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:

fredgraph-23

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:

fredgraph-24.png

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?

#Theonlygameintown

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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:

fredgraph-22.png

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.

Posted by: Dirk | April 29, 2019

The problem with the supply curve

In his book Debunking Economics: The Naked Emperor of the Social Sciences (link) Steve Keen uses a 1952 paper to make a very important point about neoclassical economics: There is a problem with the supply curve. In the paper, the authors asked business people what they thought their supply curve looked like. In neoclassical economics, the theory is quite clear what it should look like:

supply

The supply curve slopes upwards, as a rise in supply can only be effected through an increase in price. The logic is that if you want to sell more of something, you will have to charge a higher price as it marginally gets more expensive to increase production. This is a central “insight” of neoclassical economics: resources are not limited, but rather they can be provided, given that the buyers are willing to pay a higher price.

Interestingly, it should not be too hard to see whether this theoretical supply curve is a realistic description of reality. So, Eiteman and Guthrie in their AER paper presented some supply curves to businesspeople and asked them which ones would represent best the situation of their respective business. Here are four proposals (the other four received an insignificant amount of approval, so I did not bother to reproduce them):

AER 1952.png

All these curves are “far away” from the supply curve presented in neoclassical economics. Maybe number 5 is kind of close, at least at a significant scale of output. The table that the authors present is a nasty surprise for any neoclassical economist:

TABLE II.-CHOICE OF COST CURVE BY COMPANIES WiTHOUT REFERENCE TO NUMDBER OF PRODUCTS

Curve Indicated – Number of Companies

1 – 0

2 – 0

3 – 1

4 – 3

5 – 14

6 – 113

7 – 203

8 – 0

Total – 334

Have a look at curves 6 and 7 above. Number 7 received almost twice as much support as number 6, and that is a DOWNWARD SLOPING supply curve! The authors conclude: “The replies demonstrate a clear preference of businessmen for curves which do not offer great support to the argument of marginal theorists.” To non-economists this is perhaps not that much of a surprise. If you produce more of something, you can use more machines and hence you will be more efficient. Prices would then be expected to fall. Industrial mass production typically features falling prices, as the expansion of output allows firms to operate at a larger scale, using more resources.

Eiteman and Guthrie conclude their paper with this statement: “If the beliefs of businessmen in general coincide with those included in this sample, it is obvious that short-run marginal price theory should be revised in the light of reality.” That was in 1952, and microeconomics is still presented to young economists as an insight to build on. Never mind that later on increasing returns to scale are introduced – the whole foundation of modern micro has collapsed decades ago. What would companies like Amazon, Google or facebook say about their supply curves? If you would add another account at facebook, have another user using Google’s search engine or another user buying books at Amazon – would marginal costs increase? Obviously not.

Microeconomics, the behavior of firms and households, is very important. Starting the subject by repeating theories that should have long been discarded blocks more relevant approaches from being taught. These new approaches could provide proper foundations of the behavior of firms and households if they are not based on “economic laws” that are refuted by reality.

In the face of climate change and the fight against it economics needs to be reformed from bottom up. A microeconomic theory that basically says that resources are unlimited – if only buyers accept a rising price – is not a good way to start thinking about our economy. The supply curve should not slope upwards by default. It should be presented as something that is conditional on technology and regulation.

My new working paper Knapp’s State Theory of Money and its reception in German academic discourse makes a couple of interesting points. Here is the short version with three key takeaways (apart from the fact that Knapp’s book was discussed by many other economists, and at some length – 20 pages was normal, even more than 40 was possible!):

  1. In The State Theory of Money, Knapp never says: government spends first and taxes later. The word “spending” does not appear even once, and the word “spend” appears twice – once in the context of a commodity and once in the context of time. That has led many to wonder whether Knapp understood that government spending comes first and taxation follows rather than the other way around. On page 14/15, I write about a book review from Voigt from 1906: “Voigt recognises the importance of the issue at hand: if the idea that the state is above the economic laws and can hence manipulate, change (abändern) or modify (modifizieren) them is correct, then it would have opened the door wide for any sort of radical economic policy. The state then should be able to push down the price of real estate, regulate the price of bread and meat and also the worker’s wage. Thus the question of the organisation of the economy is one of legislation, and problems would only exist because of the “good will” of the ruler.28 The “good defense“ that some things are impossible for economic reasons, which the state has to protect itself from radical claims, would be lost.” This means that surely academics (economists, mostly) understood that was Knapp was saying is: government can just spend. Note that today we have all the radical policies in place that Voigt feared: subsidies and tax breaks for house purchases, state controlled prices in agriculture, minimum wages and wages set by unions or the state because it is the employer. Funny how in 1906 all that happened only 30 years later with the New Deal was “radical policy”!
  2. Knut Wicksell, author if Interest and Prices, read Knapp and was positive: Wicksell (1999, 219) agrees with Knapp and closes his account with the comment that “in terms both of its content and its form [..] it is to be counted among the pearls of economics literature”. He missed an explanation for the value of money (which Knapp treated in the Appendix under “Value of Money” and Prices. Knapp’s point was that since there are many things you can buy with money – goods, labor, assets, capital goods – it is not at all clear what “value” would be. Apparently Wicksell thought that the discussion was not satisfying.
  3. Schumpeter was not a friend of Knapp’s work. “Schumpeter (1970, 82-86) discusses Knapp’s book at some lengths. He disagrees with Knapp’s theory and writes that it is not even a “fruitful error”. Schumpeter argues thatKnapp’s theory was a “Theorie des Geldwesens”, a theory of finance – however, it was no such thing. As Knapp wrote again and again, he was interested in what money “is”.Schumpeter is wrong then to think about Knapp’s ideas as a theory of finance, and he is also wrong when he bemoans that Knapp’s theory had nothing to do with the level of prices. In the English translation, the table of contents lists §20 “Value of Money” and Prices in the Appendices and Additions section, which has not been translated. The little chapter summary, however, has been translated and reads like this:

    ‘Value’ always implies a comparison, and in the particular object compared with it we have an expression for the value of money. These different forms of expression are mutually independent, cannot be interchanged, and still less be regarded as one. Money can also be compared with groups of commodities, but the composition of the group must be agreed upon. Index-numbers are a welcome indication of the alterations in price of the goods contained in the group. Other groups would give other index-numbers. There are always alterations in price, due to the condition of the market. They should not be explained as showing that the value of money has altered in the opposite direction, for that would be merely tautology. As to the value of money, price statistics a help, but need an interpreter. In the case of income,‘producers’ or ‘consumers’ differently affected by price alterations. Alterations in price not alterations of the ‘validity’ of a piece. The State Theory of Money to be kept separate from economic reflections on Money.

    Schumpeter (1970, 85) wrongly states that Bendixen discovered his “Anweisungstheorie”(claim theory) independently from Knapp and that Bendixen would not be building on Knapp and expanding his theory towards the economic dimension. The exchange of letters between Knapp and Bendixen, in which Bendixen writes that he would be the first Chartalist, say otherwise. Schumpeter’s pages on Knapp are full of scorn. No further economic arguments can be extracted from these passages.”

     

That’s all. If you have any questions or comments you can email me at dirk@ehnts.de.

There is a lot of talk about how MMT would lack a “model”. Some commentators on Twitter even claim that MMT would have “no model” and that they just created one themselves. Others believe that stock-flow consistent (SFC) models are basically SFC models. All of that is not quite right!

I think that the only model that can really claim to be a “MMT model” is the one I published in a peer-reviewed journal in 2014. The article in the International Journal of Pluralism and Economics Education (IJPEE) was named “A simple macroeconomic model of a currency union with endogenous money and saving-investment imbalances” (link). With hindsight, it was not a good title, since there is nothing specific about “currency union” or (private!) “saving-investment imbalances” in the model. It is really a replacement of the IS/LM-model and nothing else. The working paper version is accessible freely and was written in 2012 (link). During that year, I was at the Hyman-Minsky summer school at the Levy Institute of Bard College, NY. I showed the model to Randy Wray and Scott Fullwiler and some other people and they all liked it. Given that my model has the sectoral balances at its core that did not surprise me.

Since the model has not gotten a lot of attention so far – I presented it at University of Cassino in Italy after being invited there to spend a week with SFC modeler Gennaro Zezza and in some other place – I would like to use this blog post to explain the model briefly. Of course, the IJPEE paper is the long version. (The working paper contains some minor flaws that had been fixed in the journal version.) For those who can’t wait to see it, you can download a spreadsheet file of the ISMY model here. It has all the equations and is solvable by toying around with it.

(For those interested in MMT and European Macroeconomics please have a look at my 2016 book of that very same name published with Routledge.)

Why should we get rid of the IS/LM model?

  1. There is always “equilibrium” in the money market. It does not make sense to claim that supply and demand interact. Banks borrow reserves against collateral, so demand determines supply.
  2. Central banks don’t use open market operations to influence interest rates – they set some interest rates that establish a corridor for the interbank market interest rate.
  3. An increase in government spending does _not_ increase the rate of interest.
  4. While the IS/LM-model features Saving (excess of income over expenditure), there is no corresponding change in (net) debt (excess of expenditure over income).
  5. Investment is negatively dependent on the interest rate, which is highly doubtable.
  6. There is no external sector, hence there are no imports and exports.

In my model, I fixed all these things and I added the sectoral balance equation. Change in net financial saving by private, public and external sector has to add up to zero. I equation form: (Sp-I) + (T-G) + (IM-EX) = 0. All changes in net financial debt of the sectors can be read off the graphical model, which I think is an important innovation. An economy that shows an increase in private debt is not “sustainable” – private debt cannot grow forever. If something cannot go on forever it will stop. So, the discussion of how flows translate into stocks is what is important.

The graphical model

So, here is the short version of the IS/MY-model (I=S, change in M changes Y). You find the long version in the paper (see link above). We start with the SE quadrant, where income (real GDP; in the base scenario inflation is zero and hence nominal is real) is determined by the changes in net deposits (given everything else!). If there is net injection of bank deposits through any combination of increases in private investment (financed by loans), government spending (“financed” by the central bank via banks if necessary – remember that the central bank is the monopoly issuer of currency and hence cannot finance its expenditures. It just spend!) , or exports (leading to an increase in net deposits as well).

Given some rate of inflation, changes in net deposits translate into changes in income (GDP) as additions to net deposits are created to be spend – and they are, creating higher income along the way. We assume that there is some unemployment, so that increases in spending translate into changes in income only. However, you would be free to shift the P/V=M/Y curve (which is an identity!) around as you like. So, if you think that increases in government spending are inflationary, just turn the line around clockwise and then an increase in net deposits leads only to a small increase in (real) income. If you come out of  a depression (preferably with no private debt overhang), the line might be even flatter then the line I’ve drawn – an increase in net deposits creates a large increase in GDP.

bank deposits and income.png

The NE quadrant is the heart of the IS/MY-model since it is here that changes in net deposits translate into changes in the macroeconomic variables. Note that government spending (G), private investment (I) and exports are exogenous variables. They do not depend systematically on any other macroeconomic variables in the model. Government spending is what the budget says plus some changes due to relatively strong/weak economic growth (automatic stabilizers). Investment depends on animal spirits and financing conditions (Minsky) and past validations of investments (Minsky again) more than on the nominal rate of interest set by the central bank. Once private investment grows there is a strong tendency to continue to grow. This resembles what Gunnar Myrdal called “cumulative causation”. Exports depend on what the rest of the world wants to buy at current exchange rates (or whatever expected exchange rates you can imagine).

Anybody familiar with macro models will then no be surprise by the way the endogenous variables work. Taxes (not visible), consumption (C) and imports depend on domestic income (real GDP). There is a tax rate of t that, multiplied with Y, determines T. Also, consumers spend a share c of their income. Some share imp of total income is spend on imports. Since expenditures and income have to add up, we must be on the 45 degree line. And that is it!

real economy.png

The last (NW) quadrant is the change in net financial savings of the private sector. Since in the last quadrant you can read off current account (EX-IM) and government budget surplus or deficit (imagine a tax line that starts at zero/zero and then increases with income), you can determine the net financial savings of the private sector: Sp – I.

netfinsavpri.png

If you end up on the left half, the private sector is net saving. This is connected to relatively low levels of demand. If you end up on the right half, then the private sector is investing more than it is saving (which leads to an increase in its debt). Starting to view the economy from this quadrant you can easily think about private sector deleveraging and private investment driving the economy in a (real estate) boom.

The business cycle and economic policy

Now here is a stylized account of the business cycle. We start in a situation where the current account is in balance, the public budget is in balance and hence the private sector balance is in budget as well. We assume that there is some unemployment so that income (GDP) can rise during a boom. Obviously, there must be a resource constraint somewhere to the right of the initial equilibrium but since in the last 50 years we never reached it there is no discussion of it. (That does not mean that it does not matter!)

islm1

We then have a business boom financed by loans which shifts private investment up, pulling the economy along. Note that net deposit creation is positive as more new loans are taken out than old loans are repaid. The private sector moves into more debt, the current account moves into deficit. The economy expands, GDP and employment go up.

islm2

At some point, the boom stops. Private investment collapses (for whatever reason), restoring the private sector’s traditional surplus (upper left). Net deposits are destroyed by loan repayment as the private sector deleverages (lower right). GDP falls as a result of less investment, the current account swings from deficit to surplus as GDP falls. (By assumption, the public sector’s balance is zero.)

islm3

In order to increase employment the government spends more, which allows the private sector to continue to be a net saver. The deficit is now with government. The current account is balanced. Since government spending does not crowd out private investment or increase interest rates there is no problem with this policy. Public debt is just the outstanding amount of tax credits that the government has injected into the economy in the past.

islm4

As you can see, the model and the macroeconomic MMT story fit quite well. We have some exogenous variables, for very good reasons. Some are endogenous and well-established. Who would doubt that with a rise in income the variables taxes, imports and consumption go up? Of course, what the actual relationship should be depends mostly on real world data. So, the numbers in the spreadsheet are not to be taken as carved in concrete!

Of course, there are things missing that need to be explained in more detail – like the role of inequality, the role of wage growth, the effects of an export strategy (China, Japan, Germany), Colonial monetary systems, the twin deficits (public and external sector), the role of inflation (turning and shifting that line in the SE quadrant), the role of monetary operations and policy and the legal origins of money, the connection to environmental sustainability, the role of digital currency, the effects of a Job Guarantee and a Green New Deal. The model presented so far is just the basic version – all these things can be thought about in terms of the model! (Obviously, not all issues have [significant] macroeconomic effects, but it is sometimes interesting to see why not – think about QE.)

Conclusion

I hope that it now clear why I believe that the IS/LM-model should be replaced and why my IS/MY model would be a good candidate to do that. I believe that this model helps students and scholars alike to better understand the economy. It definitely passes the market test as it explains the sectoral balances that, for instance, the chief economist of Goldman Sachs has been using for years. It includes the latest writings on endogenous money as published by MMT authors (I am deeply indebted to Randy Wray, Stephanie Kelton, Scott Fullwiler, Pavlina Tcherneva, Fadhel Kaboub, Warren Mosler and all the others!) and recently confirmed by central banks worldwide. There is no hiding of the fact that a government cannot go broke if indebted in its own currency and being supported by its central bank (like in Japan). Also, the discussion of balance sheets prior to looking at the macroeconomic model – this is basically where MMT comes in directly – provides realistic “microfoundations” (actually, a description of behavior of economic agents) of the economy.

I hope that in the area of simple, graphical models it is now also wrong to say: “There is no alternative”. There is!

(c) 2019 Dirk Ehnts (dirk@ehnts.de)

Posted by: Dirk | February 18, 2019

The Economist misrepresents MMT

I have read the articles that The Economist published on Modern Monetary Theory (MMT) in the current edition of the liberal-leaning magazine (here and there). I am not happy with the reporting, which includes false statements in general and also misrepresentations of what MMT is.

First of all, let me point out that MMT is not a “left-wing doctrine”, as claimed by the paper. Defining a doctrine as something that is taught, as the Merriam-Webster dictionary does, means that MMT is indeed a doctrine – but so is neoclassical (mainstream) economics. What I do not agree with is “left-wing”. MMT is a scientific theory about how money “works” – how it is created and destroyed, how it is spent and received and what follows from this.

In my own book on “Modern Monetary Theory and European Macroeconomics”, which was published by Routledge in 2017, I discuss the balance sheet approach to macroeconomics that MMT truly is. Focusing on the Eurozone, there is a lot of discussion of money creation, but there is nothing political in it apart from the usual presuppositions – that we want full employment and price stability. If somehow this constitutes “left-wing” politics then it is only fair to say that the current mainstream approach is “right-wing” politics – or is it not?

I think that The Economist makes a grave error when it mistakes a scientific theory, which is falsifiable, for a “left-wing doctrine” (that is not). We need to talk about what money is, where it comes from, what it does, and how it is destroyed. We need to talk about how it changes the way that people think and act. We need to discuss the legal dimension as well. All of this cannot happen as long as The Economist claims – wrongly –  that MMT is a doctrine.

The other issue that I’d like to point out is that there are many statements in the articles on MMT that are plain wrong or confused or made by people who have no authority. Take this paragraph, for instance:

Jonathan Portes of King’s College, London, points out that under mmt a country facing a combination of weak growth and high inflation, as Britain did in 2011-12, would require spending cuts rather than the increased stimulus called for by Keynes.

Who is Jonathan Portes? I have never heard of him. Given his statement I do not think that he understands MMT, so why would The Economist let him act as an interpreter for MMT? Couldn’t they find an MMT economist and ask them what MMT economists would have counseled in Britain in 2011-12? This statement construct an MMT straw man, and a clumsy one at best. “Under MMT”? MMT is not a policy regime, but a theory of how money works. The UK cannot be “under MMT” or “off MMT” since MMT is a description of reality and not a policy proposal.

Apparently, the writer believes that since neoclassical economics supports neoliberal society, the same must be true for other theories. That is wrong. Where neoclassical theory is normative – it tells you how things should be: free markets, no/little government interference, etc. – MMT is descriptive. Once you have understood how money works you will find that it should be much easier than you thought to attack unemployment and to achieve price stability, but that is not MMT.

You can build policy proposals using the insights of MMT, but then these are not “MMT”. They have “MMT inside” in that they rely on the framing of MMT. Policy proposals based on MMT include The Green New Deal, the Job Guarantee, the Euro Treasury and many more.

The last issue I want to raise has to do with the way the article misrepresents MMT. Here is a paragraph which covers what supposed is MMT:

Some radicals go further, supporting “modern monetary theory” which says that governments can borrow freely to fund new spending while keeping interest rates low. Even if governments have recently been able to borrow more than many policymakers expected, the notion that unlimited borrowing does not eventually catch up with an economy is a form of quackery.

MMT does not say “that governments can borrow freely to fund new spending while keeping interest rates low”. There is no MMT author that I know that has said something like this, and I have been around for ten years. There is no paper or book where you can find this, and I challenge The Economist to show me their source. If they can’t I accuse them of sloppy reporting and misrepresenting a scientific theory.

What is the problem with that sentence? That is very easy to answer: the framing. MMT economists know that the government does not have to borrow in order to spend and therefore does not “fund new spending”. Actually, it can’t even do it, even if it wants to. In a monetary system with a sovereign currency, which the UK has, the government just spends the money by crediting the account of the seller’s bank with reserves. This is the Bank of England’s job.

The Treasury has a publication which confirms this story.

5 Funding

5.1 The framework for public expenditure control

5.1.1 Most public expenditure is financed from centrally agreed multi-year budgets administered by the Treasury, which oversees departments’ use of their budget allocations.

There you have it: “Public expenditure is financed from […] budgets administered by the Treasury”. It does not say: Public expenditure is financed from bond issuance. It does not say: Public expenditure is financed from taxes.

So, in an enlightened world where science helps society to make the right choices, you would point out that government spending in the UK is not financed through either taxation or bond issuance. That is a technical insight that is falsifiable. The Parliament can ask the Treasury whether this is true or not and have it explained to the public if it feels like this is a good idea.

As John Maynard Keynes once said: “I give you the toast of the Royal Economic Society, of economics and economists, who are the trustees not of civilization, but of the possibility of civilization”. Whether a society is civilized depends, among other things, on the way that scientific debates are conducted. The Economist just put the UK debate on progressive economic policy on a slippery slope, claiming that a particular school of economics science constitutes “doctrine” and then misrepresenting that school’s views. They should know better than this.

Posted by: Dirk | February 8, 2019

Re: “MMT Sounds Great In Theory…But”

An article appeared this week which runs a critique of MMT. It is basically this (my highlighting):

MMT has a cost that we have yet to hear about from its proponents.

The value of the dollar, like any commodity, rises and falls as the supply of dollars change. <<< For instance if the government suddenly doubled the money supply, one dollar would still be worth one dollar but it would only buy half of what it would have bought prior to their action. >>>

This is the flaw MMT supporters do not address. MMT is not a free lunch. MMT is paid for by reducing the value of the dollar and ergo your purchasing power. MMT is a hidden tax that it is paid by everyone holding dollars. The problem as Michael Lebowitz outlined in Two Percent for the One Percent, inflation tends to harm the poor and middle class while benefiting the wealthy.

Our fear is that MMT, which promises “free college,” “healthcare for all,” “free childcare,” and “jobs for all” with no consequences, instead delivers inflation, generates further wealth/income inequality, and ultimately greater levels of social instability and populism. Just as has been seen in every other country which has run such programs of unbridled debts and deficits.

The claim that the government could suddenly double the money supply and that this would lead to a depreciation of 50% of the US dollar is theoretically unsound and empirically wrong. Let us have a look at the relationship of money supply (I use all aggregates that I can get) and real exchange rate (data from FRED):

Monetary base:

fredgraph-7

M1:

fredgraph-4

M2:

fredgraph-5

M3:

fredgraph-6

I think that you don’t have to be an economist or have done a PhD involving econometrics (economic statistics) to see that the claim “doubling the monetary supply decreases the dollar’s exchange rate by 50%” does not hold at all. While monetary supply goes up almost all of the time, the exchange rate swung back and forth. There does not seem to be any causal relationship at all. This is not a surprise: almost all scholars of economics point out that the trade-weighted exchange rate is influenced by interest rates and expectations of interest rates. Textbooks of international economics contain discussions of (uncovered) interest parity and other issues, but there is no textbook that I know of that claims that monetary supply drives “the” exchange rate. Given the empirical picture above it is quite reasonable.

The other “arguments” against MMT belong firmly into the territory of “monetary cranks”, so that I will stop here. MMT, right from the start with Warren Mosler’s 1997 paper “Full Employment and Price Stability” has addressed concerns of inflation. Also, MMT does not promise anything. It is that when people understand the way the monetary system works – and THAT is what MMT is about – then certain problems seem to have rather simple solutions.

Posted by: Dirk | January 7, 2019

Treasury Deposit Receipts (TDR) in the UK in 1940

This is from a paper by Geoff Tily in 2009:

In WWII Keynes and his HM Treasury colleagues devised Treasury deposit receipts that formalised processes for borrowing from banks. Howson is one of the few authors to discuss this vital tool of government policy:

The introduction in July 1940 of Treasury Deposit Receipts (TDRs), by which the major banks were obliged to lend directly to government added a new instrument to the floating debt, enabling the authorities to borrow on short term without either increasing the Treasury bill issue or having recourse to Ways and Means Advances. Of longer maturity (six months) than three-month Treasury bills and non-marketable, TDRs were less liquid than Treasury bills and carried a slightly higher interest rate (1 1/8%). This wartime expedient [14] was, as Sayers put it, ‘concocted . . . [so as] not to disturb the customary relationship [between banks, discount houses, and the Bank of England] and customary “ratios” of the peacetime [banking] system’, but it was nonetheless seen as a revolution in fiscal policy, at least in Labour Party circles … (Howson, 1988, pp. 252–3)

TDRs were quickly discontinued after the war, in spite of Keynes’s and HM Treasury’s recommendations to the contrary.

This is very interesting since apparently here the power balance between banks and the government was readjusted. It is a different arrangement from what the US did in WWII, where it was clear that “taxes for revenue are obsolete” (FRBNY chairman Beardsley Ruml). However, the logic is the same. You could just add some central bank deposits to the Government’s account and then it could spend. If your central bank won’t create them for you, you can force private banks to surrender their central bank deposits in return for more central bank deposits in the future – Treasury Deposit Receipts. I can imagine that the Bank of England was allowing banks to use the TDRs as collateral for borrowing.

For some reason, Amazon.com was selling the “Selected Essays in Economics” of Knut Wicksell and edited by Bo Sandelin (two volumes) for €7.51 per volume, so I had them shipped over to Germany. They arrived this morning and I went to read the book review of “The State Theory of Money” in volume II on pages 210-219 (Some pages are readable at Google Books, btw). It was originally published in Ekonomisk Tidskrift in 1907, two years after Knapp’s book.

Wicksell, very much concerned with the connection between the state of credit and the interest rate and, very importantly, the changes in the level of (consumer goods) prices, does not like that Knapp aims to have a fixed exchange rate as the ultimate goal. This is one of the instances of the debate of what anchors a currency: a fixed exchange rate or a stable domestic price level.

Nevertheless, Wicksell agrees with Knapp and ends with this: “it can probably be said that in terms both of its content and its form – though most of all its form, its refined dialectical style, the elegance which the brief account given above has only been able to hint at dimly – it is to be counted among the pearls of economics literature.

There is more on Wicksell and MMT in my working paper – written with Nicolas Barbaroux – published here.

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