The past three years have been a disaster for most Western economies. The United States has mass long-term unemployment for the first time since the 1930s. Meanwhile, Europe’s single currency is coming apart at the seams. How did it all go so wrong?Unfortunately, the class most at fault are academic economists like Paul Krugman. Because they do not understand basic accounting, and because they do not understand monetary operations, they push bad policy through the iron polygon of newspapers, government agencies, universities, and talk shows.
Well, what I’ve been hearing with growing frequency from members of the policy elite — self-appointed wise men, officials, and pundits in good standing — is the claim that it’s mostly the public’s fault. The idea is that we got into this mess because voters wanted something for nothing, and weak-minded politicians catered to the electorate’s foolishness. So this seems like a good time to point out that this blame-the-public view isn’t just self-serving, it’s dead wrong.
The fact is that what we’re experiencing right now is a top-down disaster. The policies that got us into this mess weren’t responses to public demand. They were, with few exceptions, policies championed by small groups of influential people — in many cases, the same people now lecturing the rest of us on the need to get serious. And by trying to shift the blame to the general populace, elites are ducking some much-needed reflection on their own catastrophic mistakes.
When people save money in a bank that money becomes "dead" because deposits do not fund loans. Quite the opposite -- loans create deposits. Since the demand for this dead money changes unpredictably, the Government must fund that desire by printing (and unprinting) money to maintain full employment and price stability. This is measured by the deficit. The US drained the private sector of its savings during the Clinton surplus, leading to an overleveraged population which remains out of money and work because Obama won't run sufficiently large deficits. Europe eliminated its ability to respond to this change in demand at all as it has no centralized currency issuer. And, when one realizes the entire point of private sector credit extension is credit analysis, most of Wall Street securitization becomes a sham -- these loans are better left on bank balance sheets as receivables than traded.
All of this came straight from the Ivory Tower, where Paul Krugman sits today trying to shift the blame to other people.
I do not know what you mean by deposits becoming dead, something you have used often.
ReplyDeleteWhile loans make deposits, it doesn't mean banks don't look for funding or anything like that. Securitization is not only one form of funding, its a "Reg Arb".
People not only "save" in deposits, they save in government bonds, corporate bonds and ... equities as well (including abroad)!
So imagine you are a national accountant. You calculate the difference between income and expenditures and call this "Net Lending" and figure out how you lent the other sectors .. currency, deposits, bonds, equities etc (in more detail figuring details of Net Acquisition of Financial Assets and Net Incurrence of Liabilities) ... actually verify that Net Lending is equal to the difference between income and expenditure.
Why the above ? ... the private sector doesn't just demand deposits ... it has a propensity to save and saving in the form of deposits is just one part.
Ramanan: You're correct of course, banks do seek deposits as it lowers their cost of capital etc.
ReplyDeleteHowever, the standard narrative for bank deposits is that "when people stop spending and put more of their money in the bank, the bank then has more to loan out" and this simply isn't true.
People "save" (loose definition) in lots of ways -- to your list I would add gold, land, family business (especially abroad!) etc. But in the US, and in the present time, deposits dominate. Thus my focus on them.
Plus of course at macro level if one person saves in gold, then the person that had the gold before now has the cash. Nothing new was created as the gold already existed.
ReplyDeleteWhereas the act of deferring consumption 'creates' savings in the current period.
> economists like Paul Krugman. Because they do not understand basic accounting
ReplyDeleteI would go farther. While I am not fully convinced that I'm right, I am increasingly coming to the conclusion that economists (with the possible or even likely exception of MMTers), *don't know what money is.*
Which means they don't understand credit and debt, or wealth.
Those are pretty damning statements, for a "discipline" whose central focus is money.
Even MMTers, as far as I can tell, haven't worked out a fully coherent view of money, credit, debt, financial assets, and wealth, in their relationship to real assets (in the widest sense of assets). But I think they're getting closer than anyone has over 300 years trying to model economies as barter systems, with faulty models of money/financial assets loosely bolted on.
My intuition is that the disconnect relates to utility -- how the human value of real assets is mapped to money/financial assets.
Representative agent models have completely punted on this, of course, by assuming all agents have the same incomes/wealth and/hence the same utility functions. (The efforts to overcome this have all resulted in self-contradiction.) But even MMTers have a good deal of conceptual/accounting work cut out for them here.
But at least they understand that money is credit. I'm not sure they've fully grasped that all financial assets are as well, even though they've clearly stated that the only way to "save" or "store" money is by lending it.
I agree with Ramanan. Debt (and therefore saving and borrowing) pre-dates money as a social construct therefore how a deposit which is undeniably a 'saving' can be 'dead' in any meaningful sense I cannot understand.
ReplyDeleteWhile I agree with MMT analysis for the most part I cannot make the leap to agree with the prescriptions which follow.
Its all very 'left brain'. I would like to see the MMT folks dispense with the accounting for a post or two and address their theories to a hunter gatherer tribe putting something by for winter.
Hunter gather tribes don't use fiat money.
ReplyDeleteIt is the existence of an intermediate form that causes all the fun.
If you want a theoretical world without money and government then the Austrians have all the theories you need.
"But at least they understand that money is credit. I'm not sure they've fully grasped that all financial assets are as well, even though they've clearly stated that the only way to "save" or "store" money is by lending it."
ReplyDeleteI've made exactly the same point to the MMT crowd before and been quickly shown the door.
Given that debt predates money, all money must have been manufactured from debt of some kind. Fiat money is made by declaring taxpayers to be in debt and then issuing some means of paying that. So fiat money is collective debt.
But the MMT implication seems to be that fiat money issuance is in fact cost free...
"But the MMT implication seems to be that fiat money issuance is in fact cost free.."
ReplyDeleteIn the sense that it never has to be paid back in full, it is cost free. When the govt runs a deficit, taxes less than it spends, it is permitting you to keep some of its scrip. You never have to pay it all back. There is never a time that the govt must have no debt or no deficit.
Doesn't matter, the fact that some of it must be paid back creates a debt obligation at the point of issue.
ReplyDeleteWe don't look at the stock of private debt and imagine that somehow all of it needs to be paid back and so conclude its not debt do we?
Why the difference in treatment here?
Sorry, that should have read:
ReplyDelete"We don't look at the stock of private debt and because we can see not all of it needs to be paid back and therefore conclude its not debt do we?"
Fiat money needs to originally come from *somewhere*, and that somewhere is the currency issuer.
ReplyDeleteThe currency issuer must run negative equity so (in aggregate) currency users can run positive equity.
All private debts dont need to be paid back?? Since when? Many are NOT paid back thats for sure but the expectation is there from the start that they will be repaid. No one enters into a private debt contract otherwise.
ReplyDeleteTheres a difference in treatment of govt and private debt because they are 180degrees apart from the standpoint of the private citizen.
Greg, In aggregate we never expect the total **stock** of private debt (basically Mn - M0) to be paid back in full do we?
ReplyDeleteIn the same way, we don't expect the total stock of the public debt to be repaid, because we expect the issuer to re-issue tax receipts.
Therefore there is no difference in essential form between the two.
"Fiat money needs to originally come from *somewhere*"
Yes, it comes from the DEBT created as a result of tax and/or legal tender laws. And there need not be negative equity if the value of the public goods and service provision were properly accounted for.
liminalhack: sorry, let me be more exact.
ReplyDeleteBy "equity" I mean net financial assets (equity). For one sector to run a positive net financial assets (equity) balance, some other sector must run a negative net financial assets (equity) balance. The non-govt sector runs a positive balance (which makes sense).
Yes I understand that. So the govt sector has a liability permanently to the private sector. However on the asset side they have their taxpayers.
ReplyDeleteThe future value of taxes due ought to result in an asset that offsets the net financial liabilities to the private sector. The NPV of future tax flows can be used to calculate the value of that asset in the same way a loan asset belonging to a commercial bank is valued can it not?
As to whether that produces a net positive equity for the public sector is another question, but I can't see any reason public sector assets that are comprised of future tax flows would not be incorporated in the MMT accounting.
What is the reason for that, if I may ask?
liminalhack: taxpayers are certainly an asset, but they are not (strictly speaking) a financial asset. Their labor is a real asset, but that's not what we're talking about.
ReplyDeleteThe future "value" of taxes should not equal the (negative) net financial assets (equity) position of the Govt sector unless one assumes that the Govt wants to zero this out in the future. Why the Govt might want to do this is exactly the point of this discussion, so to assume it is begging the question.
The MMT position is that since this negative equity on the Govt side represents the positive equity "capitalization" of the non-Govt sector, there is no reason why the Govt should ever want to zero it out because of the very negative impact it has on real output.
Financial Asset="An asset that derives value because of a contractual claim. "
ReplyDeleteIn which case there is an argument that future taxes due through a contract with the state are certainly a financial asset. I'm not sure exactly why you think future tax flows are not financial-asset-worthy.
"The future "value" of taxes should not equal the (negative) net financial assets (equity) position of the Govt sector unless one assumes that the Govt wants to zero this out in the future. "
Agreed. But I am saying that that negative net financial asset position of the govt sector is in fact in practice balanced by two things:
1) future tax flows
2) the book value of all other government assets. How one values these is problematic, but they are assets that can be accounted for even though they are not financial assets.
In order to restore aggregate demand for example a government could just add liabilities to its balance sheet increasing its "net negative equity", or it could for example just buy unwanted assets from the private sector which could include real estate, bank loans, equities or whatever. The former of these practices definitely decreases public sector equity and the latter may actually increase it over time.
Deciding which of the two is preferable would require some practical theory of the implications of the actual (is in, every public asset accounted for) equity position of the public sector.
You can't say that equity position doesn't matter, because clearly a govt with a good base of schools, roads, forces, institutions and so on, has a far greater equity position than one that doesn't.
Public equity matters, because when it dwindles and decays we know what happens don't we?
liminalhack: Investopedia may not be your best source for a strict definition of a "financial asset". I would suggest that a financial asset is an asset that has an offsetting liability. This distinguishes it clearly from a real asset (that has no offsetting liability) and, most importantly, makes the underlying accounting logic clear. Being clear in the accounting rules is important to understanding the monetary system.
ReplyDeleteThe government need not add liabilities to its balance sheet to increase its negative NFA (equity) position, it could also book a contra asset. The point though is that for the non-Govt sector to have a positive NFA (equity) position, the Govt sector *must* have a negative NFA (equity) position.
Roads etc. are all certainly important, but they aren't financial assets, nor do they become financial assets if you assign some sort of book value to them.
Thanks for the reply. Let me make it quite clear that I am not disputing the need for govt to run a net -ve NFA position. What I am questioning is why you would view the govt as a pure financial entity when it is clearly not.
ReplyDeleteMost corporations (or indeed most households) will have an asset base comprised of both financial and non financial assets, and there is no problem in accounting for both to determine the company's overall equity position.
The government is not any different in this regard. In fact even financial sector companies have physical assets on their balance sheet like their premises of work.
On this basis then, we could in theory calculate the net equity position of the government, taking all its liabilities and all its assets - financial and otherwise into account. Now this net equity position may or may not be negative, but what I am trying to get at is what MMT can say about the net equity position of the entire public balance sheet. Do you think it matters, or not? If not, why not?
liminalhack: I'm not sure why you think I view the Govt as a purely financial entity.
ReplyDeleteIt does have a unique (and purely financial) role as the monopoly issuer of currency, and in this role, it needs to run a negative net financial asset (equity) position of the appropriate size. Right now it is not.
This is causing a real and material harm to the real assets and people who live under that Government.
I cant understand why you think there would be any value to doing the calculations you ask for in regards to the government.
ReplyDelete"This is causing a real and material harm to the real assets and people who live under that Government."
ReplyDeleteOh, I agree, like I said above. I agree with most of you MMT guys on most things, including the natural rate etc etc.
But to run the appropriately sized -ve NFA position, it can just credit bank accounts (or if it really must, do this disguised as "debt issuance", wink wink),
OR
it can buy assets from the private sector.
Which is the best of the two choices, and why? Perhaps its best to consider this question in the theoretical scenario in which all the outstanding government bonds have been monetised, which I believe is the ideal MMT scenario.
liminalhack: I would frame the two options in a different way.
ReplyDelete1. Crediting bank accounts *is* buying private sector assets, as, when the Government buys a private sector asset it pays by crediting a bank account.
2. It can debit bank accounts less (lower taxes).
Which is the best of these two choices is beyond MMT, although some MMTers like Government spending (in the form of an Employer of Last Resort program) others prefer something like a payroll tax holiday.
"Crediting bank accounts *is* buying private sector assets, as, when the Government buys a private sector asset it pays by crediting a bank account."
ReplyDeleteNot if what's being bought is labour, or what is being payed is social transfer payments. No, I'm specifically talking about buying income generating assets only.
Sure, the -ve NFA position can be increased by "unfunded" tax cuts, or by increasing "unfunded" benefits payments or through some job scheme, but an identical outcome can be achieved by buying income earning assets off the private sector.
There is a huge difference in principle between the two, and which of the two is the right option could only be answered by having some theory or model of the economic implications of the public sectors net equity position (e.g. including net financial and non financial assets and liabilities).
I appreciate you taking the time to answer these, BTW.
liminalhack: Governments credit bank accounts when they buy labor. Every government employee, or contractor, is paid for their work. The government pays them by crediting their bank account. Similarly, whenever anyone clears a SS cheque, the Government credits their bank account the same way.
ReplyDeleteAll (Fed) government spending is money creation (via crediting bank accounts). All (Fed) government taxation is money un-creation (via debiting bank accounts).
The -ve NFA position is simply the federal deficit (or national debt -- depending on whether you're looking at the stock or flow). I don't think the bigger government question can be answered by understanding this accounting identity.
I agree with all your points, and the final question posed, with one exception.
ReplyDeleteThere is the issue that if we don't consider the offsetting assets of public sector liabilities, then it is non-sensical to talk about public sector liabilities as a matter of financial accounting, which I think is the achilles heel of MMT.
While I think I agree that the answers to the questions I have raised can't be answered purely by recourse to accounting (how do you value an aircraft carrier and its capability or the value of education?) I think it's about time MMT at least acknowledged this key question, at least from a socio-economic POV.
Given that MMT is predicated on measurement of sectoral financial balances (and thus offers a sensible analysis when compared to traditional macro) its still very left-brain, concerned with models, abstractions and numbers.
If the answer to "the bigger government question" can only be answered by right brain intuition, then its time IMO to admit that and start to tackle that problem, or alternatively propose a more specific format in which it can be modeled and analysed in the absence of specific political assumptions of value judgements. Either way, MMT scholars should have a clear position.
I suspect that once again, Japan will start to provide some empirical insight to help with this, because it can't be long before some inflation (not hyperinflation, just the kind you would expect as a result of a long gentle contraction) returns to those shores.