No, You Should Not Take What John Cogan and John Taylor Write in the Wall Street Journal Seriously Until They Even Try to Explain What They Got Wrong in 2009. Why Do You Ask?
No, John Taylor's Piece Doesn't Say What Taylor Says It Says: Noah Smith to the Rescue! Weblogging

Is There Still a Demand for Even More Modern Monetary Theory Weblogging?

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Sigh. This morning was supposed to have been spent outlining the inner logic of the perspective of today's Austerians. It wasn't. It was spent thinking about MMT.

My lack of self-discipline is depressing. It is particularly so because, as Paul Krugman says, this is not an argument to be having now. Right now the question of how the government budget constraint binds in a floating-rate fiat-money economy in which government debt is perceived as a highly valuable safe nominal asset is a question of interest only to schoolmen. There are other questions that are much more important to deal with--like why John Taylor thinks that Europe's taxes must have turned it into an impoverished hellhole...

OK. Let me try to lay out what the differences are…

When people like Paul Krugman or me read the writings of, say, Warren Mosler, we tend to focus on statements like "a government that can print its own currency can never be forced into default", and "if government bonds find no buyers, that simply means that instead of lending the government money and a positive nominal interest rate the banks are holding excess reserves and constructively lending the government money at zero", and that the government is not constrained by its budget because "the deficit can present no financial risk.

The underlying gestalt we get from things like Warren Mosler's Soft Currency Economics is this:

  • The government spends what it wants.
  • The government pays for it spends by creating reserve deposits.
  • The government then faces two technical financing decisions: (i) how much of the zero-nominal interest rate government debt that are reserve deposits does it wish to transform into interest-bearing government debt? and (ii) how much of its reserve deposits does it want to to extinguish via taxation?
  • But these are technical government financing decisions: they don't carry with them real constraints on what the government can spend when.

Each individual sentence is certainly correct. But the entire gestalt feels wrong. It is certainly the case that, at least until we reach the top of the hyperinflation Laffer curve, the government can always spend more in real terms and pay its creditors by creating reserve deposits out of thin air. It is certainly the case that these reserve deposits created can then, at the governments option, be either left to live, extinguished via taxation, or transformed interest-bearing taps of the government.

But it is also the case that in the long run the governments spending has to be balanced by the government's taxes, with two qualifications. (1) The first qualification is that the tax on real money balances that is inflation must be included in the government's tax accounting. (2) The second qualification is that if we are in the peculiar situation in which the real rate of return on government debt is and is certain to be less than the growth rate of the economy, the government can finance its spending by engaging in the highly profitable business of banking--of getting people to pay it real resources to carry their purchasing power forward in time.

The true knowledge is, I think, to maintain a proper balance between these two perspectives--the government-can-never-run-out-of-money perspective and the government's-books-must-balance perspective--and to understand how they complement each other.

From Paul's perspective, the Austerians who shriek about how the US is about to become Greece have no understanding of how the money systems and government debt actually work in the real world.

But, also, from our perspective, the MMT folks are under strong suspicion of heresy for failing to acknowledge that the resources the government deploys cannot always be manufactured out of thin air, but (sometimes) involve real allocations of scarce resources to alternative uses.

For example, things that seem off balance:

L. Randall Wray:

[M]y inquiring mind wants to know why Brad is worrying about “funding” tax cuts…. Here I only examine the notion that you must “pay for” tax cuts by either higher taxes or lower spending…. No analogy is perfect…. Economists often use a bathtub analogy to explain stocks and flows: water runs into the bathtub from the faucet (in-flow) that fills the tub (stock), so long as the water running out of the drain (out-flow) is less than the water running into the tub. If we plug the drain, the water stops running out—so the in-flow fills the tub. Brad wonders how do we “fund” the reduced outflow? I think that is a nonsensical question. Now, he might instead have wondered: what do we do when the tub is full? Would it then make sense to open the drain, or to slow the flow from the faucet? Sure. But how is that “funding” the previously reduced outflow during the period in which we closed the drain?

My answer, IMHO, is that reducing the outflow--lowering tax collections--means that that date is closer at which the tub is full and we have to either open the drain (i.e., raise taxes) or slow the flow from the faucet (cut spending).

Randy continues:

Makes no sense to me…. Tax cuts today cannot be “paid for” later by tax increases or spending reductions. There could come a time in the future when we decide that aggregate demand is too high--perhaps sparking inflation. At that time we might raise taxes, or cut spending, or stimulate more production, or use non-price rationing, or institute wage and price controls, or… who knows? But if and when we take those actions, they do not “pay for” today’s tax cuts…

To this my response is: yes they do.

Cutting spending in the future when you would not otherwise have done so is paying for today’s tax cuts. Raising taxes in the future when you would not otherwise have done is is paying for today’s tax cuts. Introducing non-price rationing to diminish aggregate demand--as a way of telling people: “You know that money you loaned us and we promised to pay back with interest so that you could then spend it? Well, guess what? You can’t spend it!”--is paying for today’s tax cut with a rather sneaky future tax, and so are wage and price controls, and so is the implicit tax on holdings of government debt via explicit inflation, and so is the implicit tax via financial repression.

Now the terms on which you pay in the future for today’s tax cuts are wildly variable. It is the business of fiscal policy for the government to be a good steward for taxpayers and set things up so that the terms on which the government pays for what it does are as attractive as possible. And there certainly are times—like right now—when at the margin at least it looks as though additional government purchases are at least at the margin free, in what we hope is only a once-in-a-lifetime opportunity.

But the tub may fill. And odds are that larger government deficits over the next twenty years will bring the date at which the tub may fill and policy has to change closer in time. And it would be only prudent to have a plan for how to push off the time at which we might have to deal with the full bathtub, or at least to have a plan for how to deal with the full bathtub, or at least to measure how full the bathtub is.

And Stephanie Kelton:

Brad DeLong is worried. And now I’m worried. He’s worried about “unfunded tax cuts,” which, he says, are “bad juju” in the long run. I don’t mean to pooh-pooh his juju, but what the heck is an “unfunded tax cut”?… Tax cuts leave taxpayers with more money to spend, but they don’t compromise the government’s ability to spend later. Nor is the debt ratio a binding constraint…. Can’t we just admit that the U.S. dollar comes from the U.S. government? That the i$$uer of the currency can never “run out” of money or be forced into bankruptcy…. Until people like us help awaken the population to the way modern money works, the deficit scolds will have the upper hand and the American people will suffer needlessly as Democrats and Republicans alike continue to hide behind the time-honored ”how will we pay for it?”

As I understand it, Stephanie is going Abba Lerner--qualification (2) above. The hope is that the U.S. government can borrow and spend and that investors will always value U.S. government debt so highly as a safe store of value that, even without high inflation, the real interest rate on the debt will be on balance lower than the real growth rate of the American economy. If so, then the issuing of debt by the U.S. government is a very profitable business indeed: it makes something--safe nominal assets--that investors love and are willing to pay for through the nose, and we can finance whatever we want our government to spend on from the profits of this very profitable debt-issuing business.

If not, then while it is certainly true that the U.S. government cannot be forced into bankruptcy or “run out of money”, it would be imprudent not to take steps now to guard against the possibility of monetary and financial disruption--not now, not five years from now, but ten, thirty, or fifty years from now--when we can no longer refinance our debt on easy terms but instead need to retire our outstanding government debt via high explicit taxes or very rapid rates of money creation that levy the inflation tax on holders of outside money.

As I have said, repeatedly, austerity now and for the several years is surely counterproductive. But it is not the case that austerity is always and everywhere unneeded.