XXI. mendeko Independentziaz

Iruzkinak (2)

• 

  joseba says:

  2021/02/18 at 11:28

  Central banks should just write off all their government debt holdings
  (http://bilbo.economicoutlook.net/blog/?p=46891)

  The tensions in the public policy debate between economists is intensifying and on show in Europe, where these sort of obvious conflicts between adherence to dogma and a recognition that ‘out-the-box’ solutions are not only possible but preferred. More of these latter thought offerings are starting to appear as more people come to understand that the mainstream dogma has become more of a security blanket for reputations rather than saying anything about reality. One such proposal emerged last week in the form of a letter to the major European newspapers signed by more than 100 economists and politicians calling for the ECB to write-off its massive public debt holdings, which currently amount to around 25 per cent of total outstanding public debt. It is a good idea but some of the framing leaves a lot to be desired. At any rate, central banks everywhere should be buying up massive amounts of government debt and hitting the keyboard with zeros and writing it off. The world would be a much better place if they did that.
  Historical Precedent

  Around about this time, 68 years ago (February 27, 1953), the victorious nations from the Second World War formalised the – London Agreement on German External Debts – at a meeting in London.

  The agreement covered:

  … Germany’s pre-war public and private indebtedness and to the German debt arising out of post-war economic assistance …

  That is, the deal excluded any reparations that might have been enforced as a result of Germany’s conduct during the War.

  The amounts were staggering at the time:

  1. 16.1 billion marks outstanding from the First World War settlement finalised at the Treaty of Versailles, which Germany had defaulted on in the inter-War period.

  2. 16.2 billion marks owed to the US government for loans made to rebuild Germany after WW2.

  The London Debt Conference was held between February and August 1952 and the offer of debt forgiveness was initially rejected by the German government.

  The deal cut the outstanding debts in half and tied the repayment schedule to Germany’s subsequent export revenue, which reinforced the growing export-bias that then made it difficult to achieve currency stability in Europe given the growing trade imbalances that followed between European nations.

  An recent article published in the European Review of Economic History (Vol 23, No 1, February 2019) – The economic consequences of the 1953 London Debt Agreement – studied the consequences of the Agreement and found that:

  1. Germany’s immediate post WW2 growth was stunning given the circumstances.

  2. The “debt relief program in 1953, known as the London Debt Agreement (LDA), might have partially contributed indirectly to growth by creating a propitious economics environment as well as directly by stabilising German public finances and allowing for greater public investment”.

  Remember, this was during the early Bretton Woods period where fiscal policy was constrained by the need to manage the agreed exchange rate parities.

  in more recent times, it was pointed out that one of the terms of the Agreement was that Germany would honour its reparation obligations arising from WW2 to Greece and that the current German government refused to acknowledge that obligation during the GFC.
  Can a central bank cancel its holdings of debt?

  Answer: Yes and it should.

  I have long argued that after central banks purchase government debt either in the primary issue (less frequent now) or in the secondary markets they should just type a zero against the balance and write it off.

  While there is all this pretence about central bank independence, the fact is that the central bank and the treasury functions are intertwined on a daily basis and both are parts of the currency-issuing government.

  So when the central bank holds government debt it is just a left-pocket/right-pocket sort of situation.

  In most situations, the central bank will receive interest payments from the treasury and then remit them back to Treasury in some form (dividends, etc) by arrangement within the government.

  So a rather curious accounting charade with no significance for financial markets outside of the government (once the secondary bond market transactions are made).

  Mainstream economists are horrified by this suggestion claiming it would be inflationary and would unleash a lack of discipline from Treasury departments.

  They clearly misunderstand that the inflation risk, inasmuch as there is any in these current circumstances, is already in the system, the moment the deficit spending is exeecuted.

  The fact that the central bank buys the debt, or, indeed, that the government issues the debt in the first place to match (or in the Eurozone Member State’s case to fund) the spending beyond tax drains, doesn’t alter that inflation risk.

  So what happens to the government debt held by the central bank has no impact on the inflation propensity inherent in the spending.

  The only question then is whether the spending was excessive in relation to the productive capacity of the nations and it would be far fetched to conclude that it was given the state of these economies and the excess capacity that is rife.

  The question then is what would happen if the central banks around the world just wrote off all their holdings of government debt?

  Answer: Nothing much at all.

  They can still maintain liquidity management concerns using interest rate payments on excess reserves.

  If they found themselves with ‘negative capital’, who cares. They are not corporations and do not have to be ‘solvent’ in the private corporate sense.

  This is like comparing a household to a treasury (given that the central bank is part of the consolidated government sector).

  See these blog posts (among others):

  1. The consolidated government – treasury and central bank (August 20, 2010).

  2. The ECB cannot go broke – get over it (May 11, 2012).

  3. The US Federal Reserve is on the brink of insolvency (not!) (November 18, 2010).

  4. Better off studying the mating habits of frogs (September 14, 2011).
  Should the ECB cancel its public debt holdings?

  Answer: obviously.

  Last week over 100 economists and politicians published an ‘Open Letter’ in the leading European newspapers demanding that the ECB to cancel €2.5 trillion in debt it is holding.

  That would wipe out around 25 per cent of the debt issued by EMU Member States.

  The letter states in part (Source):

  Citizens are discovering, some with much shock, that about 25% of the European debt is now held by their own central bank. In other words, we owe ourselves 25% of our debt and, if we are to reimburse that amount, we must find it elsewhere, either by borrowing it again to “roll the debt” instead of borrowing to invest, or by raising taxes, or by cutting spending.

  Which is a statement that the EMU Member States in question do not enjoy currency sovereignty (using a foreign currency – the euro) and so are financially constrained.

  Such a wedge is why a nation should never surrender their currency sovereignty.

  The current proposal stated that the ECB could simply write the debt off and this would give the EMU nations renewed fiscal space to pursue a “green recovery” and “heal the severe social, cultural and economic damages undergone by our societies during the devastating covid-19 health crisis”.

  I am supportive of the proposal but there are gaps in logic.

  First, Brussels has already invoked the temporary emergency rules in the Treaty Annexe relating to the Stability and Growth Pact, which gives the Member States the latitude to engage in significant spending.

  So there is no reason for Europe to be languishing in the state pointed out by the signatories to this proposal.

  One reason they are languishing is that they have adopted the austerity mentality after years of being thrashed by the narratives and actions coming out of Brussels and they are scared stiff that the technocrats will get nasty soon and start raving on about the Excessive Deficit Mechanism procedure again.

  Second, with the ECB purchasing significant proportions of the debt issued, such that bond yields are low and can stay low as long as the ECB wants, then the concerns of the proponents that the interest serving burdens will damage the prospects of recovery are somewhat exaggerated.

  Sure, the ECB might turn on the Member States as it did during the GFC.

  But it knows as well as anyone that insolvency is just a blink away for heavily-indebted nations in the Eurozone if bond yields rise quickly or significantly.

  The ECB has to keep purchasing the debt or the monetary union will collapse.

  Ironically, the Delors gang thought they could inflict their version of neoliberalism onto the Member States by producing a flawed architecture for the common currency but have produced a situation where the central bank that they thought could be bolted down is now exhibiting behaviour that is the anathema of these neoliberal pedants.

  Third, none of this is to say that the proposal to cancel the debt is excellent.

  The ECB, in fact, should ramp up the PEPP program to ensure it buys all the debt issued by the currency-using governments, which would maintain yields at zero levels and then simply write off the issue once purchased.

  That would be the most desirable outcome.

  I doubt that the politics of Europe could cope with Germany and the Frugal Four, at least being intolerant.

  The Proposal thinks that their idea would be a “foundational” moment and pointed to the historical precedent made by the London Agreement (discussed above).

  They think this would be an “extraordinary measure” to fit “extraordinary times.”

  I agree the pandemic is an extraordinary time, but I would argue that progressives (which are represented by the proponents) should be ‘mainstreaming’ central bank debt cancellations.

  It would only be ‘extraordinary’ if you think the appropriate benchmark was the mainstream taboo that central banks should not hold any public debt above the amount they might use to manage liquidity via open market operations.

  I reject that benchmark.

  The Modern Monetary Theory (MMT) benchmark is that the currency-issuing government has no need at all to line the pockets of bond investors by issuing corporate welfare in the form of the public debt.

  In the Eurozone context, the situation is somewhat different given that the Member States surrendered currency sovereignty. So the MMT benchmark in that context would be that the ECB should just control all yields by purchasing the debt.

  By avoiding the framing that a debt cancellation would be ‘extraordinary’ we can move the debate away from the neoliberal framing more quickly.

  But the proponents clearly understand that:

  1. “The ECB can without a doubt afford it. As many economists already recognize, even among those who oppose this solution, a central bank can operate with negative capital without difficulty.”

  2. “It can even print money to compensate for these losses: this is provided for by the Protocol 4 annexed to the Treaty on the Functioning of the European Union.”

  Once again framing and language here is a concern.

  The way in which the ECB would restore its capital would be via some computer entries to its balance sheet. It alone can do that.

  Protocol (No 4) on the statute of the European System of Central Banks and of the European Central Bank – is an annexe to the Treaty on European Union and to the Treaty on the Functioning of the European Union.

  Chapter IV of the Protocol relates to the “Financial Provisions of the ESCB”.

  Article 16 relates to “Banknotes” and says that “the Governing Council shall have the exclusive right to authorise the issue of euro banknotes within the Union. The ECB and the national central banks may issue such notes. The banknotes issued by the ECB and the national central banks shall be the only such notes to have the status of legal tender within the Union.”

  Article 28 relates to the “Capital of the ECB”.

  So in a situation that the ECB has negative capital, the Governing Council can authorise restoring that capital whenever it wants.

  A commercial bank does not have that right. If its assets fail and they find they cannot cover their liabilities then they are insolvent unless they can inject more capital from private investors.

  A central bank cannot become insolvent.

  And remember that the euro is a fiat currency just like the US dollar or the Japanese yen, except that the governments involved use it rather than issue it.

  The currency is not backed by any of value including the ECB’s assets.

  It enters the eurosystem costlessly – keyboards typing numbers – and the IOU characteristic is only notional.

  The ECB dealt with the question of insolvency in this Working Paper (No 392) – The Role of Central Bank Capital Revisited – way back in May 2004.

  The authors noted that:

  a central bank with a loss-making balance sheet structure would in this context still able to conduct its monetary policy in a responsible way, even with a negative long-term profitability outlook …

  In practice, a central bank can never achieve an absolute, guaranteed institutional independence. In particular, no government can commit future governments (whether they obtain power by election, war, or revolution) not to change the central bank law or abolish its exclusive right to issue legal tender …

  … central bank capital still does not seem to matter for monetary policy implementation, in essence because negative levels of capital do not represent any threat to the central bank being able to pay for whatever costs it has … Although losses may easily accumulate over a long period of time and lead to a huge negative capital, no reason emerges why this could affect the central bankís ability to control interest rates.

  That should seal it.

  The Proponents then ask whether this would be violating the “spirit of the treaty” and acknowledge that the ECBs conduct over many years in buying massive amounts of Member State debt has effectively already violated the prohibition on funding Member State deficits.

  That is the point.

  The EMU technocrats talk big on rules but violate them continually when it is convenient to maintain their positions.
  Conclusion

  I thought the most telling part of their letter was the following:

  The European Union can no longer afford to be systematically impeded by its own rules. Other states in the world, such as China, Japan and the USA, are using their monetary policy tool to its full extent, i.e. in support of their fiscal policy.

  The EU always impedes progress because of its rules.

  Which is why Britain is lucky to be out of the mess.

  And why, ultimately, the Treaties have to be scrapped and a new Europe based on intergovernmental agreements is created.

  And, in doing so, the euro is scrapped and currency sovereignty restored. Then the newly sovereign states will cease being ‘Member States’ and can deal with the crises they face with the full currency capacity they lack now.

• 

  joseba says:

  2021/02/18 at 11:32

  The income-expenditure relationship in macroeconomics – graphic treatment

  (http://bilbo.economicoutlook.net/blog/?p=46895)

  We have been doing a lot of work developing the MOOC at the University of Newcastle which will also mark the first – MMTed material. We will follow up the MOOC with more detailed learning options in subsequent months. Tomorrow, we will be filming some more material for the MOOC and I think you will enjoy what we have planned when the MOOC begins on March 3, 2021. As part of the planning I have been thinking of simplified frameworks for teaching rather complicated concepts and relationships. Here is an example of that sort of thinking.
  MOOC Modern Monetary Theory: Economics for the 21st Century

  Over the last several months by way of advancing Modern Monetary Theory (MMT) education initiatives, we have been involved in development a MOOC that will be launched in March 2021.

  I am working with – NewcastleX – which is my university’s digital team to create the course material which will be available all around the world for free.

  Anyone can enrol and participate and the material is suitable for anyone who is keen to learn new things and discuss these things with others of a like mind.

  That is the philosophy of a MOOC.

  The course – Modern Monetary Theory: Economics for the 21st Century – will start on March 3, 2021 and you can get all the enrolment details (it is free) from the link.

  This will mark the first stage of the – MMTed project – that I have been trying to get off the ground for a while now.

  We have been hampered by lack of funds to date, but the partnership with the University on this MOOC has really been a massive first step. The digital learning team at the University is first-class and have really helped me understand how these new platforms work.
  Understanding the importance of fiscal deficits

  What follows is a teaching device I use in introductory programs on macroeconomics which allow students to understand the basic rule of macroeconomics – spending equals output equals income, which drives employment.

  It helps us understand the concept of equilibrium in macroeconomics and disabuses us of any notion that equilibriums is equivalent to ‘market clearing’ or full employment, which is the way the mainstream economists think of it.

  We learn that an equilibrium can persist at very high levels of unemployment indefinitely without some external influence, like a fiscal stimulus entering the picture.

  It can also be used as an alternative form of pedagogy (to algebraic derivations) of the sectoral balances and makes the role of fiscal policy very obvious.

  Some people prefer this form of elaboration to the more concise algebra.

  We also can easily establish the principle that if there is mass (involuntary) unemployment then we know at least one other thing – the fiscal deficit is too small or the surplus too big.

  So I thought I would share this exposition with you all on my blog to diversify the way I usually present things.

  And those who have previously studied economics will identify that this sort of structure is based on the long-standing circular flow exposition, which I tailor to suit my Modern Monetary Theory (MMT) perspective.

  So a series of pictures which start from a simple basis and then get increasingly complicated as we introduce more and more real world elements.

  Households and Firms

  We start with a simple representation of the economy where we have households and firms.

  The government is there too but we will abstract from its role at first even though none of this could happen without currency injections from the government.

  Throughout this analysis, we assume that prices are stable so that all the dollar flows are effectively in real purchasing power terms.

  Business firms form expectations of what total spending in the economy will be and then assemble working capital and workers to produce to that expected sales volume. They price according to their unit cost estimates and their desired markup, the latter which reflects their profit ambitions.

  That deployment then pays incomes to the suppliers of productive inputs.

  Household consumption expenditure is then driven by total income, which returns revenue to the firms and around we go.

  Spending drives output and employment which equals income.

  If there are no leakages from this circular flow and/or external shocks, then the system would be stable and persist indefinitely.

  This is what we call a macroeconomic equilibrium state.

  Now there is no presumption that this steady-state will coincide with full employment. It might but it is highly unlikely.

  And it was this sort of underemployment equilibrium state that Keynes said justified government stimulus to break it up and push the economy to a higher employment state.

  Tax leakage

  Now what happens if we disturb this state by forcing the non-government sector to pay taxes?

  In this example, I am abstracting from corporate taxes (and, as you will see social transfers). Their inclusion doesn’t fundamentally alter the story.

  Now if that is all the happened – the taxes draining income out of the non-government sector into the government sector then total income flow becomes a disposable income flow and the consumption spending flow would be less.

  As a result, firms would respond to the rising unsold inventories and produce less and lay off workers.

  So, in a modern monetary system, the imposition of taxes creates the condition where idle resources increase.

  To return the economy to the previous equilibrium (restore the level of GDP and national income), the flow of government spending must at least offset the leakage of purchasing power from the tax drain.

  Now, we stated before that the original steady state was probably one where involuntary unemployment existed even though firms’ expectations of sales volumes were being continually met.

  So even if the government spending injection offset the loss of consumption spending arising from the tax leakage, the economy would still be at below full employment.

  In other words, the only way the economy could move towards full employment in this context (noting that households consume 100 per cent of their disposable income), would be for the government deficit to rise.

  The excess government spending over taxes (G > T) would stimulate sales and firms would hire more workers and pay out higher incomes, which would then lead to higher tax revenue (if the tax system was linked to incomes) and higher household consumption expenditure.

  This adjustment process – to the increase in government spending into deficit is what is called the expenditure multiplier.

  Please read my blog post – Spending multipliers (December 28, 2009)- for more discussion on this point.

  So under these conditions it is easy to understand that if there is involuntary unemployment (which means that people would take a job at the current wages if one was offered to them), then we know the fiscal deficit is too low.

  You may also wonder how this new deficit spending state would restore equilibrium.

  Well in these simplified conditions, the initial government spending impulse (into deficit) would stimulate rising income, rising taxation, rising consumption, with each additional induced increase in taxes and consumption spending being smaller than the last (because of the tax leakage at each step).

  A new equilibrium would be reached at a higher income level once the change in tax revenue reached zero and total tax revenue was equal to the new level of government spending – thus wiping out the fiscal deficit.

  If households consume all their income (as is being assumed at present) then equilibrium can only occur with the government in balance once a tax leakage is created.

  The general rule is that equilibrium occurs when the leakages equal the injections.

  This doesn’t mean we support fiscal balance. It is just a condition that would have to apply in this highly simplified case.

  So let’s complicate it further.

  Saving leakage

  Now what happens if we are at a new equilibrium and households decide to save a proportion of their disposable income.

  So now the marginal propensity to consume (MPC), which is the proportion of every extra dollar of disposable income receive that households consume is less than one.

  That means that the marginal propensity to save (MPS) would be equal to 1 minus MPC.

  We now have an additional leakage from the income-expenditure stream, which if nothing else happened would reduce output, income, employment and subsequent consumption expenditure.

  So higher saving alone will create unemployment in the non-government sector at the current settings.

  With the current institutional complexity, the unemployment could be mopped up if government went into deficit (remember under our simplistic conditions the government was in balance previously).

  The rising fiscal deficit could offset the loss of household consumption expenditure arising from the saving leakage.

  The adjustment process would see national income rising again (as government spending exceeded the current tax revenue), tax revenue rising, household consumption spending and saving flows rising and would reach a new national income level when the sum of the leakages (taxes plus saving) equal the injection of government spending (into deficit).

  So now there is no requirement that the fiscal position remain in balance. It has to be in deficit under these conditions to maintain full employment when household saving propensity is greater than zero.

  Introduce imports

  Now we add the foreign sector and recognise that the domestic economy spends some of its income each period on goods and services produced abroad – imports.

  The flow of spending on imports constitutes an additional leakage from the leakage from the income-expenditure stream, which if no other intervention occurred would reduce output, income, employment and subsequent consumption expenditure.

  Leakages reduce spending on domestic production and reduce national income.

  Injections add to spending on domestic production and increase national income.

  Again, the loss of national income could be avoided if the fiscal deficit rose again to counter the leakages of imports.

  Introduce Business Investment and Exports

  In this framework, there are two additional injections that can offset the saving, tax, and import leakages – business investment and exports expenditure from the rest of the world.

  At the current fiscal deficit, the spending flow injections from investment and exports would drive the economy beyond the full employment income level.

  In fact the government could cut its net spending as these other spending injections entered the expenditure stream in order to maintain the output level at full employment.

  There are, of course, many different scenarios that we could play with in this framework.

  One could construct a situation where export revenue is so strong relative to the import leakage that the economy could sustain full employment with the government in fiscal surplus.

  The condition for equilibrium is that the leakages have to equal the injections.

  So:

  Saving + Taxes + Imports = Investment + Government + Exports

  That condition will hold in equilibrium, and, given that in this simple model the three leakages are also functions of income (they rise when national income rises according to the propensities to save and import and the tax rate), there is a unique sum of injections that are required to offset the sum of the leakages that would be forthcoming at a full employment level of national income (GDP).

  That doesn’t necessarily mean a government deficit is required.

  But it does mean that if the sum of business investment and exports, given current government spending is not sufficient to equal what the the sum of the leakages that would be forthcoming at a full employment level of national income (GDP), then the only way the economy can reach full employment is if government spending rises.

  So the equilibrium condition will deliver a stable level of output, but that, however, does not guarantee full employment.

  Accordingly, to sustain full employment the condition for stable national income above can be re-written more specifically in this way:

  G = Government spending
  T = Tax revenue
  S = Saving flow
  M = Import spending
  I = Investment spending
  X = Export spending

  The Yf qualifier refers to the value of the flow in question at full employment given that the S, T and M flows will be higher at full employment than if the economy is in recession.

  If the non-government drains > the injections which would occur at full employment, then for national income to remain stable, there has to be a fiscal deficit (G – T) sufficient to offset that gap in aggregate demand.
  Conclusion

  We eventually reached the sectoral balance relationship.

  But the graphical exposition might provide further understandings that evade those who dislike the algebraic exposition.