Posted by: Dirk | September 2, 2015

The International Panel on Social Progress

The International Panel on Social Progress (IPSP) is a new attempt at saying something about the social and economic problems of today without relying exclusively on today’s economics. It seems a very interesting project and I am looking forward to see some of their chapters. The IPSP describes themselves in the following:

The International Panel on Social Progress (IPSP) will harness the competence of hundreds of experts about social issues and will deliver a report addressed to all social actors, movements, organizations, politicians and decision-makers, in order to provide them with the best expertise on questions that bear on social change.

The Panel will seek consensus whenever possible but will not hide controversies and will honestly present up-to-date arguments and analyses, and debates about them, in an accessible way.

The Panel will have no partisan political agenda, but will aim at restoring hope in social progress and stimulating intellectual and public debates. Different political and philosophical views may conceive of social progress in different ways, emphasizing values such as freedom, dignity, or equality.

The Panel will retain full independence from political parties, governments, and organizations with a partisan agenda.

While the Panel will primarily work for the dissemination of knowledge to all relevant actors in society, it will also foster research on the topics it will study and help to revive interest for research in social long-term prospective analysis.

IPSP includes some economists like Sen, Arrow and Atikinson, but it seems that a more united social science front has been formed. Over at Crooked Timber one can find some impressions of the latest meeting in Istanbul.

Posted by: Dirk | September 1, 2015

Chocolate coiner or green shirter?

The Federal Reserve Bank thinks about moving interest rates up – or doesn’t it? The NYT reports:

Conservative activists who want the Federal Reserve to raise interest rates distributed chocolate coins in golden wrappers at the local airport last week as Fed officials arrived for their annual policy retreat.

Liberal activists in green “Whose Recovery?” T-shirts formed a receiving line at the resort hotel in the heart of Grand Teton National Park where the meeting was held, to personalize their argument that the Fed should wait.

The quick&easy answer to the question of moving interest rates up is a look at the chart depicting the civilian employment to population ratio:


Everybody on board? No, apparently not – some people who had been employed before the crisis still haven’t found a job. Hence, inflation is very unlikely to show up, since employers know that there is a lot of (hidden) unemployment out there and will be able to keep wages rising only very slowly. Count me as a liberal activist in this one. (Given that inflation is low – see chart below.)


Such is the title of Tianhao Zhi’s recent paper. Zhi sums up MMT like this:

core mmt

A quick read seems to show that Zhi is mostly fair to MMT. There are the usual claims about MMT as a theory would ignore the inflationary effects of government spending, but the claim is repeated once again without a source. Wray (2012) in his MMT Primer writes on page 194: “Lerner realized that this does not mean that government should spend as if “sky is the limit” – runaway spending would be inflationary (and, as discussed earlier, it does not presume that government spending won’t affect the exchange rate).” The book by Wray has the word “inflation” in the index, and it comes up 27 times. If I am not mistaken, there is no text passage that says that the inflationary effects of government should be ignored.

The second section of the paper discuss the “loans create deposits”-story, which has recently been backed up by the Bank of England. The third section deals with the central bank setting the interest rate by varying the amount of reserves, which is only one possibility, by the way (the other being arbitrage by banks themselves that guides them towards the target interest rate). It is assumed that the central bank is exchange rate targeting, which something that MMT explicitly does not assume.

Section four is on “crowding in” of government spending, that is, the the fall in the interest rate that would normally occur with an increase in government spending. That it does not happen in the real world is understood by MMT authors, since central banks are able to set (most often short-term) interest rates. Zhi assumes here that having more reserves, the banks can extend more credit. This rests on the reserve requirements fallacy which assumes that banks need reserves before they extend loans. In reality, banks need them afterwards and can get them from various sources. Since the author is from China, where reserve requirements are used as a policy tool, I can understand that it might sound crazy that reserve requirements do not have any effect on lending. However, most economists – both MMT and non-MMT – agree that there is no effect (see this book).

Section 5 is a scenario which applies the money multiplier denied by MMT to a purchase of a bond by government and hence comes to alternative conclusions which are based solely on the existence of a money multiplier and the idea that banks need reserves to make loans. Section 6 builds on the same framework and concludes that government should spend until inflation increases. This is something many MMT authors would probably not reject as a practical policy.

In his conclusion, Zhi says #1 that government deficits can lead to more demand for reserves if the fall of the interest rate triggers loan creation. This is not refuting MMT in any way, I assume most MMT authors would be in agreement. #2 will lead to disagreement, since for Zhi only fiscal deficits have a long-run influence on growth (that one is interesting!) and inflation. #3 is once again not a refutation, since Zhi want government spending to increase to the point of inflation (using marginal terminology). I guess that #1 and #3 would find him in agreement – more or less – with MMT, so only #2 would be an original point of disagreement.

Since the paper is well-written, I hope that it triggers some more debate on the claims of MMT.

The ECB in its dealings with Greece was giving emergency liquidity assistance to the Greek banking system. Here is a typical ECB press release concerning this issue:

ELA to Greek banks maintained

6 July 2015
  • Emergency liquidity assistance maintained at 26 June 2015 level
  • Haircuts on collateral for ELA adjusted
  • Governing Council closely monitoring situation in financial markets

The Governing Council of the European Central Bank decided today to maintain the provision of emergency liquidity assistance (ELA) to Greek banks at the level decided on 26 June 2015 after discussing a proposal from the Bank of Greece.

ELA can only be provided against sufficient collateral.

The financial situation of the Hellenic Republic has an impact on Greek banks since the collateral they use in ELA relies to a significant extent on government-linked assets.

One of the big questions is about collateral. I would argue that the Treaty of Lisbon contains a clause which should be interpreted as a lender of last resort clause. Article 127 says (my highlighting):

1. The primary objective of the European System of Central Banks (hereinafter referred to as “the ESCB”) shall be to maintain price stability. Without prejudice to the objective of price stability, the ESCB shall support the general economic policies in the Union with a view to contributing to the achievement of the objectives of the Union as laid down in Article 3 of the Treaty on European Union. The ESCB shall act in accordance with the principle of an open market economy with free competition, favouring an efficient allocation of resources, and in compliance with the principles set out in Article 119.

2. The basic tasks to be carried out through the ESCB shall be:

– to define and implement the monetary policy of the Union,

– to conduct foreign-exchange operations consistent with the provisions of Article 219,

– to hold and manage the official foreign reserves of the Member States,

– to promote the smooth operation of payment systems.

I would argue that the promotion of smooth operation of payment systems, as a basic task, has to take priority over other concerns. That means, if the payment system in Greece only works if Greek sovereign bonds are seen as riskless collateral and the ECB can make it so (through QE or OMT or “whatever it takes”), then article 127 says it has to do that.

Blackmailing the Greek government/banks by threatening to withdraw liquidity support to me seems like a misreading of the primary objectives of the central bank. They way it was set up it was supposed to be independent from politics, and not an instrument to support Germany’s drive to impose austerity on countries that are in crisis. Whatever one thinks of central bank independence, but the political use of the emergency liquidity assistance would constitute a break with the spirit of the European System of Central Banks.

The New Yorker had an article on Matteo Renzi – the Demolition Man, they called him – in late June. Towards the end, there is an enlightening passage about the intellectual problems of the German political elite:

Monti told me that, when he was Prime Minister and visited Barack Obama at the White House, Obama admitted to being at a loss to know “how to engage Merkel on matters of economic policy.” Obama asked his advice, and Monti replied, “For Germans, economics is still part of moral philosophy, so don’t even try to suggest that the way to help Europe grow is through public spending. In Germany, growth is the reward for virtuous economics, and the word for ‘guilt’ and ‘debt’ is the same.”

It is correct to say that ‘Schuld’ means both guilt and debt in German. Sadly, it is also correct “that For Germans, economics is still part of moral philosophy”. Well, probably I would argue that the “still” there is misplaced. German economics was in a much better state during the 1950s and 1960s, perhaps through the 1970s. However, the rise of monetarism seems to have been stronger in Germany compared to other countries and that means that macroeconomics has suffered to the point where one side basically says that it does matter for GDP how much purchasing power the public holds. Supply creates its own demand, and if it doesn’t, your wages are too high.

That theory used to be called neoclassical theory and it failed in the Great Depression. It also failed in the last crisis but the zombie keeps walking because … that is a really good question. I guess that the problem in Germany is that the academic scene is more monolithic than elsewhere. Also, politicians apparently bet on the wrong horse and now are trapped with the economic advisors that got them into the mess. Admitting mistakes is something which is difficult anywhere. Especially if you ruin a couple of decades of European integration built on consensus and peace and replace it with economic ruin and nation-against-nation rhetoric.


Whatever the words from the ECB, quantitative easing was all about lowering the exchange rate of the euro. Why? Because aggregate demand falls short in the euro zone, way short. With 11% unemployment – now rising again – and an increase in government spending taboo, mostly because of German policy makers not understanding the fundamental importance of the role of demand, government spending and the monetary circuit, Draghi has tried to provide some help in the form of a lower euro. He also proved that the ECB buying up sovereign bonds does not lead to hyperinflation, by the way. As I have commented before, the euro zone is too big to be able to devalue itself out of a demand problem.

So, it was no surprise that China – which fixes its RMB against the USD – started to experience problems. A weaker euro is a stronger dollar is a stronger yuan, as Bloomberg reported three days ago:

China’s exports declined more than expected in July, hobbled by a strong yuan and lower demand in the European Union, and adding pressure on Premier Li Keqiang to stabilize growth.

Overseas shipments fell 8.3 percent from a year earlier in dollar terms, the customs administration said. The reading was well below the estimate for a 1.5 percent decline in a Bloomberg survey and compared with an increase of 2.8 percent in June. Imports dropped 8.1 percent, widening from a 6.6 percent decrease in June, leaving a trade surplus of $43 billion. It came despite a few bright spots, including the highest monthlysteel exports since January.

The Chinese authorities reacted today and devalued the RMB by 2% against the USD, the NY Times reports:

The central bank set the official value of the renminbi nearly 2 percent weaker against the dollar. The devaluation is the largest since China’s modern exchange-rate system was introduced at the start of 1994.

China’s abrupt devaluation is the clearest sign yet of mounting concern in Beijing that the country could fall short of its goal of roughly 7 percent economic growth this year.

The euro zone, by trying to beggar their neighbors – US and China, which form a dollar zone that has been doing much better than the euro zone – has triggered a currency war. In a world economy with insufficient demand, all countries try to secure market shares for their exporters by lowering the nominal exchange rate. This, obviously, is a zero sum game, so countries only gain if other countries to not react to devaluation with a subsequent devaluation of their own currency.

Since governments that care for their people in terms of employment will not let unemployment rise just because another country decided to devalue its currency, this strategy often fails. Especially so if there is no formal or informal agreement. The current non-system of global monetary matters now comes back to haunt us. Some exchange rate coordination would surely be preferable to a full-blown currency war. It will be interesting to listen to the comments following today’s policy change.

When I speak to other economists about how money and fiscal spending work, I often get strange looks: if what I say is true, than economists would have taught something that is wrong for the last couple of decades! That must be impossible. If I could name some historical sources to back up my claims? For the description of endogenous money I then refer to Knut Wicksell (and Irving Fisher), and when it comes to the deficit and public debt I refer to Abba Lerner’s Functional Finance. Now I have an even better source: non other than Richard Musgrave, the grandfather of public finance! Here is a paragraph from his 1959 book “The Theory of Public Finance” (International Student Edition), page 582:

Criteria of Policy

The government is never forced to borrow in the market or to maintain and service outstanding debts. There is always the option of monetizing the debt, that is, of printing money and purchasing the outstanding obligations. Whether this is done outright or through the open-market operations of the central bank need not concern us now. For purposes of the discussion, both central bank and Treasury are considered integral parts of one and the same public policy. If it is decided not to monetize the debt, there should be a good reason, since the servicing of the debt involves a cost to the government. This cost must be looked upon as the price paid for persuading people not to spend on consumption or private investment but to tie up their funds in the purchase of public assets. This purchase of nonspending, or illiquidity, serves to avoid the inflationary increase in private expenditures that could result if the debt were turned into money. It is this purchase of nonspending, or illiquidity, that is the crux of debt policy.

This, I think, is very enlightening. More than fifty years ago, students were informed in a completely different way about the mechanics of government debt. Today’s books are full of arithmetics, providing students with some “hard science” to calculate “sustainable” debt. Musgrave knew, and I am very sure that this is still true, that “government is never forced to borrow in the market or to maintain and service outstanding debts”.

Economics then has been in intellectual decline, probably for at least some decades. I am talking about the theories of money and public finance, which are at the core of economics. There has been some progress at the periphery, but the core is definitely rotten. It is time for a new generation of economists to provide a modern economics that integrates the insights of the past that are still important. There are many broad shoulders to stand on!

In a recent paper by Sylvie Rivot titled Rule-based frameworks in historical perspective: Keynes’ and Friedman’s monetary policies versus contemporary policy-rules (link to paper) I found this very interesting paragraph:

The precise target imposed upon monetary authorities depends on the particular institutional setting in which the rule applies. Friedman’s point is that the complex and fractional reserve system might impede the central bank’s ability to control the total stock of money. As early as 1948 and in 1959, he calls for a 100% reserve requirement for demand deposits to avoid the endogenous creation of money, a procedure whereby ‘the total of money and of high-powered money would then be the same’ (Friedman 1959). The instability of the total stock of money due to changes in the forms in which the public holds money (i.e. currency or deposits) would be eliminated. Open-market operations would be the key instrument used to achieve this target. Later Friedman (1984) abandoned the 100% proposal and then advocated contemporary reserve accounting instead of lagged accounting, whatever the type of deposit.

This is very interesting because there are contemporary movements that have the same ideas. History of economic thought is a very important field because many debates of the past provide a good starting point or at least some perspective for contemporary debates. In footnote 35, Sylvie Rivot present the view of Keynes on the issue of reserves management – or control of the monetary supply, as Friedman would put it:

He does not believe that ‘the rules of wise behaviour by a central bank could be laid down – having regard to the immense complexity of its problems and their varying character in varying circumstances – by Act of Parliament’ (Keynes [1930] 1971, p. 234). Quite the contrary: ‘it would be much better to leave the management of the reserves of the central bank to its own unfettered discretion than to attempt to lay down by law what it should do or within what limits it should act’ (Keynes [1930] 1971, p. 243).

There is an article in the Financial Times from March 9th, 2010 (ht to Jasper Sky). Under the headline ‘Germany’s eurozone crisis nightmare’, Martin Wolf sums it up nicely:

Ever since the federal republic was founded, Germany has had two over-riding strategic objectives: sound money and European integration. These were the twin imperatives learned from the calamities of the early 20th century. The euro embodies these aims. Now they conflict with each other. […]

Greece is a special case. Today’s fiscal excesses are not the result of fiscal indiscipline, but of private indiscipline. The latter, moreover, was an inherent element in the workings of the eurozone itself. It is how the eurozone economy balanced, at a reasonable level of overall demand, in the pre-crisis period.

The point is best understood from the financial balances of eurozone members in 2006, before the crisis, and 2009, at its height (see charts). […]

Germany is in a trap of its own devising. It wants its neighbours to be as like itself as possible. They cannot be, because its deficient domestic demand cannot be universalised. As another great German philosopher, Hegel, might have said, the German thesis demanded a Spanish antithesis. Now that the private sector’s bubble has burst, the synthesis is a eurozone fiscal disaster. Ironically, Germany must become less German if the eurozone is to become more so.

It is very obvious that in August 2015 the vision of Martin Wolf has come true. The eurozone is stagnating, unemployment rises again. Deficient domestic demand is the main problem. Wolf, of course, was not the first and not the only one to bring forward these arguments. Many economists predicted that austerity policies would be disastrous, that sovereign debt and government spending were not the cause of the crisis, and that because of accounting Germany’s “model” of wage suppression and low government spending cannot be exported.

To those who say that the economists are to blame I would reply that this is not correct. Some economists, who got us into this mess, are surely to blame. However, there have been alternatives from the start of the crisis onwards. It seems to be a political problem rather than an economic problem. Many people invested a lot of time joining or building networks around the idea that less government and more market is always better. Now that they found out he hard way that this is an ideology they are uncomfortable.

Change in economic thinking will come from new and young economists (and politicians), not from the old garde. Five years after the article by Martin Wolf, they are still believing in “sound money”, even if it means mass unemployment for some Europeans. As Keynes said, “Practical men who believe themselves to be quite exempt from any intellectual influence, are usually the slaves of some defunct economist. Madmen in authority, who hear voices in the air, are distilling their frenzy from some academic scribbler of a few years back”.


Thomas Mayer, formerly at Deutsche Bank, has written a letter to the FT:

The two key founding fathers of economic and monetary union, France and Germany, have a different understanding of what kind of game the currency union is. France has a chartalist understanding of money as a state-issued IOU. In the chartalist understanding, the sovereign may delegate money issuance to a central bank but remains the master of money. Sovereign default in the sovereign’s own money is an oxymoron. Germany, on the other hand, views money primarily as a means of exchange and store of value for private entities. If it is not tied to a commodity, such as gold, it must be issued by a central bank operating like an intelligent gold mine. In a virtual commodity money standard, sovereigns can of course default.

I think that Mayer is not the first one to understand this difference of approaches. Since he sums it up nicely, the question then is how to move on. The Germans (there are exceptions to the rule, of course) have shown that they don’t mind having mass unemployment in the European periphery. The market, they believe, will fix it. If it is not fixed, it must be the people – government – that do not allow the market to work. In the latter case nothing can help them.

The enlightened view is the French one, which sees both demand and supply as potential problems of macroeconomic management. The realization that employment depends on demand and that parts of demand depend on creation of net debts provides a completely different angle. Debts are not bad per se, but are acceptable if the outcome in the real world is improving welfare, however defined. The political process should define what public spending and public policies are acceptable, not restrictions on government spending and deficits.

Europe, it seems, has reached a point at which two points of view have emerged that both claim to further European integration. The pro-euro camp believes (or says) that without the euro Europe will fail. The anti-euro/reform the euro camp believes that with the current arrangements Europe will fail. Meanwhile, as the Eurostat reports, unemployment in the eurozone is on the rise again:


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