Reexamining the economic costs of debt

21 Nov, 2019 at 12:00 | Posted in Economics | 19 Comments

conbudIn recent months a new approach to national government budgets, deficits, and debts—Modern Money Theory (MMT)—has been the subject of discussion and controversy. A great deal of misunderstanding of its main tenets has led to declarations by many policymakers (including Federal Reserve Chairman Jerome Powell and Japan’s Prime Minister Shinzō Abe) that it is crazy and even dangerous. Supposedly, it calls on central banks to just print money to pay for ramped-up spending. It is purported to claim that deficits don’t matter. It is said to ignore the inflationary consequences of spending without limit, and even to invite hyperinflation.

None of these claims is true. MMT is based on sound economic theory. Most of it is not even new. Rather it represents an integration of a number of long-standing traditions that heretofore had not been linked. It does reach some surprising conclusions, but these conclusions are more consistent with real world outcomes that mainstream theory has trouble explaining. Further, a growing number of prominent economists and financial market participants have recognized that it is worth examining MMT. Its conclusions—especially those regarding the fiscal policy space available to sovereign governments—are being embraced by some policymakers.

In this testimony I do not want to rehash the theoretical foundations of MMT. Instead I will highlight empirical facts with the goal of explaining the causes and consequences of the intransigent federal budget deficits and the growing national government debt. I hope that developing an understanding of the dynamics involved will make the topic of deficits and debt less daunting. I will conclude by summarizing the MMT views on this topic, hoping to set the record straight.

L. Randall Wray’s congressional testimony

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  1. Dear Lars,
    As you argued some days ago, MMT is founded on neoclassical economics. Do you consider now neoclassical economics as a sound economic theory?

  2. Wray uses his testimony to explain the three balances approach and uses that analysis to in turn argue for the futility of policy targeting the quantity of national public debt per se. He is a bit vague on what he would target as a public policymaker, but he seems to believe in “growth” as a goal.
    .
    Missing almost entirely is any thing that would make “growth” practical in detail. His private sector “as a whole” saves more than it invests, while the growth of private debt within the whole goes unremarked. U.S. current account deficits are driven by the export surpluses pursued by other countries; no word from Wray on the implications of being the consumer-of-first-and-last-resort for China, Germany, et alia. He does note in passing the declining efficiency of tax collection, but again seems disinclined to question it. The secular trend in U.S. public spending in Wray’s telling has become a constant and nothing to worry about; the wearing down of public infrastructure goes unremarked.
    .
    Between neoclassical stupid and MMT, I will take MMT I guess, but it is getting harder and not easier to trust the intelligence and intentions of people like Wray.

  3. “Supposedly, it calls on central banks to just print money to pay for ramped-up spending. It is purported to claim that deficits don’t matter. It is said to ignore the inflationary consequences of spending without limit, and even to invite hyperinflation.”
    .
    This is real heterodoxy, and basically my theory (inspired by C. H. Douglas). MMT is too orthodox in its inflation theory. MMT is also too rigid in the sectoral balance sheet analysis, ignoring how the private financial sector can create new net financial assets faster than it creates liabilities and before the central bank realizes it.

  4. “While we cannot necessarily ascertain causation—which could be quite complex—the sectoral balance tells us that if the US domestic sector spends less than its income (“saves”) and the US runs a current account deficit, the government will run a deficit (equal to the sum of the first two).” (From Wray’s testimony.)
    .
    What a stunning contradiction contained in one sentence. A sentence that goes to the heart of the argument in MMT.
    .
    In the first breath Wray says causation cannot be ascertained when using the sectoral balance equation then in the next breath he proceeds to assert the outcome of government deficit spending.
    .
    Many times have I read an MMT proponent say, effectively, $1 of additional government deficit ends up as $1 of private surplus, if the foreign balance remains unchanged.
    .
    There is no way this statement can be made without considering a behaviourial relationship between the variables under scrutiny.
    .
    The sectoral balance equation is an ex post accounting record. It is a truism.
    .
    However, the ex ante statement that an additional $1 of government deficit will result in an additional $1 of private surplus cannot be made without a behaviourial model.
    .
    MMTers are always on precarious ground when they start playing with the sectoral balance equation.

    • What stunning contradiction do you see in Wray’s statement? You call it a ‘truism’ as if that is something bad we need to avoid. God forbid an economist says something true?

    • Is it even possible that a contradictory statement is also a truism?

    • Jerry,
      .
      “What stunning contradiction do you see in Wray’s statement?”
      .
      I can see my attempt at the dramatic failed.
      .
      On the face of it the statement is borderline tenable. It is only borderline tenable because parts of it use the future tense, pushing it in the direction of ex ante statement.
      .
      Whenever MMTers start to play with the sectoral balance equation they invariably use in an ex ante fashion.
      .
      This is not tenable. This is my point.
      .
      It is an accounting equation not a behavioural equation.

    • Jerry,
      .
      Maybe I conceded too easily.
      .
      I’m tossing up between borderline tenable and borderline contradiction.
      .
      Wray should have been more careful with his words.

    • • Jerry,
      .
      “What stunning contradiction do you see in Wray’s statement?”
      .
      I can see my attempt at the dramatic failed.
      .
      On the face of it the statement is borderline tenable. It is borderline tenable because parts of it use the future tense, pushing it in the direction of an ex ante statement.
      .
      Maybe I concede too easily. It’s a toss up between borderline tenable and borderline contradiction.
      .
      Wray should have been more careful with his words.
      .
      Whenever MMTers start to play with the sectoral balance equation they invariably use it in an ex ante fashion.
      .
      This is not tenable. That is my point.
      .
      It is an accounting record not a behavioural equation.

    • You say, “behavioural” but I am not confident I know what you mean or even that you know what you mean. Where the 3-sectoral-balances approach is useful, I think, is in demolishing the pretenses of the “moral causes” approach to economic policy: the advocacy of austerity or thrift or sound money on grounds of moral idealism: a belief that a public policy of probity to some abstract ideal will induce desired behaviour in other, private persons. Such moral reasoning has no respect for functional necessity. It can be like the idealist who wants to eat without waste. Anyone can tell a foggy story about behaviors, but if that story is inconsistent with the accounting identities that must by definition hold, that story is exposed as a tangle of lies.
      .
      Such tangles are quite common in political discussion. People advocate for the impossible: they want a thrifty people and a thrifty state and surplus without deficit anywhere.

      • “surplus without deficit anywhere.”
        .
        Finance makes this possible. A series of derivatives can allow all counterparties to book a profit. Reypothecation effectively multiplies an asset, allowing it to appear as an asset on multiple balance sheets. In financial panics, the Fed has proven it can supply liquidity from its vertical supply curve of reserves so that everyone can continue to book profits without anyone needing to run a deficit. The Fed’s vertical supply curve on reserves does not send anyone into deficit …
        .
        MMT fails to account for such ability of the private financial sector to create new net financial assets before the central bank knows it.

    • “You say, “behavioural” but I am not confident I know what you mean or even that you know what you mean.”
      .
      I know precisely what I mean, the rest is your problem.
      .
      “Anyone can tell a foggy story about behaviors, but if that story is inconsistent with the accounting identities that must by definition hold, that story is exposed as a tangle of lies.”
      .
      Can’t help it if you don’t understand the difference between ex post and ex ante relationships.

    • “The sectoral balance equation is an ex post accounting record. It is a truism.”
      .
      Yes, and it is made true by fudging data as needed. GDP calculations ignore holding gains, for example.

  5. “While we cannot necessarily ascertain causation—which could be quite complex—the sectoral balance tells us that if the US domestic sector spends less than its income (“saves”) and the US runs a current account deficit, the government will run a deficit (equal to the sum of the first two).” (From Wray’s testimony.)

    There is no contradiction in this statement. It says that IF two things occur, THEN one other thing will occur. It does not explain how likely it is for the first two events to happen, but it is still a useful statement of fact. Ex ante, ex post, whatever Latin terms you prefer don’t change the truth of the statement.

    You don’t ‘concede too easily’ here. Actually, I don’t ever remember you conceding an argument easily 🙂 One of the reasons I enjoy arguing with you. Thanks Henry.

    • Jerry,
      .
      “It says that IF two things occur, THEN one other thing will occur.”
      .
      That’s an ex ante statement.
      .
      “….but it is still a useful statement of fact.”
      .
      How can it be a statement of fact if what is purported to happen hasn’t happened yet?

      (Apologies for the doubling up of comments. The first appeared to be not coming thru.)

      • “That’s an ex ante statement.”
        Still using the Latin. Well whatever. So what if it is an ‘ex ante’ prediction or statement. So what?
        Is it wrong? Is it ever going to be wrong?
        I think you were right to concede this particular argument earlier.
        Tomorrow, the sun will rise. ‘Ex ante’ statement or whatever you want to call it. It hasn’t happened yet- but you would be silly to bet against it. Or spend much time worrying whether it might happen.

      • “Is it wrong? Is it ever going to be wrong?”
        .
        It’s only as good as the behavioural relationships it’s based on.

        • Henry. Would it really hurt you all that much to admit there is no contradiction in Wray’s statement? I mean this is a statement that YOU happened to pick out in order to criticize him. But there is nothing wrong with the statement- and you know there’s nothing wrong with that statement.
          So WTF?

          • Jerry,
            .
            Wray knew he was skating on thin ice when he raised the matter of the sectoral balance equation (SBE).
            .
            Despite knowing “…. we cannot necessarily ascertain causation—which could be quite complex…” he goes on to use the SBE.
            .
            He’s something else for you to chew on.
            .
            The “S-I” in the equation, as you know, stands for the private sector surplus. Whose surplus? Do we know? Does anybody bother to ask? Does it matter?
            .
            The surplus is made up of the surplus of the various income groups across the economy – there’s the wealthy and the not so wealthy. There’s the possibility of a business surplus. So we could write the S-I (i.e. the private sector surplus) part of the SBE as, for instance:
            .
            Private Sector Surplus = Surplus of top 1% of income earners + Surplus of the rest + Surplus of business.
            .
            So if there is a private surplus, how is it distributed between these groups?
            .
            Should we care? Some of us might.
            .
            In the light of this is a private sector surplus universally “good” as MMTers make out?
            .
            The SBE gives us no clues as to how this surplus is distributed.
            .
            Some income groups may have a deficit but the other income groups have surplus which overwhelms it, still leaving a surplus on balance.
            .
            Is this good or bad?.
            .
            No point asking this question because the way the MMT narratives are framed we can’t tell.


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