Bill Mitchell-en Fiscal space has nothing to do with public debt ratios or the size of deficits
(http://bilbo.economicoutlook.net/blog/?p=40224#more-402249)
“(…) In this blog post, I discuss Jeffrey Frankel’s latest UK Guardian article (August 29, 2018) – US will lack fiscal space to respond when next recession comes – which was syndicated from Project Syndicate. Frankel thinks that the US is about to experience a major recession and that its government has run out of fiscal space because it is not running surpluses. We could summarise my conclusion in one word – nonsense. But a more civilised response follows.(…)”
(i) Enplegu osoa eta defizit fiskala1
(ii) Sektore-balantzeak2
(G – T) = S(Yf) + M(Yf) – I(Yf) – X
(iii) Superabit fiskala3
(iv) Ekonomia monetario modernoa eta espazio fiskala4
Ondorioak
(…)
The facts are:
1. We can never conclude that the coexistence of a fiscal deficit and strong growth requires the government push back into surplus. Sometimes yes, usually no.
2. Fiscal space has nothing to do with what the current fiscal balance is or has been and what the current public debt ratio is or has been.
1 Ingelesez: “In this blog post – The full employment fiscal deficit condition (April 13, 2011) – which I consider to be core MMT, I showed the conditions that determine the fiscal deficit, once the government assumes its responsibility to achieve and sustain full employment.
The lessons, in summary are:
1. A macroeconomy is in a steady-state (that is, at rest or in equilibrium) when the sum of the injections equals the sum of the leakages. The point is that whenever this relationship is disturbed (by a change in the level of injections, however sourced), national income adjusts and brings the income-sensitive spending drains into line with the new level of injections. At that point the system is at rest.
2. The injections come from export spending, investment spending (capital formation) and government spending.
3. The leakages are household saving, taxation and import spending.
4. An economy at rest is not necessarily one that coincides with full employment.
5. When an economy is ‘at rest’ and there is high unemployment, there must be a spending gap given that mass unemployment is the result of deficient demand (in relation to the spending required to provide enough jobs overall).
6. If there is no dynamic which would lead to an increase in private (or non-government) spending then the only way the economy will increase its level of activity is if there is increased net government spending – this means that the injection via increasing government spending (G) has to more than offset the increased drain (leakage) coming from taxation revenue (T).”
2 Ingelesez: “So in sectoral balance parlance, the following rule hold.
To sustain full employment the condition for stable national income defines what I named the Full-employment fiscal deficit condition:
(G – T) = S(Yf) + M(Yf) – I(Yf) – X
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.
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).
What that means in relation to the issues I identified above is that there is a difficulty in defining pro-cyclicality in terms of a given fiscal balance.
It is nonsensical to say a fiscal surplus is always pro-cyclical and a deficit is always counter-cyclical. It all depends on the spending and saving patterns of the non-government sector.
We can only really appraise the impact of the fiscal balance in terms of changes at specific points in the cycle.
So if an economy was at full employment and the fiscal deficit was, say 2 per cent of GDP and that satisfied the condition specified above.
That is not a pro-cyclical position even if the economy is growing – it is maintaining a steady-state growth path.
Should the government, with no other changes evident, increase its net spending to say 3 per cent of GDP, under those circumstances, we might consider that a pro-cyclical policy change because it is pushing the cycle beyond its full employment steady-state growth path.
So the fact there is a fiscal deficit coinciding with strong GDP growth should not be taken as a case of irresponsible and dangerous policy.”
3 Ingelesez: “What about running surpluses when recovery is apparent?
The same logic holds. It might be that the non-government spending and saving decisions drive overall spending so fast that total spending then starts to outstrip capacity.
Then, to restore the full employment steady-state (and this also requires stable inflation), the fiscal stance has to contractionary – which might require a fiscal surplus.
For example, nations such as Norway will typically solve the Full-employment fiscal deficit condition with a fiscal surplus given how strong their external sector is (energy resources).
The second issue relates to Jeffrey Frankel’s notion of ‘fiscal space’.
I considered that issue in these blog posts:
1. Fiscal sustainability 101 – Part 1 (June 15, 2009).
2. Fiscal sustainability 101 – Part 2 (June 16, 2009).
3. Fiscal sustainability 101 – Part 3 (June 17, 2009).
Frankel claims that the:
The US deficit is being blown up on both the revenue and expenditure sides … As a result, when the next recession comes, the US will lack fiscal space to respond.
The next recession, when it comes, will coincide with millions of workers in need of jobs, capital equipment lying idle, and other productive resources looking for a buyer (user).”
4 Ingelesez: “That is what fiscal space relates to in a modern monetary economy.
It has nothing to do with what the current fiscal balance is or has been and what the current public debt ratio is or has been.
A sovereign government can purchase any idle resources that are for sale in its own currency, including all idle labour.
That is the fiscal space the US will have.
And, it can never run out of funds to do that.
So a past deficit poses no particular constraints on what the US government can do in the future, except to say that if the deficit has been properly calibrated to satisfy the Full-employment fiscal deficit condition then there will be less to do should the private sector contract.
The rest of Frankel’s article is irrelevant to this discussion.
The questions that the US policy makers have to answer are:
1. How close the economy is to being at full capacity – labour, capital and other productive resources.
2. If, it is, is the current net public spending position driving total spending beyond the Full-employment fiscal deficit condition.
My assessment of Question 1 is that there is still some idle capacity in the US economy. Just look at wages growth and the broader indicators like participation rates.
There is a massive public infrastructure shortfall – in terms of quality and scope.
Inflation is benign as is wages growth.”
joseba says:
Korronte nagusiko ekonomia eta DTM
(i) Bill Mitchell-en The divide between mainstream macro and MMT is irreconcilable – Part 1
(http://bilbo.economicoutlook.net/blog/?p=40313#more-40313)
(…) The three-part series will consider a recent intervention that was posted on the iNET site (September 6, 2018) – Mainstream Macroeconomics and Modern Monetary Theory: What Really Divides Them?. At the outset, the iNET project has been very disappointing. Very little ‘new’ economic thinking comes from it – its offerings are virtually indistinguishable from the New Keynesian consensus that dominates my profession. The GFC revealed how impoverished that consensus is. It has also given space for Modern Monetary Theory (MMT) to establish itself as a credible alternative body of theory (and practice). The problem is that the iNET initiative has been captured by the mainstream. And so the Groupthink continues. The article I refer to above is very disappointing. It claims to offer a synthesis between Modern Monetary Theory (MMT) and mainstream macroeconomics by way of highlighting “what really divides” the two schools of thought. You might be surprised to know that according to these authors there is not much difference – only that mainstream economists think that monetary policy should be privileged to look after full employment and price stability and MMT economists (apparently) think fiscal policy should have that role. The authors claim that for the on-looker these minor differences are opaque in terms of outcomes (if the policies are applied properly) and suggest that there is really no reason for any debate at all. Accordingly, the New Keynesian consensus is just fine and the mainstream economists knew all the MMT stuff all along. It is an extraordinary exercise in sleight of hand engineered by constructing the comparison in terms of two ‘approaches’ that cull the main aspects of each. The real issue is why would they waste their time. Degenerative paradigms (or research programs in Imre Lakatos’ terminology) typically try to absorb challenging paradigms that, increasingly have more credibility and appeal, back into the mainstream through various dodges – ‘special case’, ‘we knew it all before’, ‘really nothing new’, etc. This is Part 1 of my response. It won’t be an easy three-part series but stick with it and I hope it gives you a lot of insights into the abysmal state of the mainstream macroeconomics profession.
I wasn’t surprised by the discussion. Resistance from the dominant paradigm is part of the evolution of a new idea.
There is the famous construction (sometimes attributed to German philosopher Arthur Schopenhauer, sometimes to Gandhi) that “All truth passes through three stages: First, it is ridiculed. Second, it is violently opposed. Third, it is accepted as being self-evident.”
I actually think there are four stages – the first being that new ideas tend to be ignored initially.
In terms of what I might call the intrusion (or challenge) of MMT to the mainstream orthodoxy in macroeconomics, we are now well into the ridicule, opposition phase, which means we are making progress.
And a derivative of the ridicule/opposition phase is what I call the ‘absorption’ phase or the ‘we knew it all before’.
It goes like this – okay guys this MMT thing, there really isn’t much about it, nothing new, and …. and when we apply some of the policies we get inflation, rising interest rates, transfers of tax burdens to the future generations, insolvency, etc
These predictions come straight out of the mainstream macroeconomics model (see below). To compare MMT with the mainstream macroeconomics we have to consider the building blocks of each. Otherwise, the comparison will be fraught.
I considered this issue, in part, in this suite of blog posts:
1. Modern Monetary Theory – what is new about it? (August 22, 2016).
2. Modern Monetary Theory – what is new about it? – Part 2 (long) (August 23, 2016).
3. Modern Monetary Theory – what is new about it? – Part 3 (long) (August 25, 2016).
Over the 24 or so years that we have been working on the MMT project together (the core team, that is) – I have observed the process through which MMT ideas have entered the economic debate, first at conferences and in the scholastic literature, and more recently, through various Op Ed, Social Media type avenues.
At first, there was no engagement from the mainstream economists, apart from some isolated hostility, usually the manifestation of previous personal disputes anyway.
Then, over the last several years, after that even longer period of being ignored, MMT ideas have entered the popular discourse.
While many commentators are increasingly viewing the core MMT ideas as a progressive answer to fill the void created by a discredited mainstream macroeconomics, an increasing number of economists have attempted to disabuse people of the validity of MMT ideas.
Interestingly, the economists seeking to discredit MMT have not been confined to those working within the mainstream tradition (New Keynesian or otherwise). Indeed, considerable hostility has emerged from those who identify as working within the so-called Post Keynesian tradition, even if that cohort is difficult to define clearly.
Earlier criticisms by so-called Post Keynesian economists were specifically targetted at their disdain for the Job Guarantee concept and open economy issues.
Randy Wray and I wrote an article in 2005 addressing those criticisms.
[Reference: Mitchell, W.F. and Wray, L.R. (2005) ‘In Defense of Employer of Last Resort: a response to Malcolm Sawyer’, Journal of Economic Issues, XXXIX(1), 235-244].
At the outset, we consider mainstream macroeconomics to be the type of economics that is almost universally taught in undergraduate courses in universities around the world and represents the usual dialogue in the financial press.
As you will see, the iNET article has a rather bizarre redefinition of mainstream macroeconomics, which in no small part, they require to blur the differences between what they call ‘mainstream’ macroeconomics and what they, in turn, call MMT.
Neither version they present is particularly credible.
(…)
(ii) Bill Mitchell-en The divide between mainstream macro and MMT is irreconcilable – Part 2
(http://bilbo.economicoutlook.net/blog/?p=40315)
This is Part 2 of a three-part response to an iNET article (September 6, 2018) – Mainstream Macroeconomics and Modern Monetary Theory: What Really Divides Them?. In Part 1, I considered what we might take to the core body of mainstream macroeconomics and used the best-selling textbook from Gregory Mankiw as the representation. The material in that textbook is presented to students around the world as the current state of mainstream economic theory. While professional papers and policy papers might express the concepts more technically (formally), it is hard to claim that Mankiw’s representation is not representative of what current mainstream macroeconomics is about. Part 1 showed that there is little correspondence between the core propositions represented by Modern Monetary Theory (MMT) and the mainstream. Yet, the iNET authors want to claim that the differences between the two approaches to macroeconomics only really come down to a difference in “assignment of policy instruments” – jargon for MMT prefers fiscal policy while the mainstream prefers monetary policy as the primary counter-stabilising tool. Given the lack of conceptual and theoretical correspondence demonstrated in Part 1, it would seem surprising that there is really only just this difference in policy preference dividing MMT from the mainstream. If that was the case, then what is all the fuss about? Clearly, I consider the iNET article presents a sleight of hand and that the differences are, in fact, significant. So, in Part 2, I am tracing how the iNET authors came to their conclusion and what I think is problematic about it. This discussion will spill over into Part 3.
(…)
To begin, the iNET article characterises the MMT position in this way:
If a government seeks to adjust the budget position to bring output to potential, it can do so regardless of the current budget deficit, debt-GDP ratio, or similar measures of fiscal space.
Already, you can see the problem.
MMT economists never consider these (or “similar”) ratios, financial aggregates to be “measures of fiscal space”.
That is mainstream ‘sound’ finance language and is one of the differentia specifica between MMT and the mainstream body of thought.
MMT economists consider ‘fiscal space’ to be only defined in terms of availability of real resources that can be purchased using the currency capacity of the government.
(…)
In MMT, there is always ‘fiscal space’ when there is mass unemployment and idle capital even if the bond markets are demanding high yields from government debt issuance and fiscal deficits and public debt ratios are already at elevated levels.
Quite simply, the bond markets have no influence over this assessment. The government can always deal them out of the game whenever they wish in one of two ways:
1. Stop issuing debt (preferred).
2. Instruct the central bank to buy debt to control yields – as many central banks have been doing for decades.
(…)
A most recent example of this sort of mainstream reasoning was discussed in this blog post – Fiscal space has nothing to do with public debt ratios or the size of deficits (August 30, 2018).
This sort of reasoning is anathema to MMT economists. The fact that a government has run a large (historically) fiscal deficit during a recession in no way reduces its capacity to respond to a downturn in non-government spending in some future period, even if, the fiscal position remains in deficit.
Governments do not ‘pay back’ past deficits. Deficits are flows of net expenditure. They are not stocks. Once the expenditure has flowed it has flowed. Move on to the next day. The currency-issuing capacity doesn’t alter as a result of yesterday’s flow.
To better understand the concept of fiscal sustainability and disabuse yourself of the false claim that it is somehow related to deficit history or public debt ratios, the following introductory suite of blog posts will help:
1. Fiscal sustainability 101 – Part 1 (June 15, 2009).
2. Fiscal sustainability 101 – Part 2 (June 16, 2009).
3, Fiscal sustainability 101 – Part 3 (June 17, 2009).
They explain how Modern Monetary Theory (MMT) constructs the concept of fiscal sustainability.
(…)
The point is that we cannot get a practical reduced form that fits the real world data from the basic New Keynesian (mainstream) theoretical model.
I have discussed the implications of this before – see blog post – Mainstream macroeconomic fads – just a waste of time (September 18, 2009).
(…)
(iii) Bill Mitchell-en The divide between mainstream macro and MMT is irreconcilable – Part 3
(http://bilbo.economicoutlook.net/blog/?p=40320)
This is Part 3 (and final) of my series responding to an iNET claim that Modern Monetary Theory (MMT) and mainstream macroeconomics were essentially at one in the way they understand the economy but differ on matters of which policy instrument (fiscal or monetary) to assign to counter stabilisation duties. In Part 1, I demonstrated how the core mainstream macroeconomic concepts bear no correspondence with the core MMT concepts, so it was surprising that someone would try to run an argument that the practical differences were really about policy assignment. In Part 2, we saw how the iNET authors created a stylised version of mainstream macroeconomics that ignored the fundamental building blocks (how they reach their conclusions about the real world), which means that they ignore important differences in the way MMT economists and mainstream macroeconomists interpret a given economic state. I will elaborate on that in this final part. Further, by reducing the body of work now known as MMT to be just ‘functional finance’, the iNET authors also, effectively, abandon any valid comparison between MMT and the mainstream, although they do not acknowledge that sleight of hand.
(…)
MMT is not functional finance
)…)
While Modern Monetary Theory (MMT) proponents do make “the case for functional finance”, following Abba Lerner’s work in the 1940s and beyond, MMT cannot be distilled as being solely about functional finance.
Abba Lerner’s aim was to distinguish between what he called “sound finance” and “functional finance”.
I deal with that distinction in detail in this blog post (among others) – Functional finance and modern monetary theory (November 1, 2009).
(…)
MMT clearly draws on that statement although the language we use is different (we never talk about “printing money” as a short-hand for central bank monetisation) and we do not share Lerner’s view that taxation revenue and debt-issuance provides ‘funds’ to facilitate government spending.
But we do consider fiscal policy should be directed to advancing public purpose and the particular levels of resulting aggregates (for example, fiscal deficits/surpluses) are immaterial.
But in reaching that conclusion the core MMT team has drawn on many other historical sources and added some new ideas that put the support for Lerner’s functional finance vision into context.
One has to consider all the MMT components to understand why we think the fiscal aggregates, in themselves, are immaterial, contrary to the dominant role these aggregates play in mainstream macroeconomic narratives.
One has to understand the radical departure from the mainstream macroeconomics presentation of banking that MMT provides to understand why we think that there can be no financial crowding out in a modern monetary economy and why we were unconcerned about any inflationary consequences of the massive expansion of central bank balance sheets.
Etc.
To simply distill MMT down to being an application of functional finance is to ignore all the other components that give functional finance within MMT context.
(…)
We considered the Brexit nonsense in our recent Jacobin article (April 29, 2018) – Why the Left Should Embrace Brexit.
See also this blog post (with links within) – Mainstream macroeconomics in a state of ‘intellectual regress’ (January 3, 2017).
(…)
For example, a mainstream New Keynesian consider that short-run output is capable of policy manipulation because there are ‘sticky prices’. This is the Keynesian economics as a ‘special case’ of neoclassical theory argument.
Accordingly, they also claim that in the long-run no such manipulation is possible and policy interventions will only generate price effects (inflation).
An MMT economist doesn’t think that at all. For us, the long-run doesn’t exist independently of the short-run. Where you are is conditioned by where you have been.
And fiscal policy interventions are always able to manipulate demand and maintain full employment and that capacity has nothing to do with ‘sticky prices’.
So the way we see the short-run is not reconcilable with mainstream macroeconomics.
Further, while some New Keynesians are comfortable with short-run increases in the fiscal deficit (although usually only if monetary policy is deemed to be ineffective – the zero-bound interest case) to stabilise a recessed economy, they consider that the government must run surpluses in the upturn to ensure the debt ratio is stable or declining.
MMT economists don’t think that at all. Continuous fiscal deficits are typically required to allow the non-government sector to save overall.
Further, mainstream macroeconomists believe that if the central bank stabilises inflation, full employment (zero output gap) will follow as a market process – the restoration of the natural rate of unemployment.
MMT economists don’t think that at all.
There is no natural rate of unemployment that the economy converges to. In 1987, as a young academic, I wrote an article – The NAIRU, Structural Imbalance and the Macroeconomic Equilibrium Unemployment Rate – which was the basis of my PhD work.
It demonstrated that any steady-state relationship between unemployment and inflation was non-unique – that is, any level of unemployment could stabilise inflation by temporarily quelling the distributional conflict between labour and capital.
And that fiscal policy could manipulate that level by reversing structural imbalances that occurred over the cycle.
I had earlier considered the way in which a buffer stock employment approach could eliminate the Phillips curve trade-off between inflation and unemployment altogether.
Those efforts are now embedded in MMT in the form of the Job Guarantee, which proposes a completely different short-run dynamic than you will find in mainstream macroeconomics.
Further, mainstream macroeconomists construct the short-run position as saying that the fiscal deficits that may arise should be temporary because otherwise bond markets will increase their risk assessments and drive up yields on government debt.
MMT economists don’t think that at all.
We have pointed out that it is the government that can control yields whenever they desire and that means that MMT economists have none of the mainstream fears that continuous deficits will result in rising interest rates.
Further, MMT economists advocate that government stop issuing debt altogether. It is unnecessary and does not insulate the economy against the inflation risk that is embodied in spending decisions.
(…)