Posted by: Dirk | May 11, 2020

The disempowerment of markets in the euro area

Relatively unobserved by the media and experts, the establishment of the Pandemic Emergency Purchase Programme (PEPP) by the ECB has temporarily severely limited the power of the financial markets over national governments in the euro area. The challenge now is to make this permanent.

The ECB’s PEPP is a programme for the purchase of public and private bonds. 750 billion have been earmarked for the first time. The aim is to keep the interest rate premiums of the countries that are particularly hard hit, such as Italy, low. In order to achieve this goal, the ECB has been given great flexibility in the composition of its portfolio and has announced that it is also prepared to implement the programme “by as much as necessary and for as long as needed”.

A look back

Let us remember: in the so-called euro crisis, the ECB felt that it was not responsible for the solvency of the national governments of the euro zone. The solvency of some member states of the European Monetary Union (EMU) – such as Greece in particular, and later also Italy, Portugal, Spain and Ireland – was doubted by creditors. The country code PI(I)GS stood for the group of countries whose government bonds plummeted in price. This was the beginning of the narrative that the euro crisis had been triggered by the crisis countries themselves and not by wage dumping in Germany and real estate bubbles in Spain and Ireland, which were co-fired by German banks.

The problem was this; in a “normal” monetary system, the central bank, as the fiscal agent of the state, also guarantees the solvency of the state. The mechanism is very simple to understand. As a monopolist of the currency, a central bank can produce an infinite amount of money for free. It does this by, for example, buying government bonds from banks. To do this, it credits the banks with the corresponding amount in its account at the central bank.

The money that it spends in so-called “quantitative easing” or also in open market transactions is thus created “out of nothing”. It is not taxpayers’ money, and the central bank does not have to and cannot “finance” this expenditure. It is the creator of the money and, within the rules in force, it can simply increase the balances of the banks and governments’ accounts by typing in the relevant numbers on a keyboard.

Why can the state not become insolvent?

The national government can sell government bonds to banks and they can sell them back to the central bank. Since the central bank can spend an unlimited amount of money to buy government bonds, nothing can go wrong. From the creditors’ point of view, government bonds are risk-free securities. This makes them particularly attractive and banks are happy to buy government bonds from the government. This in turn enables the government to replenish its account with the central bank again and again – which also keeps it solvent.

If this construct still seems too shaky to you, you can oblige the central bank to simply increase the balance of a national government account by a few billion directly, as the Bank of England has just announced.

Since the state is democratically organised in our societies, we have set up our monetary system in such a way that the national government can spend as much money as it has budgeted for (and a little more). But in a state where the national government says we want to spend X and then can’t spend X, there is no democracy. It lacks monetary sovereignty, it lacks access to money, which is needed for government spending. And this money comes from the central bank, because only the central bank is able to create money.

The Corona crisis and the role of the ECB

In the euro crisis, creditors rightly feared that the ECB would not buy Greek government bonds for an unlimited amount. Then, of course, these bonds would no longer be risk-free, but there would actually be a risk of default. So the creditors have sold Greek government bonds. Since hardly anyone wanted to buy them, the price had to fall until supply and demand converged. But lower prices of Greek government bonds inevitably increased the yield of these bonds.

Let us now look at Italian government bonds with a maturity of 3 months. Their yield was around -0.3% to -0.5% until the end of February 2020. This means that creditors (banks) considered Italian bonds to be risk-free in the short term. As the ECB’s deposit rate is currently at -0.5% (with some exceptions), banks are therefore currently indifferent as to whether they “park” money with the ECB or use it to buy Italian government bonds with a 3-month maturity.

From the beginning of March they no longer cared. The prices of Italian government bonds fell, as creditors feared that the Italian state would become insolvent. Yields on Italian government bonds rose to 1% by 18 March. This was the day the ECB announced its PEPP. Creditors quickly understood what this meant: Italian government bonds were risk-free again!

Bildschirmfoto 2020-05-09 um 16.02.56


Figure 1 shows that the price of Italian government bonds then moved back down. We are not yet back to the February level, but if the ECB gets serious and buys a sufficient number of Italian government bonds, it will make their price high and pull yields down. The price of Italian government bonds fell as creditors feared that the Italian state would become insolvent. Yields on Italian government bonds rose to 1% by 18 March. This was the day the ECB announced its PEPP. Creditors quickly understood what this meant: Italian government bonds were risk-free again!

This time it’s different

In Southern Europe, including France, there are fears that the corona crisis will once again lead to being forced into austerity policies. However, as long as the PEPP is running, national governments in the eurozone can easily get into debt. They simply spend more money. They do not need corona bonds, Eurobonds or debt relief to do so. The ECB is aware of its role and is ready to play it:

“The Governing Council will do everything necessary within its mandate.”

This is the end of financial markets’ power over national governments. This is a very positive development that makes a repeat of the austerity policy after the financial crisis at least less likely.

The other problem that countries see is the Commission’s deficit limits. However, these have been suspended for the time being. It is up to politicians to adjust these two parameters – the stabilisation of the ECB’s PEPP and the abrogation of the deficit limits. We urgently need a broad public discourse on these issues to ensure that market fundamentalists do not turn the wheel back again.

Translated with (free version)

This article originally appeared in German on April 21, 2020, at Makroskop.

In today’s ruling, the Federal Constitutional Court upheld several constitutional complaints against the Public Sector Purchase Programme (PSPP), stating that the ECB’s decisions on the Public Sector Purchase Programme were incompetent, as the proportionality had not been assessed:

A public sector purchase programme such as the PSPP, which has significant economic policy implications, requires in particular that the monetary policy objective and the economic policy implications are identified, weighted and balanced against each other. Therefore, the unconditional pursuit of the monetary policy objective of the PSPP to achieve an inflation rate below but close to 2 %, while ignoring the economic policy implications of the programme, appears to disregard the principle of proportionality.

The necessary balancing of the monetary policy objective with the economic policy implications of the means used does not follow from the decisions which are the subject of this procedure. They therefore infringe the second sentence of Article 5 (1) and (4) TEU and are not covered by the ECB’s competence in the field of monetary policy.

In my opinion, this assessment is adventurous. A central bank has a big hammer – interest rates – and almost as big – the rules on what collateral is accepted for central bank loans. To be able to influence interest rates in the long term, a central bank buys and sells government bonds. In the euro area, this is done through resale transactions (so-called repos = repurchase agreements). This is fundamental – without trading in government bonds, the central bank cannot influence interest rates and yields. (Technically, it would be possible to set interest rates in such a way that the interbank market rate is set without the central bank buying and selling government bonds, but this requires that, in case of doubt, government bonds can be bought in large quantities by the central bank. This is not permanently fulfilled in the euro zone).

A central bank sets the short-term interest rate directly via the deposit rate, main refinancing rate (maturity: 1 week) and marginal lending rate (overnight). The economy adapts to this. I am not aware of a single example of a central bank where a trade-off takes place in the sense that side effects are explicitly discussed and weighed. Of course, monetary policy has an influence on distribution, public finances and wealth. But the Federal Constitutional Court misjudges the way a central bank functions. It sets an interest rate, which is difficult enough. There is the theory of the inflation target, according to which the interest rate of the central bank is aligned with the inflation rate, but this does not work. Inflation is too low. Since its inception, the ECB has only been able to influence the inflation rate – it does not control it. (More detailed information on these issues can be found in my book “Money and Credit: A € European Perspective”, 3rd edition, February 2020).

The side effects, which the Federal Constitutional Court sees, are sometimes hair-raising:

For example, there are significant risks of loss for savings. Companies which are no longer economically viable per se remain in the market because of the general interest rate level, which has also been reduced by PSPP. Finally, as the duration of the programme and the overall volume increase, the Eurosystem is becoming increasingly dependent on the policies of the member states, as it is becoming increasingly difficult to terminate and unwind the PSPP without jeopardising the stability of the monetary union.

Could the SNB please explain to the Central Bank at what exact interest rate ‘non-viable companies’ have disappeared? That is outrageous. Such an “equilibrium interest rate” may be haunting the minds of some errant economists, but that is not something that can be seriously advocated! What comes next? A lawsuit against government spending because it keeps “businesses that are no longer viable” alive? This approach presupposes that there is a balance in the economy and that it can be observed. I do not consider both of these conditions to be fulfilled. This argument should therefore be rejected.

Similarly nonsensical is the argument about the “significant risks of loss” of savings. Have the judges perhaps ever considered what happens to asset prices when the central bank buys assets worth several hundred billion euros from asset owners? Will stock prices and property prices rise or fall? Asked the other way round, does the Constitutional Court believe that an interest rate increase to 5% by the ECB will raise asset prices? To be honest, I see more than “significant risks of loss”.

Under the same condition, the Bundesbank is obliged to ensure a coordinated – also long-term – reduction of the holdings of government bonds within the Eurosystem.

As long as other national central banks of the Eurosystem then buy these government bonds or others, this is unproblematic for the continued existence of the euro. However, it is possible that the ECB’s PEPP will then make all eurozone government bonds risk-free and accordingly in demand – except for German government bonds. This would raise their interest rates, and Germany could even become the new Greece if the other central banks refuse to buy up German government bonds. But we are nowhere near that point.

Conclusion: economic ignorance has led the BVG to make a hair-raising judgement. If the ECB’s PEPP also becomes the target of a lawsuit, this could mean the end of the Eurozone.

Translated with (free version)

logoDas Bundesverfassungsgericht hat in seinem Urteil von heute mehreren Verfassungsbeschwerden gegen das Staatsanleihenkaufprogramm (Public Sector Purchase Programme – PSPP) stattgegeben.Die Beschlüsse der EZB zum Staatsanleihenkaufprogramm kompetenzwidrig seien kompetenzwidrig, da die Verhältnismäßigkeit nicht geprüft worden sei:

Ein Programm zum Ankauf von Staatsanleihen wie das PSPP, das erhebliche wirtschaftspolitische Auswirkungen hat, setzt insbesondere voraus, dass das währungspolitische Ziel und die wirtschaftspolitischen Auswirkungen jeweils benannt, gewichtet und gegeneinander abgewogen werden. Die unbedingte Verfolgung des mit dem PSPP angestrebten währungspolitischen Ziels, eine Inflationsrate von unter, aber nahe 2 % zu erreichen, unter Ausblendung der mit dem Programm verbundenen wirtschaftspolitischen Auswirkungen missachtet daher offensichtlich den Grundsatz der Verhältnismäßigkeit.

Die erforderliche Abwägung des währungspolitischen Ziels mit den mit dem eingesetzten Mittel verbundenen wirtschaftspolitischen Auswirkungen ergibt sich nicht aus den verfahrensgegenständlichen Beschlüssen. Sie verstoßen deshalb gegen Art. 5 Abs. 1 Satz 2 und Abs. 4 EUV und sind von der währungspolitischen Kompetenz der EZB nicht gedeckt.

Diese Bewertung ist meiner Meinung nach abenteuerlich. Eine Zentralbank hat einen großen Hammer – den Zins – und einen fast genauso großen – die Vorschriften, welche Sicherheiten für Zentralbankkredite akzeptiert werden. Um den Zins langfristigen beeinflussen zu können, kauft und verkauft eine Zentralbank Staatsanleihen. In der Eurozone passiert dies über Wiederverkaufsgeschäfte (sog. repos = repurchase agreements). Dies ist fundamental – ohne den Handel mit Staatsanleihen kann die Zentralbank Zinsen und Verzinsung nicht beeinflussen. (Technisch gesehen gäbe es die Möglichkeit, die Zinsen so zu setzen, dass der Interbankenmarktzins auch ohne Kauf und Verkauf von Staatsanleihen durch die Zentralbank gesetzt wird, aber dies erfordert, dass Staatsanleihen im Zweifel von der Zentralbank in großen Mengen angekauft werden können. Dies ist in der Eurozone nicht permanent erfüllt.)

Eine Zentralbank setzt den kurzfristigen Zins direkt über Einlagezins, Hauptrefinanzierungszins (Laufzeit: 1 Woche) und Spitzenrefinanzierungszins (Übernacht). Daran passt sich die Wirtschaft an. Mir ist kein einziges Beispiel von einer Zentralbank bekannt, bei der eine Abwägung stattfindet in dem Sinne, dass explizit Nebenwirkungen diskutiert und abgewogen werden. Natürlich hat Geldpolitik Einfluß auf Verteilung, Staatsfinanzen und Vermögen. Aber das Bundesverfassungsgericht verkennt die Funktionsweise einer Zentralbank. Diese setzt einen Zins, was schwierig genug ist. Es gibt zwar die Theorie des Inflationsziels, nach der der Zins der Zentralbank an der Inflationsrate ausgerichtet wird, aber diese funktioniert nicht. Die Inflation ist zu niedrig. Die EZB kann seit Gründung die Inflationsrate nur beeinflussen – kontrollieren tut sie sie nicht. (Genauere Informationen zu diesen Themen finden sich in meinem Buch  “Geld und Kredit: Eine €-päische Perspektive“, 3. Auflage, Februar 2020.)

Die Nebenwirkungen, welche das Bundesverfassungsgericht sieht, sind teilweise haarsträubend:

So ergeben sich etwa für Sparvermögen deutliche Verlustrisiken. Wirtschaftlich an sich nicht mehr lebensfähige Unternehmen bleiben aufgrund des auch durch das PSPP abgesenkten allgemeinen Zinsniveaus weiterhin am Markt. Schließlich begibt sich das Eurosystem mit zunehmender Laufzeit des Programms und steigendem Gesamtvolumen in eine erhöhte Abhängigkeit von der Politik der Mitgliedstaaten, weil es das PSPP immer weniger ohne Gefährdung der Stabilität der Währungsunion beenden und rückabwickeln kann.

Könnte das BVG bitte der Zentralbank erklären, bei welchem Zins “nicht mehr lebensfähige Unternehmen” genau verschwunden sind? Das ist hanebüchen. Ein derartiger “Gleichgewichtszins” spukt vielleicht in den Köpfen einiger verirrter Ökonomen herum, aber das kann man doch nicht ernsthaft vertreten! Was kommt als nächstes? Eine Klage gegen Staatsausgaben, weil diese “nicht mehr lebensfähige Unternehmen” am Leben erhalten? Dieser Ansatz setzt voraus, dass es ein Gleichgewicht der Wirtschaft gibt und dass man dieses beobachten kann. Beide Voraussetzungen sehe ich als nicht erfüllt an. Daher ist diese Argumentation abzulehnen.

Ähnlich unsinnig ist die Argumentation über die “deutlichen Verlustrisiken” des Sparvermögens. Haben die Richter vielleicht mal überlegt, was mit Vermögenspreisen passiert, wenn die Zentralbank den Vermögensanlagenbesitzern Vermögenswerte im Umfang von mehreren Hundert Milliarden Euro abkauft? Steigen die Aktienpreise und Immobilienpreise wohl oder sinken sie? Andersherum gefragt: Glaubt das Verfassungsgericht, dass eine Zinserhöhung auf 5% durch die EZB die Vermögenspreise erhöht? Ich sehe da ehrlich gesagt mehr als “deutliche Verlustrisiken”.

Unter derselben Voraussetzung ist die Bundesbank verpflichtet, für eine im Rahmen des Eurosystems abgestimmte – auch langfristig angelegte – Rückführung der Bestände an Staatsanleihen Sorge zu tragen.

Solange andere nationale Zentralbanken des Eurosystems diese Staatsanleihen dann kaufen oder andere ist das unproblematisch für den Fortbestand des Euros. Eventuell werden aber dann durch das PEPP der EZB alle Staatsanleihen der Eurozone risikofrei und sind entsprechend begehrt – nur die deutschen nicht. Damit würde deren Verzinsung steigen, Deutschland könnte sogar zum neuen Griechenland werden, wenn sich die anderen Zentralbanken weigern würden, deutsche Staatsanleihen aufzukaufen. Soweit sind wir aber noch lange nicht.

Fazit: Wirtschaftswissenschaftliche Unkenntnis hat das BVG dazu geleitet, ein haarsträubendes Urteil zu fällen. Wenn auch das PEPP der EZB Ziel einer Klage wird, dann könnte dies das Ende der Eurozone bedeuten.

The last ten years have brought Knut Wicksell, a Swedish economist born in the 19th century, closer to the spotlight. His “Interest and Prices” (1898) should be understood as the birth of a new idea of how to explain monetary systems. (I have written about this elsewhere.) While some still pretend that Wicksell was a neoclassical economist, this has never been true. Just like Keynes worked in the paradigm of his time, so did Wicksell. And he found interesting spins to these old theories, like this:

The objection that a further reduction in rates of interest cannot be to the advantage of the banks may possibly in itself be perfectly correct. A fall in rates of interest may diminish the banks’ margin of profit more than it is likely to increase the extent of their business. I should like then in all humility to call attention to the fact that the banks’ prime duty is not to earn a great deal of money but to provide the public with a medium of exchange—and to provide this medium in adequate measure, to aim at stability of prices. In any case, their obligations to society are enormously more important than their private obligations, and if they are ultimately unable to fulfil their obligations to society along the lines of private enterprise—which I very much doubt—then they would provide a worthy activity for the State.

This is so interesting that I thought his “The Enigma of Business Cycles” would be worth reading. It is a short article published somewhere – really, I got no idea how I got it! – with page numbers 223 to 235. The problem with the article: It it is not interesting, at least from my point of view. Whereas Wicksell wrote interesting stuff about real estate markets and interest rates and, like above, low interest rates and credit, the article on business cycles does not follow up on these themes.

Here are some quotes to bring across this point. On p. 229, he writes about “the size and fluctuations of inventories between good and bad times”. Wicksell says he will develop a “working hypothesis” (p. 230), to be found on p. 232: “As soon as the rate of increase in output begins to lag, a hitch will immediately occur in the development of the economy. For my part, until I am shown something better, it is in this that I discern the real source of economic fluctuations and crises, which, in their present form, belong entirely to modern times”. He finishes his articles with the question: “Is overproduction an evil or a good thing; are accumulating inventories characteristic of prosperous times as a sort of by-product of such times and the inventories themselves cause of depressed times; or, on the contrary, do inventories increase during depressed times, and is this increase, taken in conjunction with technical and economic improvements, a necessary prerequisite for prosperous times?”

It took Keynes some time to develop his General Theory, which is based in the idea that business cycles are caused by fluctuations of aggregate demand. Wicksell stops short of this insight – inventories moving up and down are the consequence of demand fluctuations, not the cause. I think that this answer has been firmly established.

Posted by: Dirk | October 22, 2019

About the rules of the monetary circuit

In “Monopoly”, the bank can “print” money indefinitely, the players get into debt, and the state adds 200 Marks each round. But what if everyone had to pay 200 Marks each round and would suffer negative returns when owning railway stations?

Even if “Monopoly” comes from the US, it has long since become a classic German game. And it goes like this: In the ideal case four players buy and sell roads, build houses and hotels and pay each other rent, which depends on the price of the road and the number of real estate. So, the money circulates nicely in the “private sector” or, put differently, among the households. At some point, however, players will run out of money and will no longer be able to make payments. The only thing left is to sell streets, which in the real world is called “fire sales”. But with that they rob themselves of future sources of income. The resulting inequality brings the game to an end – when only one player has any money left.

Applied modern monetary theory

But where does the money come from? A bit of capital stock is inherited, as it were, by the central bank simply “printing” the money and bringing it into play. During the game, event cards and community cards are used for transactions with the state, and of course passing “GO” means that money enters the game. In the modern version of Monopoly, players get 200 Marks each time.

In the real world, the “players” get their income from capital possession, even from government bonds, which pay interest. But this aspect is missing in Monopoly. If we (in our minds) replace the four train stations on the playing field with government bonds, where the player earns interest when he moves onto them, then we have a realistic economy.

In addition, mortgages can be taken out, money that has to be repaid at some point. If this happens, the encumbered real estate will no longer earn rents. Of course, this is an unrealistic rule, because in the real world it is of course possible to rent houses and flats purchased on credit.

The state intervenes in the game in two ways. First, it generates state money; second, it guarantees property rights. The state injects money into the game in two ways. First, as I said, when passing “GO”. Secondly – as a mental equivalent to the income from owning the stations – by paying interest on government bonds. If we assume that the state is indebted with 100,000 Marks, then there is an income of 1,000 Marks per interest point on the player. If this kind of income is provided, the game will weigh a few rounds back and forth until a winner emerges.

Neoliberal economic policy

But what would happen if Monopoly’s rules were turned upside down? What if the state were to run a budget surplus and government bonds were to yield negative returns? Applied to the rules of the game: if 200 marks are deducted from the assets of the players who passes “GO”?

A surplus of the state is of course a deficit of the budgets, because they pay the taxes. In addition, the players have to pay a certain amount of currency units when they move onto a station, which are now triggering negative bond payments. There, too, payments to the state will cause private assets to shrink.

Shrinking household wealth will not remain without consequences in Modern Money Monopoly. Households will have greater problems making payments and will therefore be insolvent earlier than in the original version of Monopoly. Since the money is pretty tight quite quickly and the first bankruptcies will occur after a few rounds, the game would soon no longer be fun.

Progressive economic policy

If we want a progressive economic policy in which everyone can have fun, then we have to be clear about the objectives of the game. Instead of simply maximising profits, for example, the common good should also be taken into account. Because everyone should be able to play in the ‘game of life’, not just those with great fortunes.

For example, there are some arguments in favor of taxing wealth, either regularly (by passing “GO”) or through event cards. Community cards could be used to support low-income players. Rents could also be limited with a rent cap.

The role of fiscal policy – government spending and taxes – should be to enable all households to save. In the case of four players, this does not work if the state achieves a surplus. At least one player must have a deficit, probably two or three. To make it possible for all players to become savers, the state must switch to a deficit position.

Whether the government then pays a positive rate of interest on its government bonds or not depends on considerations outside the game. Only if government bond rates had an impact on players’ demand for credit would positive rates play an important role.

Economic policy and recession

If a government with a black zero withdraws more money from households through taxes every year than it transfers to households through government spending, then private wealth will grow less than it would otherwise. If government bonds also bear negative interest rates, then the state will take even more income away from its citizens. This will have an impact on the economic cycle. According to Handelsblatt, almost 7 million Germans were already overindebted in 2018. The figures have been rising for five years.

As with Monopoly, the German state can also simply bring money into play via “its” bank, the Deutsche Bundesbank, which costs nothing. It can thus create income and employment and thus eliminate unemployment.

Even if the debt brake and the Stability and Growth Pact set limits, the Federal Government still has some room for manoeuvre. If it continues to hesitate now – already in the middle of the recession – the room for manoeuvre will be smaller. At some point it will be forced to implement an austerity policy of spending cuts. That would sweep the figures of many players off the board. Such a result must be avoided by all means.

But while “new game, new luck” applies to Monopoly, reality does not know the end of a game, but it does know many losers.

Translated with

MMT-based rules for a Modern Money Monopoly are available here.

(This article first appeared in German at Makroskop on October 22, 2019.)

I have recently completed a tiny spreadsheet version of the ISMY model. The model was developed in 2014 and represents an alternative to the IS/LM model. I have a small page filled with content related to the model here. Probably I should look for a different name of the model, like Modern Macroeconomics Theory Model (MMTM) or something of that sort since it is based on Modern Monetary Theory (MMT) foundations. Anyway, here is a screenshot:

Bildschirmfoto 2019-08-28 um 10.25.26

This simple model fits today’s world very well since I got rid of:

  • money market equilibrium – because the central bank supplies the reserves the banking system demands. Otherwise you get a catastrophic collapse of the financial system.
  • downward-sloping investment curve – because the idea that lower interest rates stimulate private investment is basically dead now.
  • upward-sloping LM curve – because central banks keep interest rates constant whatever public debt / public deficit / public spending is.

What I introduce is the sectoral balances equation as used by Wynne Godley, so that in the model you can show that:

  • public deficits are private surpluses
  • in a boom, private sector net financial savings decrease
  • in a crisis, private sector net financial savings increase
  • public deficits are mainly driven by changes in tax revenue
  • full employment can be reached by increasing public spending
  • more public spending allows private sector to deleverage

I hope that this model will be taken up by more colleagues as it is very clear now that the IS/LM model “does not work”. If you make it more realistic by saying that investment does not depend on the rate of interest (vertical IS curve) and that the central bank determines the interest rate (horizontal LM curve), then you will have wasted 3-4 lectures to explain the goods market (IS curve) and the money market (LM curve) only to conclude that both do not matter in practice. It is only a small step from there to conclude that teaching the IS/LM model is a waste of time. You might just say that “demand determines supply, which determines employment” and that “government spending and private investment, which both do not depend on the rate of interest, increase demand”. Your students will easily get it and you save 3-4 lectures for something else, like my IS/MY model.

(If you have any questions please do not hesitate to email me.)

Posted by: Dirk | July 2, 2019

New chapter on Euro Treasury and Job Guarantee

Together with Esteban Cruz and Pavlina Tcherneva I have written a chapter in a book on the Eurozone. It has been published by Revista Economica and is available for download here (PDF). This is the abstract:

The problems with the design of the Eurozone came into focus when, late in 2009, several member nations– notably Greece – failed to re nance their government debt. The crisis that followed was not entirely asurprise. When the Euro was launched in 1999, many economists warned that the single currency was unworkable. Even Eurozone optimists argued that the Euro project would eventually need to be completed. More than 10 years after the crisis, unemployment rates remain elevated and continue to threaten the social, political and economic stability of the Eurozone. The institutional constraints of the single currency however preclude bold action to address these challenges. In this paper, we suggest that tackling thetwin problems of the Eurozone – its institutional aws and mass unemployment – could be addressed by creating a Euro Treasury that would nance a Job Guarantee program, which would eliminate massunemployment, enhance price stability, and foster social and economic integration across Europe.

Posted by: Dirk | May 13, 2019

Monetary policy and the zero lower … oh, wait!

Warren Mosler spoke in Berlin last night. His talk was very impressive, questioning many “self-evident truths” that economists hold dear for just a little too long. Among his slides, this was a very good one:


This is the LIBOR (Euro), a market rate that is based on surveys from banks that are asked at which rates they would lend and borrow in the market. As you can see, the rate moved seemlessly from positive to negative in mid-2017. Zero lower bound? What is that supposed to mean?

Let me also point out Sweden’s repo rate below:


Again, the rate just went from positive to negative. Zero lower bound? What is that?

Of course, people talk about the zero lower bound a lot. But then, people talk about dragons, dwarfs and Hobbits as well. Economics seems to have a problem in that it is ruled to some extent by fairy tales that are very popular among economists but that the layperson does not understand because there seems to be no logic to it. Economics needs more debate and more common sense or it will be irrelevant to the real world. Fairy tales are nice, but you wouldn’t want the actor who played Gandalf to guide your economic policy.

Investment is not very sensitive to interest rates, anyway, so even if we can go negative without problems, there is still the problem that low and negative interest rates are very unlikely to increase private investment. Even working papers from the Federal Reserve Bank from five years ago say that.

Time to turn to fiscal policy perhaps?


Posted by: Dirk | May 8, 2019

Schumpeter on Knapp in his 1954 HEA

Having recently published a working paper on the academic reception of Knapp’s “The State Theory of Money” (1905), I was confused by the lack of good will shown by Joseph Schumpeter when he discussed the book. He claimed that Knapp did not examine the value of money, when Knapp explicitly rejected the concept of “value” in favor of talking about purchasing power. He also claimed that Knapp’s theory would be one of a monetary system when it was quite clearly not.

So, I thought that maybe later in his life – his History of Economic Analysis appeared in 1954 – Schumpeter would be more reasonable in discussing Knapp’s finding that money is a creature of law. Well, he wasn’t:

Joseph on Georg 1.png

Joseph on Georg 2.png

Schumpeter was an excellent economist, his Theory of Economic Development and other writings surely stood the test of time. However, the message of Knapp – that government spends whatever it wants to spend and, as creator of money, needs not to worry about budget constraints – seems to have not gone down well with Schumpeter. It is a pity – Schumpter was the Ph. D. advisor of Minsky, who struggled with monetary theory. Only with MMT did Knapp’s Chartalism return to the center of economics, after having been hidden in plain sight for more than half a century. We can expect a return of fiscal policy to the real world before Chartalist ideas, which featured so prominently on the first pages of The Treatise on Money by John Maynard Keynes, will return to economics textbooks. But return they will.

Here is an excerpt of JMK’s letter to FDR from 1933:

The other set of fallacies, of which I fear the influence, arises out of a crude economic doctrine commonly known as the quantity theory of money. Rising output and rising incomes will suffer a set-back sooner or later if the quantity of money is rigidly fixed. Some people seem to infer from this that output and income can be raised by increasing the quantity of money. But this is like trying to get fat by buying a larger belt. In the United States to-day your belt is plenty big enough for your belly. It is a most misleading thing to stress the quantity of money, which is only a limiting factor, rather than the volume of expenditure, which is the operative factor.

The relation between output and money is a statistical one, which means… not much. Here is a graph from FRED to show M1 and GDP growth for the US:


The blue line is the growth of M1 in percent, the red line real GDP growth (also in percent). Of course, one could also use M2, M3 or monetary base to create the figure, but the result is the same. Correlation is not very high, and it is doubtful that anything can be said in terms of causation. Obviously, spending money does something to GDP, but M1 is a stock and “spending money” a flow. Attributed to Keynes is the sentence that “there are many slips between the cup and the lip”, and it is most proper in this case. The upwards change in the stock of money (M1) does not automatically translate into more purchases and hence more production. Things are more complicated.

In his letter, JMK continues with a discussion of the “techniques of recovery”. I’ve written a working paper in which I translate his “techniques” into my macroeconomic model, which fits nicely. You can download the working paper here.

Older Posts »