MMT — Krugman still does not get it!

21 February, 2019 at 20:47 | Posted in Economics | 41 Comments

mmtKrugman complains that Lerner was too “cavalier” in his discussion of monetary policy since he called for the interest rate to be set at the level that produces “the most desirable level of investment” without saying exactly what that rate should be.

It’s an odd critique, since Krugman himself subscribes to the idea that monetary policy should target an invisible “neutral rate,” a so-called r-star that exists when the economy is neither depressed nor overheating. For what it’s worth, research suggests the neutral rate “may be flat-out wrong,” and Fed Chairman Jerome Powell has admitted that the Fed has been too cavalier in relying “on variables that cannot be measured directly and which can only be estimated with great uncertainty.”

But Lerner wasn’t trying to use interest rates to optimize the economy. That was a job for fiscal policy. He argued that the government should be prepared to spend whatever is necessary to sustain full employment without raising taxes or borrowing …

Krugman’s other objection is that Lerner “didn’t fully address the limitations, both technical and political, on tax hikes/or spending cuts” as a means of fighting inflation.

In fact, Lerner actually had quite a lot to say about this. Here’s the opening sentence to an entire chapter on the subject in his 1951 book “The Economics of Employment”: “We have now concluded our treatment of the economics of employment, but a word or two must be added on the politics and the administration of employment policies in general and of Functional Finance in particular” (emphasis in original) …

Where does that leave us? Paul Krugman and I agree on a great many things, but we come at certain questions from a fundamentally different place.

He believes there are inherent tradeoffs between fiscal and monetary policy. Outside of the so-called liquidity trap, Krugman adopts the standard line that budget deficits crowd out private investment because deficits compete with private borrowing for a limited supply of savings.

The MMT framework rejects this, since government deficits are shown to be a source (not a use!) of private savings. Some careful studies show that crowding-out can occur, but that it tends to happen in countries where the government is not a currency issuer with its own central bank.

This seems like a disagreement we should be able to resolve either empirically or intuitively. But who knows? As Lerner wrote, “a man convinced against his will retains the same opinion still.”

Stephanie Kelton

Few issues in politics and economics are nowadays more discussed — and less understood — than public debt. Many raise their voices to urge for reducing the debt, but few explain why and in what way reducing the debt would be conducive to a better economy or a fairer society. And there are no limits to all the — especially macroeconomic — calamities and evils a large public debt is supposed to result in — unemployment, inflation, higher interest rates, lower productivity growth, increased burdens for subsequent generations, etc., etc.

But the truth is that public debt is normally nothing to fear, especially if it is financed within the country itself (but even foreign loans can be beneficent for the economy if invested in the right way). Some members of society hold bonds and earn interest on them, while others have to pay the taxes that ultimately pay the interest on the debt. The debt is not a net burden for society as a whole since the debt cancel itself out between the two groups. If the state issues bonds at a low-interest rate, unemployment can be reduced without necessarily resulting in strong inflationary pressure. And the inter-generational burden is also not a real burden since — if used in a suitable way — the debt, through its effects on investments and employment, actually makes future generations net winners. There can, of course, be unwanted negative distributional side effects for the future generation, but that is mostly a minor problem since when our children and grandchildren repay the national debt these payments will be made to our children and grandchildren.

To both Keynes and Lerner, it was evident that the state has the ability to promote full employment and a stable price level – and that it should use its powers to do so. If that means that it has to take on debt and (more or less temporarily) underbalance its budget – so let it be! Public debt is neither good nor bad. It is a means to achieve two over-arching macroeconomic goals – full employment and price stability. What is sacred is not to have a balanced budget or running down public debt per se, regardless of the effects on the macroeconomic goals. If ‘sound finance,’ austerity and balanced budgets means increased unemployment and destabilizing prices, they have to be abandoned.

41 Comments

  1. Krugman preferred to take issue with Lerner over Kelton. When you “knew it all along”, that’s what you do.

  2. Some members of society hold bonds and earn interest on them, while others have to pay the taxes that ultimately pay the interest on the debt.
    .
    Since the debt of a monetary sovereign is inherently risk-free, it should yield no more than ZERO percent MINUS overhead costs, i.e. negatively.
    .
    Why? To avoid welfare proportional to account balance, i.e. welfare for the banks and rich or what Bill Mitchell calls “corporate welfare.”
    .
    Positive returns are a relic of the unethical Gold Standard as is our current two-tiered banking model which is also a form of welfare for the rich.
    .
    So no, taxes are not required to the pay the interest on the debt of a monetary sovereign since the interest rate or yield should never be positive. Nor should the principal ever shrink either since budget surpluses are so dangerous and unnatural for a monetary sovereign that even a token $1 budget deficit is preferable (since a balanced budget is also unnatural for a monetary sovereign).

  3. Natural and Sound both have legacy esoteric baggage.

  4. “Some members of society hold bonds and earn interest on them, while others have to pay the taxes that ultimately pay the interest on the debt.”
    .
    This sentence bothered me, too. The value of Treasuries is really in their use for repo trades. Banks daily lend out Treasuries for funding, or accept Treasuries as collateral while using the Treasuries for window-dressing, or to short them. The volume of Treasuries used in this way is in the trillions of dollars (seevhttps://www.treasury.gov/connect/blog/Pages/Examining-Changes-in-the-Treasury-Repo-Market-after-the-Financial-Crisis.aspx ).
    .
    Money market or pension funds lend cash for Treasuries in repo, but the coupon on the Treasury is not where they make money; they make money on a repo interest rate which is independent of the interest rate on the Treasury. (Note that repo rates often go negative, meaning Treasuries are so valued that dealers pay a premium to accept them as collateral; cash borrowers are paid to borrow if they can post Treasuries as collateral, when repo rates go negative.)
    .
    MMT steadfastly ignores the importance of repo in puff pieces such as this one.

    • Tl;dr: repo allows investors to profit from Treasuries without owning them. The Treasury coupon doesn’t matter. Repo profits exceed Treasury interest payments, by a lot.

    • “MMT steadfastly ignores the importance of repo”. Nothing you write supports this statement. I doubt you can

      • “Some members of society hold bonds and earn interest on them”
        .
        Finance firms make far more through repo of Treasuries than the interest payments amount to. Repo allows banks to make money off Treasuries without owning them. The interest on the Treasuries is immaterial to the private profits made by using repo of Treasuries.
        .
        MMT steadfastly ignores such private profits that do not come from taxpayers.

        • …and…??

          • Private profit on Treasuries comes mostly from private sources, not from taxpayers as MMT claims.

            • OK, one step at a time here.
              First step – you write ” not from taxpayers as MMT claims”.
              Source for this please?

              • “Some members of society hold bonds and earn interest on them, while others have to pay the taxes that ultimately pay the interest on the debt.”
                .
                This sentence ignores the private use of repo to earn profits far in excess of the interest paid (which itself can come from further borrowing not taxpayers). Bonds have a market value independent of their face value. MMT ignores this far more lucrative private use of bonds. Taxpayers are almost not necessary.

                • You wrote “mmt” claims. You then cite a non MMT source. Where do you get Mosler or Wray or Mitchell or Fullwiler or Kelton or Tygmoigne or Tcherneva saying something like that? I do not think you will

                • Ditto with this ” MMT ignores this far more lucrative private use of bonds” Support that statement.
                  It seems you are just making up stuff in your head quite frankly

                • Or Forstater.
                  (How does he always fly under the radar when he has been so influential and writes such good stuff! 🙂

        • Robert S Mitchell
          You have made up some strange argument: “the private use of repo to earn profits” thus “MMT wrong” and “Taxpayers are almost not necessary.”

          1) you are not showing anywhere where this relates to actual MMT literature
          2) you are not explaining your “blah blah blah repos blah blah taxes blah blah mmt wrong” ‘argument’ in anything like a coherent idea
          3) I am pretty sure the reason for (2) is that you are unable to. But if you could a) manage to show any supporting evidence from MMT literature and b) string any kind of coherent thought-train together, I would love to see it.

          • “government deficits are shown to be a source (not a use!) of private savings”
            .
            This is maybe 5% of the picture. The rest, which MMT ignores, is the private use of repo to make private money on Treasuries without needing any coupons on the Treasuries. Private firms use repo to make money without transacting with the government because they don’t need to own the repo. Thus private profits are not only sourced from government deficits. MMT does not acknowledge this. I base the last claim on extensive and numerous discussions with MMT theorists across many platforms.
            .
            Kelton’s use of “private savings” betrays the archaic theory MMT subscribes to. Money, as Mehrling describes, is a public-private hybrid. MMT denies the existence of private money by denying that privately-created credit can become money. Bill Mitchell has stated numerous times on his blog that the private sector cannot create new net financial assets without transacting with the government first. But Mehrling notes that credit becomes money. MMT denies that credit can become money without the government creating money before the credit was created. But private credit is most often created first, then later, if needed, the Fed backstops the credit with new money. MMT, based on my many discussions about this, steadfastly ignores this process of private new net financial asset creation.
            .
            Please see Mehrling’s blog: http://www.perrymehrling.com/2018/12/where-is-politics-in-the-money-view/
            .
            “We are talking here about new purchasing power that arises from nothing, or more precisely from a mere balance sheet operation.”
            .
            This is a new net financial asset, because the new purchasing power easily enough stays in circulation indefinitely. The private net new financial asset is created before the Fed backstops it with new public money.

            • “by denying that privately-created credit can become money”
              MMT perfectly well distinguishes between bank credit-money (horizontal money) and government tax-credits (vertical money). Familiarize yourself with that literature.

              “financial asset is created before the Fed backstops it with new public money”
              This has been discussed extensively. Peter Cooper is good as usual http://heteconomist.com/verticalhorizontal-vs-exogenousendogenous/

              Robert, credit-money is a promise to pay in tax-credits.
              That’s it.
              It can never BE a tax-credit.

              Yes, it has real effects. Yes, these can be problematic. The way to control that is to keep credit-money limited to its purpose of aiding in the capital development of the private sector.
              Warren Mosler describes how we can best do that here ( http://moslereconomics.com/2009/09/16/proposals-for-the-banking-system-treasury-fed-and-fdic-draft/ ) .
              The idea that “mmt” somehow a) doesn’t “get” credit-money or b) doesn’t know how to deal with the problems it can present is simply wrong.

              Cheers,
              Clint Ballinger
              1000 CASTAWAYS: Fundamentals of Economics
              https://clintballinger.wordpress.com/

              • The way to control that is to keep credit-money limited to its purpose of aiding in the capital development of the private sector. Clint Ballinger
                .
                So using what is (much more so under MMT proposals*) the public’s credit but for private gain by, say, using automation to eliminate jobs is a perfectly good use of credit-money? Because it increases private capital at the expense of the public?
                .
                And assuage the victims with a Job Guarantee? As if that’s justice? The supplementation of wage slavery to the private sector with wage slavery to government?
                .
                Why not instead aim for ethical finance and asset redistribution and then we can all benefit from automation?
                .
                .
                * Notes:
                1) FREE(!) unlimited deposit insurance for bank deposits – including the deposits the banks create themselves via lending (“Bank loans create bank deposits”).
                2) Unlimited, unsecured loans from the Fed at ZERO percent.

                • “So using what is (much more so under MMT proposals*) the public’s credit but for private gain by, say, using automation to eliminate jobs is a perfectly good use of credit-money?”
                  Short answer is “yes”
                  All the private credit system does is outsource something a large gov can’t do well, which is study and monetize private credit-worthiness. It is a gain to society, but it is a very large power that must be managed correctly. Mosler’s rules basically show the right way to do that. How the two systems work together I explain from first principles here 1000 CASTAWAYS: Fundamentals of Economics
                  https://clintballinger.wordpress.com/
                  And yes, we already have machines do most of our work. I want more still to replace me on the job. Of course, the production gains must be distributed fairly. No, we are nowhere close to getting that right. But that is political, pure and simple. Always will be. The only real “economics” is Political Economy.

                  And no, tax-credits should not have negative interest. Nor positive. Just zero. Fiscal does everything else. Yes, you should be able to save and transact in your own tax-credits. Yes, the gov in some way subsidizes the system. Just like a bridge or healthcare, it is something that having the gov do raises overall wellbeing. Again, see 1000 Castaways for explanation from first principles.
                  Cheers,
                  Clint

                • All the private credit system does is outsource something a large gov can’t do well, which is study and monetize private credit-worthiness. It is a gain to society, but it is a very large power that must be managed correctly. Clint Ballinger

                  Inexpensive fiat and equal fiat distributions to all citizens allow a “loanable fiat” banking model with the banks as loan brokers between accounts at the Central Bank with interest rates as low as desired.

                  Please explain then why we should still have a two-tiered banking model premised on expensive or scarce fiat and that requires heavy government privileges to boot and which you admit has wealth distribution problems?

              • “credit-money is a promise to pay in tax-credits. That’s it. It can never BE a tax-credit.”
                .
                See https://www.newyorkfed.org/aboutthefed/fedpoint/fed21.html
                .
                “Under the Treasury Tax and Loan (TT&L) program, tax payments by individuals and businesses go into accounts at depository institutions, rather than directly to the Treasury’s accounts at the Federal Reserve.”
                .
                In other words, privately-created credit can indeed settle tax claims.

                • You could always settle a tax-claim with your credit-money account. TT&L just streamlines that.
                  The underlying accounting is the same, with, as a whole, the amount of taxes paid taking out an equal amount of reserves from the system. TT&L is just reserves management, not a change to the underlying accounting.

              • Total private debt is too high world wide. Result is Vague and Keen and Minsky banking crises or Richard Koo balance sheet recessions. It’s going to be painful bringing private debt down. Bringing debt down and keeping it down are separate things. I get MMT position on keeping it down but have not seen a position on bringing it down in the least painful way. Given the world social fabric probably depends on the quality of the answer it matters.

            • Correct. Minsky says this too. Chartered bank lending creates new credit money. And these days this new credit creation, so called endogenous money, dwarfs new deficit monetization money. Total private debt is around $27T. Credit, the rate of change in debt is just resuming its climb in US but is exploding in China. Richard Vague sums up the basic dynamics of private debt here:
              https://democracyjournal.org/magazine/42/the-private-debt-crisis/
              I have not seen MMT deal with this important aspect.

  5. Lars said:
    .
    “To both Keynes and Lerner, it was evident that the state has the ability to promote full employment and a stable price level………”
    .
    I think we have to be very clear here – did Keynes actually say this? I’m not so sure and not having read enough of Lerner I would like to see some references to this assertion.
    .
    I guess it depends on how full employment is defined?
    .
    MMT will assert this by defining employment as including those in JG work programmes.
    .

    • Read this: Functional Finance and Full Employment:
      Lessons from Lerner for Today? by Mathew Forstater
      The Jerome Levy Economics Institute
      http://www.levyinstitute.org/pubs/wp272.pdf

  6. Jan,
    .
    Thanks for the link.
    .
    It’s one thing to hold as goals the attainment of full employment and price stability, it’s another to explain how both those goals are complementary. Give the generally accepted inverse relationship between employment and inflation, it is difficult to reconcile the joint goals.
    .
    The paper you linked doesn’t delve into these issues in any great detail. There is no definition of full employment or price stability (does it mean stable prices or stable rate of inflation, for instance, at a bare minimum).
    .
    It may have been “evident”, in Lars words, that Keynes and Lerner believed “that the state has the ability to promote full employment and a stable price level”, it’s another to offer the theoretical arguments and empirical evidence to support this contention.
    .
    And I would question whether Keynes believed that two goals are entirely compatible.

  7. “The debt is not a net burden for society as a whole since the debt cancel itself out between the two groups.”

    Debt is a mechanism that moves income from borrowers to savers. It is a vehicle that facilitates the growth of inequality.

    • …moves income from borrowers to savers, or from taxpayers to savers, either way a vehicle that facilitates the growth of inequality.

    • It finances Social Security benefits for the elderly, many of whom would be unable to assemble enough property and savings to finance an extended period of retirement.

      • We should provide current real wealth to support the elderly directly. The idea we need “finance” to so so is archaic. Only current real resources matter; it is always our collective choice how to use them. Including whether to use them for education, pure research, healthcare, and supporting the elderly

  8. Historical data is clear that total private debt and its derivative, credit are terribly important for predicting/explaining unemployment. When total private debt to GDP reaches 1.5 to 2.0 or more and credit expands much faster than GDP over 5 years there is going to be a banking crisis as we saw in the Great Depression and the GFC. (See Richard Vague)
    MMT seems silent on how fiscal deficits per se work to reduce total private debt and restore credit growth to normal values. It will be a shame if we try embracing MMT, which is probably a good way to run an economy once private debt is successfully reduced, and it doesn’t “work”(restore growth). MMT might help reduce total private debt but it’s not guaranteed. Indeed, I can see how it might just reignite private borrowing especially if the chosen rate is too low. We don’t need another short term speculative asset price bubble.

  9. Kelton vs. Krugman with Lerner in the background! I love it! But make no mistake, Krugman has moved his position considerably now, while still masking it… his crowding-out argument now relies on the reaction function of the CB and not on the existence of a loanable funds market with an upward loan supply schedule… this is noteworthy, but he won’t admit it… Krugman and Delong are now on the same page…

  10. “And I would question whether Keynes believed that two goals are entirely compatible.”

    But is it always right to assume there is an inverse relationship? The causes of inflation can be multifaceted and have nothing to do with the overall level of employment. It might be because of an unstable political system or similar uncertainty. Very likely it is because of a particular capacity constraint or a supply shortage in a particular sector, and there may be lags in investment before such capacity constraints can be addressed. It is very possible to have liquidity gluts, high unemployment but high inflation all at the same time. Mid 1920s Japan before the restoration of the gold standard was a good example of such a mess.

    While the two goals of price stability and employment are not obviously compatible, my guess is that Keynes would have similarly been against simplistic assertions that there was an obvious inverse relationship and an obvious ‘natural rate'(?).

    • I can agree with most of what you say, however, I find your last sentence at odds with itself. Can’t have it both ways. And I don’t understand your reference to “natural rate”.

      • That there is a Natural Rate of Unemployment – that is a level of employment above which you get inflation. I find NAIRU an unhelpful means of looking at inflation. In other words if ‘analysis’ and (in neo-classical economics) model calibration revolves around this, I feel we are likely to overlook the real causes of inflation and get dangerously inappropriate policy. Inflation may not be directly related to the overall level of employment, and therefore targeting an output gap or employment level as a means of containing inflation is likely to be an inappropriate policy response.

        • I would argue that Keynes would view any relationship between the price level and employment as indirect, and it would not be one that was always going to hold.

          • “and therefore targeting an output gap or employment level as a means of containing inflation is likely to be an inappropriate policy response.” Sorry, that should read: “employing an output gap or aggregate employment level as a means of containing inflation (via for example an interest rate target) is likely to be an inappropriate policy response.”


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