of financial markets. The so-called loanable funds market is constructed by the mainstream economists as serving to mediate saving and investment via interest rate variations.

This is pre-Keynesian thinking and was a central part of the so-called classical model where perfectly flexible prices delivered self-adjusting, market-clearing aggregate markets at all times.

If consumption fell, then saving would rise and this would not lead to an oversupply of goods because investment (capital goods production) would rise in proportion with saving.

So while the composition of output might change (workers would be shifted between the consumption goods sector to the capital goods sector), a full employment equilibrium was always maintained as long as price flexibility was not impeded.”

15 Ingelesez: “The interest rate became the vehicle to mediate saving and investment to ensure that there was never any gluts.

So saving (supply of funds) is conceived of as a positive function of the real interest rate because rising rates increase the opportunity cost of current consumption and thus encourage saving. Investment (demand for funds) declines with the interest rate because the costs of funds to invest in (houses, factories, equipment etc) rises.

Changes in the interest rate thus create continuous equilibrium such that aggregate demand always equals aggregate supply and the composition of final demand (between consumption and investment) changes as interest rates adjust.

According to this theory, if there is a rising fiscal deficit then there is increased demand is placed on the scarce savings (via the alleged need to borrow by the government) and this pushes interest rates to “clear” the loanable funds market. This chokes off investment spending.

So allegedly, when the government borrows to ‘finance’ its fiscal deficit, it crowds out private borrowers who are trying to finance investment.

The mainstream economists conceive of this as the government reducing national saving (by running a fiscal deficit) and pushing up interest rates which damage private investment.”

16 Ingelesez:”The basic flaws in the mainstream story are that governments just borrow back the net financial assets that they create when they spend. Its a wash! It is true that the private sector might wish to spread these financial assets across different portfolios. But then the implication is that the private spending component of total demand will rise and there will be a reduced need for net public spending.

Further, they assume that savings are finite and the government spending is financially constrained which means it has to seek ‘funding’ in order to progress their fiscal plans. But government spending by stimulating income also stimulates saving.

Additionally, credit-worthy private borrowers can usually access credit from the banking system. Banks lend independent of their reserve position so government debt issuance does not impede this liquidity creation.”

17 Ingelesez: “But we jump ahead.

The Post Keynesian literature rejects the crowding out claims. Davidson’s (…) discussion (…) is representative of the arguments that are offered in this regard. He places the debate within the so-called IS-LM framework, where the debate as to whether fiscal deficits cause rising interest rates comes down to whether the LM curve is vertical or not (which comes down to a debate about the income and interest-rate sensitivity of the demand for money when the money supply is fixed).

Clearly, even the starting points of this framework are at odds with reality. Most Post Keynesians eschew the crowding out hypothesis by recourse to statements about the capacity of the government to ‘print money’ or the access global capital markets, which are outside of the direct influence of domestic interest rates, offers local borrowers.

In other words, they do not directly challenge the notion that fiscal deficits drive up interest rates per se, an effect which can be mitigated by these other channels (money printing, global borrowing).”

18 Ingelesez: “Where MMT departs from this literature is to explicitly integrate bank reserves into the analysis in a way that no previous Post Keynesian author has attempted.

The MMT framework shows that far from placing upward pressure on interest rates, fiscal deficits in fact, set in place dynamics that place pressure on interest rates in the opposite direction.

You will not find that result in the extant Post Keynesian or mainstream literature.”

19 Ingelesez: “How does that occur?

The central bank operations aim to manage the liquidity in the banking system such that short-term interest rates match the official targets which define the current monetary policy stance.

In achieving this aim the central bank may: (a) Intervene into the interbank money market (for example, the Federal funds market in the US) to manage the daily supply of and demand for funds; (b) buy certain financial assets at discounted rates from commercial banks; (c) offer a return on excess bank reserves, and (d) impose penal lending rates on banks who require urgent funds.

In practice, most of the liquidity management is achieved through (a), although in recent times (as QE has become the norm) central banks are using option (c) more than in the past.

That being said, central bank operations function to offset operating factors in the system by altering the composition of reserves, cash, and securities, and do not alter net financial assets of the non- government sectors.”

20 Ingelesez: “Money markets are where commercial banks (and other intermediaries) trade short-term financial instruments between themselves in order to meet reserve requirements or otherwise gain funds for commercial purposes. In terms of the diagram all these transactions are horizontal and net to zero.”

21 Ingelesez: “Commercial banks maintain accounts with the central bank which permit reserves to be managed and also the clearing system to operate smoothly.

In addition to setting a lending rate (discount rate), the central bank also sets a support rate which is paid on commercial bank reserves held by the central bank. This support rate becomes the interest-rate floor for the economy.

The short-run or operational target interest rate, which represents the current monetary policy stance, is set by the central bank between the discount and support rate. This effectively creates a corridor or a spread within which the short-term interest rates can fluctuate with liquidity variability. It is this spread that the central bank manages in its daily operations.

MMT has highlighted those relationships but does not claim any originality for doing so.”

22 Ingelesez: “In most nations, commercial banks by law have to maintain positive reserve balances at the central bank, accumulated over some specified period. At the end of each day commercial banks have to appraise the status of their reserve accounts. Those that are in deficit can borrow the required funds from the central bank at the discount rate.

Alternatively banks with excess reserves are faced with earning the support rate which is below the current market rate of interest on overnight funds if they do nothing.

Clearly it is profitable for banks with excess funds to lend to banks with deficits at market rates. Competition between banks with excess reserves for custom puts downward pressure on the short-term interest rate (overnight funds rate) and depending on the state of overall liquidity may drive the interbank rate down below the operational target interest rate.

When the system is in surplus overall this competition would drive the rate down to the support rate.

The demand for short-term funds in the money market is a negative function of the interbank interest rate since at a higher rate less banks are willing to borrow some of their expected shortages from other banks, compared to risk that at the end of the day they will have to borrow money from the central bank to cover any mistaken expectations of their reserve position.

The main instrument of this liquidity management is through open market operations, that is, buying and selling government debt.”

23 Ingelesez: “In the absence of adjustments to the support rates offered on reserves, when the competitive pressures in the overnight funds market drives the interbank rate below the desired target rate, the central bank drains liquidity by selling government debt.

This open market intervention therefore will result in a higher value for the overnight rate.

The significant point for this discussion is to expose the myth of crowding out.

Net government spending (deficits) which is not taken into account by the central bank in its liquidity decision, will manifest as excess reserves (cash supplies) in the clearing balances (bank reserves) of the commercial banks at the central bank.

MMT refers to this a system-wide surplus.

In these circumstances, the commercial banks will be faced with earning the lower support rate return on surplus reserve funds if they do not seek profitable trades with other banks, who may be deficient of reserve funds.

The ensuing competition to offload the excess reserves puts downward pressure on the overnight rate. However, because these transactions necessarily net to zero, the interbank trading cannot clear the system-wide surplus.

Accordingly, if the central bank desires to maintain the current target overnight rate, then it must drain this surplus liquidity by selling government debt or offering a competitive return on the excess reserves to choke off the competitive forces.

That is, the bond sales (debt issuance) allows the central bank to drain any excess reserves in the cash-system and therefore curtail the downward pressure on the interest rate. In doing so it maintains control of monetary policy.”

24 Ingelesez: “Importantly:

• Fiscal deficits place downward pressure on interest rates;

• Bond sales maintain interest rates at the central bank target rate.

Accordingly, the concept of debt monetisation, which is a central part of mainstream thinking, is a non sequitur. So Friedman, for example, claimed that “the entire deficit must be financed by a concomitant increase in the supply of money (to avoid ‘crowding out’) (…).

That assertion remains standard doctrine. Even the Post Keynesian economists consider crowding out to be overcome by the government’s capacity to print money (…).

But once we understand how bank reserves are affected by fiscal deficits (an MMT insight), we quickly realise that once the overnight rate target is set by the central bank, the latter should only trade government securities if liquidity changes are required to support this target.”

25 Ingelesez: “Given the central bank cannot control the reserves then debt monetisation is strictly impossible unless the central bank permits the excess reserves to rise indefinitely and pays a return to the banks for excess reserve holdings.

Imagine that the central bank traded government securities with the treasury, which then increased government spending. The excess reserves from the fiscal deficits would force the central bank to sell the same amount of government securities to the private market or allow the overnight rate to fall to the support level (which might be zero).

This is not monetisation but rather the central bank simply acting as broker in the context of the logic of the interest rate setting monetary policy.”

26 Ingelesez: “Ultimately, private agents may refuse to hold any further stocks of cash or bonds.

With no debt issuance, the interest rates will fall to the central bank support limit (which may be zero).

It is then also clear that the private sector at the micro level can only dispense with unwanted cash balances in the absence of government paper by increasing their consumption levels.

Given the current tax structure, this reduced desire to net save would generate a private expansion and reduce the deficit, eventually restoring the portfolio balance at higher private employment levels and lower the required budget deficit as long as savings desires remain low.

Clearly, there would be no desire for the government to expand the economy beyond its real limit.

Whether this generates inflation depends on the ability of the economy to expand real output to meet rising nominal demand. That is not compromised by the size of the budget deficit.”

27 Ingelesez: “Next week I will provide the fourth part of this series which will consider the consolidation of the central bank and the treasury.”